In its March 2024 climate risk disclosure rule, the SEC emphasizes the materiality of climate change risks faced by public companies to investors. It points out that when companies disclose their climate risks, investors factor them into the share price they are willing to pay. Companies with high carbon emissions are seen as riskier investments, resulting in lower valuations and a higher cost of capital. However, some carbon-intensive firms that shift to low-carbon business models are rewarded with transition finance. Conversely, companies failing to manage transition risks face higher rates of return, known as a carbon premium, as investors demand compensation for bearing exposure to higher carbon emissions.
The SEC’s rule highlights the need for transparency not only for individual investment decisions but also for the stability of the financial system. The Bank for International Settlements warns of a carbon bubble created by artificially inflated carbon-intensive assets, threatening sudden asset deflation that could impact the entire economy. The failure to update valuations to reflect the transition to a low-carbon economy could result in trillions of dollars in stranded assets. Deceptive narratives by fossil fuel interests in the media, and the concealment of risks in audited financial statements, are contributing to this dangerous carbon bubble that must be addressed through improved transition risk disclosure policies.
Despite the looming risks, litigation by the fossil fuel industry and its allies has put a hold on the SEC’s climate risk disclosure rule. During this period, regulators must take action using existing authorities to investigate transition assumptions in financial statements, ensure auditors disclose critical climate matters, update standards for asset retirement obligations, and ensure large companies doing business in California disclose transition impacts and expenditures. These actions are crucial in addressing the financial instability posed by climate-related risks and ensuring a smoother transition to a low-carbon economy.
Research firms like RMI and Climate Analytics indicate that the world is approaching peak fossil fuel demand, with renewable energy and electric vehicle sectors experiencing exponential cost reductions. However, the International Energy Agency notes that oil exploration and production continue, leading to an anticipated oil supply glut and crashing commodity prices. The failure of companies to disclose transition risks and update their valuations could have significant financial impacts, especially for oil companies facing trillions in liabilities for asset retirement obligations. Urgent action is needed to address these risks and ensure a sustainable future for the economy and the planet.
