Through some combination of government intervention and the development of carbon trading markets, it seems inevitable that a price will eventually be put on carbon around the world. Underscoring this, a carbon price has been proposed as part of several bills before Congress, but other mechanisms like a cap on emissions in a sector or geography would achieve the same effect. Economic models and the experience of the EU Emissions Trading System suggests that a price could likely be between $50 and $100 per ton of CO2 in the near term and rise from there. At $100 per ton that would represent five percent of the global economy. Five percent of the global economy is a huge number. But where does this liability sit? With the world’s corporations.

Yaroslav Danylchenko/Stocksy

A sad joke for corporate climate activists is that acting on climate plans is always “the next CEO’s job.” But every company has an uncovered “Carbon Short” position based on their emissions, and it needs to recognize this hidden liability today. This short position arises from the carbon emissions produced by their own operations (Scope 1 and 2, in the argot of climate accounting), and their products and services (Scope 3). Most companies don’t recognize this liability because these emissions are priced at zero today, were priced at zero last year, and so it seems natural to assume that they will be priced at zero in the future. One could say that companies are engaging in the carbon futures market, assuming that this fundamental “input cost” will never change. Anyone who works in commodity markets knows that uncovered positions can turn from profit to significant loss in the blink of an eye.

As Nicholas Kukrika, Partner at Generation Investment Management, puts it, “Companies need to manage their carbon exposure, and there is just about enough time if companies start mitigating these risks today. Corporate executives might be tempted to wait for ‘cheaper technologies’ to come, but there are projects that make perfect economic sense even at today’s relatively low carbon prices.”

To see the implications for one company, consider the example of ExxonMobil. The company recently had three board members replaced by a small activist investor, Engine No. 1, as a result of its failure to recognize that the energy transition requires some fundamental changes in its strategy and capital allocation decisions. Why were investors so incensed? In 2020 ExxonMobil released 112 million metric tons of CO2 “equivalent” (along with carbon, they also released other greenhouse gasses such as methane). At $100/ton, they would owe $11B annually on their own emissions. Since the company has earned only $8 billion on average over the past five years, this means they would rapidly be bankrupt. That surely is a good way to finally get the attention of their board. Add in the company’s share of the annual $60 billion from pricing the roughly 600 million metric tons of its Scope 3 emissions (it’s not clear how much they could pass on to purchasers) and the situation is even more dire.

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