Carbon price risk: The missing piece in your climate risk model

Jul 5, 2024

The threats presented by climate change to people, corporates and investments have become a key aspect of a broader discussion, with many institutions trying to quantify the risk arising from global warming. In its latest climate risk stress test, the ECB estimates that banks could lose at least €70bn in the next three years alone [1]. Investors typically conceive physical risk to be the most significant; however, not only is the ECB putting more and more focus on transitional risk, but in their stress test it was shown to be the most significant risk factor by far, responsible for €53bn of those losses.[2]

A key driver of the high transitional risks in the ECB scenario is often misunderstood and mispriced[3]: Carbon price risk. Indeed, the ECB see an ‘immediate and sustained increase in carbon prices’ as the main channel to address transitional risks.

This paper examines carbon price risk in more detail, explaining how it fits in within other climate risks and what considerations are needed to measure it accurately.

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