In Australia’s move to a low carbon economy, what are the key transition risks for the property sector?

The property sector has been a leader for many years in exploring the potential impacts of climate change and addressing their effects on business operations and the broader economy. Much of the focus to date has been on the physical impacts like extreme heat, intense rainfall resulting in flooding and sea level rise enhanced coastal flooding and erosion. While this is important, the rise of the Task Force on Climate-related Financial Disclosures (TCFD) and continued focus on net zero emissions targets in the lead up to Glasgow COP 26 has meant increased interest in the other ways that climate change impacts businesses. Transition risk, which is the risk (or opportunity) of moving to a low carbon economy is increasingly front of mind and holds critical financial implications.
 
With the move to a low carbon economy set to fundamentally change how our economy is structured, there is now growing industry level discussion about the potential material financial impacts of this transition for the property sector. For some businesses these could be considerable and navigating a way through will be challenging. Three key issues to explore are:
·       The implications of leasing versus owning buildings on Scope 1, 2 and 3 emissions
·       The role of target setting, and
·       How to factor in shadow carbon pricing
 
1.       Implications of leasing versus owning
One issue that can cause confusion when exploring transition risks and opportunities is the impact of owning versus leasing property. Put simply, if your operations are located within assets you own, you have direct control over the greenhouse gas emissions they produce. These emissions are mostly included in Scope 1 and 2 emissions, which most companies have a good understanding of and have been reporting and addressing for some time.
 
Emissions from leased assets are generally dealt with in Scope 3 though, which includes both upstream (leased from others) and downstream (lease to others) assets. For some companies, up to 85% of their emissions come from Scope 3 sources, which in addition to lease assets include purchased goods and services, employee commuting, waste generated and investments.  
 
So, when considering leasing versus owning, emissions do not go away – they will simply be captured as part of a different emission scope category. Allocating emissions to the right scope also needs to consider the organisational boundary and the lease type to avoid double-counting by a lessor and lessee.
 
2.       Target setting   
A further issue is the financial ramification of decarbonisation pathways. The two most popular choices for target setting, being carbon neutral and/or setting a Science Based Target, have different transition risk profiles.
 
Carbon neutrality can apply to products, services, organisations, precincts and events. It involves reducing emissions through direct actions with any remaining emissions being offset by carbon offset programs or credits. Formal certifications involve annual recertification to maintain carbon neutral status. With the increasing cost of carbon offsets in Australia, this can be a costly annual exercise if the amount to offset is high.

As a voluntary initiative, Science Based Targets (SBT) rely on ongoing commitment to self-report and implement reduction actions, notably without purchasing carbon offsets to meet the target. While the associated validation fee is a single payment, the cost of reduction initiatives should be viewed as a long-term value creation investment.
 
The typical financial costs involved with each program are outlined below:

So while there is some debate about which path to take and there are different costs associated with each, both carbon neutrality and SBTs are valid approaches for managing transition risk and decarbonising.

3.       Shadow carbon pricing
An economic challenge of responding to climate change is that emissions are generally a negative externality – that is an impact which imposes costs on others but is not paid for by the consumer. One way to address this is by consciously making consumption choices with lower emissions implications, such as purchasing renewable energy.

A more rigorous approach is to price the externality. For emissions, in the absence of a legislated carbon price in Australia, organisations can set their own internal carbon price. This is called a “shadow carbon price”, which can be set to reflect a traded carbon price such as the Australian carbon credit units sold by the Clean Energy Regulator. In practice this involves taking the financial cost of an activity and adding a corresponding cost of carbon.

An example of where this has already occurred is Wesfarmers, which have applied a shadow carbon price to their capital investment decisions since 2014.[1] This has been used to inform Bunnings’ commitment to 100% renewably sourced electricity by 2025.[2]

Applying a shadow carbon price may lead to investment choices which have lower financial cost alternatives. However, there are clearly a range of benefits associated with embedding environmental considerations into investment decision making. This includes lowering the transition risk associated with a legislated carbon price being introduced in the future.

The future
While the risk and opportunity of moving to a low carbon economy has been flagged for some time, it is now increasingly being critically assessed for the property sector. As the interest in transition risk grows with rising demand for TCFD aligned reporting from investors, greater focus is required on understanding who is responsible for different sources of emissions, options for target setting and feeding carbon pricing into decision making processes.

While these represent short term challenges, in the medium term it should be expected that this type of analysis will feed into P&L and balance sheet analysis and reporting so that investors and shareholders in general gain greater insights into the materiality of the move to a low carbon economy.

Why us?
Edge Environment in partnership with Frontier Economics provides comprehensive sustainability and economic advice to guide businesses through climate change risk and reporting.

If your business is grappling with these issues, how best to address and/or quantify the risks, please Jackie McKeon at Edge Environment to discuss this further.

This article was written by: Mark Siebentritt, Miranda Siu and Jackie McKeon (Edge Environment) in partnership with Ben Mason from Frontier Economics.

[1]            Wesfarmers (2021), 2021 Annual Report – Climate-related financial disclosures
[2]            See: https://www.wesfarmers.com.au/sustainability/our-stories/bunnings-commits-to-100-per-cent-renewable-electricity-by-2025 [Accessed 14/10/21]

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