The Climate Institute has researched the effect of two climate policy scenarios delayed and early action on long term savings and superannuation.The Institute examines the implications for stakeholders at either end of the funds management chain the holders of superannuation funds and the superannuation trustees

The Australian Business Roundtable on Climate Changei and The Climate Institute (TCI)ii have demonstrated that early action to reduce greenhouse emissions is achievable, affordable and avoids potentially disruptive shocks to the economy.

However, as governments inevitably move to reduce greenhouse gas emissions, carbon pricing will have an effect on the share values of Australian companies. As the value of the companies in which our super is invested is impacted by policies to deal with climate change, our superannuation earnings are likely to be impacted.

Whilst there is a growing understanding of potential carbon liabilitiesiv and of the physical impacts of climate change, reflecting this in equities markets has so far been challenging. This is because equities are valued on a discounted cash flow basis which means that profits earned in the short term are weighted much higher than profits earned over the long term – a kind of a bird in the hand is worth two in the bush philosophy.

To address that gap in our understanding about the economic effects of climate change on superannuation TCI, with input from Goldman Sachs JBWere and AMP Capital, has produced a simplified lifecycle valuation model. The model which extends from today to 2050 the time by which deep cuts in emissions must be achieved to reduce the likelihood of dangerous climate changev,vi, shows the effect of early and delayed climate change policies on stockmarket valuations of the main players of the ASX100.

Data collected by the 44 companies that participated in the 2006 Carbon Disclosure Project (CDP4) form the basis of the analysis representing over 80% of the ASX100 by market capitalisation.

This briefing paper outlines the initial findings of this analysis and it is hoped this will form a foundation for more and ongoing research into the impacts of climate change policy on the retirement funds available to Australians.

Main Findings

Preliminary modelling shows that there is serious risk that delayed action will result in holders of superannuation funds having to work longer to build up greater funds or risk running out of money late in life when they are least able to cope with the loss of income. The main findings are:

• Comparison of stock market valuations for early versus delayed action show that there is a difference of nearly 3% at peak times. For super-holders retiring at those times, this represents over $1,300 per year less income.
• Climate change policy is a generational issue with today's retirees avoiding the cost of action for which older Generation Xs will pay. The peak carbon liability hits hardest for those people looking to retire in the 2020s those people currently aged between 36 and 46. 
• Women are hit even harder as they need greater funds in retirement due to their extended life expectancy.

The following table shows a summary based on the example of various men and women of different ages retiring at 60 years of age and the effect on their weekly income based on the model assumptions.

Andrew Gray, Head of Quantitative Research at GSJBW

“Whilst there is much further to go to fully quantify the impacts at an individual stock level, The Climate Institute methodology is sound, and past 2030 is probably even conservative in terms of carbon liability given how difficult it will be to bring the delayed action emissions down sharply. What it shows is that businesses need clear market signals so that they can respond to the challenges of the peak liabilities but also take advantage of the investment opportunities that the analysis implies.”

Dr Ian Woods, Senior Research Analyst at AMP Capital Investors

“The analysis highlights the potential negative risk to investment returns over the long-term and the intergenerational transfer of the risk. Detailed analysis, including consideration of other asset classes, will help identify more clearly the magnitude of the potential risk.”

Approach

To assess the equities market, TCI used several sources of existing qualified research and common assumptions. To project carbon liability, carbon prices where sourced using preliminary results from recent electricity modelling by McLennan Magasanik and Associates (MMA).vii,viii

In addition, TCI has sourced the company level emissions data from the CDP4 and Citigroup's published CDP4 adaptation reports of November 2006 and March 2007ix. The company earnings projection data is from Commsec as at June 2007.

The key assumptions behind the model are:

1. In the electricity modelling, both early and late action scenarios need to achieve the same total lifecycle emissions reduced by 2050. This reduction is roughly consistent with an 80% cut in greenhouse pollution by 2050 on 1990 levels.x 
2. The physical and market impacts of climate change itself are not considered.xi 
3. We use Goldman Sachs JBWere's historic 7.5% earnings growth. Other historic ASX data has been used. 
4. Super returns as a whole are subjected to the full differential value of ASX investments, although in practice some fixed income and property investments may on average reduce the impact of late versus early action policy differences. 
5. Fixed income level during retirement is estimated to be $1000 per week. 
6. We assume super-holders will look to retire with guaranteed fixed income products rather than market exposed products. 
7. Consistent with ABS research we have assumed a target retiring age of 60 for all examplesxi 
8. The potential negative impact on company earnings associated with abatement actions is not included. Similarly, additional costs borne by companies from the purchase of auctioned permits where those costs are not able to be passed through, have not been considered in the analysis. 
9. Superannuation returns have been taken from AMP's published superannuation calculators at www.amp.com.au. The data used by the calculators may or may not be verified under the Greenhouse Gas Accounting Protocol, making it difficult to determine whether or not companies include some unaudited emissions pertaining to other parts of their supply chain. As way of an example an airline company's emissions may also be counted as part of another company's emissions where that second company has counted the emissions created by its staff travelling with the first company's aviation fleet, thereby indicating a greater level of total emissions than should otherwise be represented. 
10. ASX valuation is based on 44 stocks, a combination of CDP4 responses in 2006 and a Citigroup CDP derivative report, made available to TCI. All the assumptions of the November 2006 and March 2007 Citigroup reports have been used. The ASX100 represents 85% of the market capitalisation of the ASX and the 44 companies analaysed represent over 80% of the ASX100. 
11. A price/earnings ratio of 15 has been used as default where specific valuation data is not available. 
12. A key assumption is that the carbon price reduces the emissions of the total sample of 44 companies at the same rate as the sectors modelled in the MMA model i.e. that the 44 companies are representative. The MMA model deals with Australia's stationary electricity sector which contributes to approximately 34% of Australia's total annual greenhouse gas emissions. TCI is using the carbon price impacts contained within this model as a proxy for likely pricing impacts on the wider economy. 
13. Some emissions data is based on 2005/6 and yet the policy pathways modelled as part of this analysis relate to a later period. 
14. In the absence of a clear directive about how international emissions will be considered in future Australian climate change policies, we have used the CDP44's total carbon liability as a guide. Indeed delayed action could result in a more extreme differential if ASX companies were exposed to tariffs by external regimes with more stringent carbon trading schemes.xiii 
15. We have assumed a straight line effect in terms of superannuation return. Therefore for each percentage lower or higher fixed return, there is a proportional unit which could be either a) a shorter payment period; b) a lower payment amount; c) a higher required starting level. 
16. ASX market cap data is taken as of June 2006.

Read the press release here

Check the online calculator here 

Comments on assumptions:

Goldman Sachs JBWere and AMP question whether or not the models used for delayed action beyond the mid 2030s reflect the severity of the impacts at that time. This is because the industrial inertia that would prevent massive infrastructural and transformational change that the model suggests would need to occur under a delayed action scenario. The impact of this would be to make the differences between early and delayed action even more marked and thus create an even bigger economic liability for delayed action.