Need to watch out for Greenflation, regulations addressing climate change; ESG norms, carbon tax

V Rishi Kumar | | Updated on: Jun 04, 2021
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Abhay Laijawala, MD, Avendus Capital Public Markets Alternate Strategies LLP talks about how regulations could affect Indian companies

As India focuses on Climate Change targets, there is a need to watch out for greenflation and a number of regulatory changes, such as Carbon Tax, across countries, that get aligned to these goals. This calls for various corporate entities, banks and others to tread cautiously as such regulations could impact their domestic/global business, according to Abhay Laijawala, Managing Director, Avendus Capital Public Markets Alternate Strategies LLP.

As an expert associated with Environment, Social and Governance (ESG) Funds and metals, in an exclusive interaction with BusinessLine, he explains how these changes could have big impact on Indian companies. Excerpts:

How do you see ESG investment as a source of alpha generation?

An important element of an ESG funds is alpha generation. Unless an investor makes money, he is not going to invest in an ESG product. Our view is that alpha is created because as the world starts recognising these carbon risks, in the next few years, a lot of the oil and gas investments with high carbon footprint will get de-rated. Therefore, a fund or an investor could actually lose out.

Can you explain with an example on how this could play out?

Europe is the only region right now that has a carbon tax. Carbon levy has gone up to about €50 per tonne. And now the European companies are telling their government that look we are being penalised. But we don't want a situation where a Chinese, Indian, an American company or any other non-European company, sells into Europe at you know higher price, because they don’t have a carbon tax. To address this, they are thinking of the border adjustment carbon tax whereby any good that is imported into Europe will have to have a carbon tax on it. Costs are going up for all exports to Europe.

It will be a matter of time before the United States under John Kerry as a climate czar and under Biden as President, who is completely committed to climate change, also goes ahead and announces a carbon tax.

So what are its likely implications on Indian companies?

For example, aluminium is largely produced using thermal power. But in the west, it is also produced using hydro power and renewable energy as in Rusal of Russia, one of the largest producers of aluminium.

In India, 100 per cent of the aluminium is produced with thermal power. Now, if a carbon tax of $50 is imposed, the cost of production of Hindalco, Vedanta and aluminium companies could go up by $500 per tonne. Because the calculation is not based on $50 per tonne, rather the calculation is based on $50 of carbon dioxide emitted per tonne of producing aluminium, so for all those using thermal power plant, the cost would go up by $500 per tonne. The cost of production right now is about $1,600 per tonne. So can you imagine what will happen to their earnings?

Seventy per cent of Chinese aluminum capacity could also be impacted if that happens. Therefore, China is moving fast on reducing the energy source from thermal energy and moving it to renewable power.  A lot of Chinese plants are shutting down leading to aluminum prices going up.

Will the challenge of meeting new targets will also drive more disclosures into the balance sheets of these companies?

We are beginning to see more companies disclosing their carbon data to Carbon Disclosure Project (CDP). The figure is still small but this will go mainstream. We also think that the Reserve Bank of India will need to come in and ask every bank to disclose what the climate vulnerability is to that particular bank.

Recently SBI and HDFC Bank, have disclosed to CDP. So, if a bank has lent a lot to a thermal power plant, there are going to be regulations on carbon taxes. Many of those thermal power plants will not be able to operate, so they become stalled assets and become NPLs. In addition, if you are an HDFC and have lent a lot in cities like Bombay, and if most of Bombay is going to be flooded, it is your duty to go out and highlight this risk and consider this risk when you are doing your own NPL analysis on which areas are at risk from flooding as sea levels rise.

Will this lead to more disclosures and call for more regulatory changes in disclosures?

Without a regulatory push, your disclosures will not increase. Regulators in the developed world are moving towards incorporating ESG disclosures and social levels for corporates, even for mutual funds it is beginning.

An existing fund suddenly rebrands as an ESG and gets inflows. So the regulators are saying you need to go out and define and also come out with a lot more compulsory disclosures on ESG related factors.

Published on June 04, 2021

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