Climate Transition Risks and Equity Portfolios: A Scenario-Based Assessment of Financial Losses

In their latest study (1), researchers Vincent Bouchet, Thomas Lorans and Julien Priol from Scientific Portfolio (an EDHEC Venture) examine the financial implications of climate transition risks for equity portfolios. Using a model that integrates firm-level revenue and greenhouse gas emissions data with long-term transition scenarios, the study highlights how policy changes, technological innovation, and shifts in demand associated with the energy transition may affect portfolio valuation.

What Are the Key Financial Drivers of Climate Transition Risks?

Climate risks can be categorized into physical risks and transition risks.

Physical risks stem from the direct impacts of climate change, such as more frequent extreme weather events, rising sea levels, and prolonged heat waves, all of which can disrupt economic activity and damage assets. 

To mitigate these risks, a rapid transition to a low-carbon economy is necessary. However, this energy transition introduces new financial risks, referred to as climate transition risks, which arise from the policy, technological, and market changes required to achieve climate mitigation goals.

For instance, the introduction of carbon taxes increases the cost of greenhouse gas emissions, thereby raising the operating expenses of carbon-intensive firms. These higher costs can compress profit margins, reduce expected future cash flows, and ultimately lead to downward revisions of their market valuations. As a result, the value of equity portfolios with significant exposure to such firms may decline, reflecting the anticipated erosion of shareholder value. Similarly, evolving consumer preferences and regulatory incentives impact demand for low-carbon goods, such as electric vehicles.

Firms that fail to adapt to these shifting market dynamics risk revenue losses due to declining sales of traditional products. This can negatively affect firm valuation and, by extension, reduce the market value of portfolios invested in these underperforming firms.

Long-term Scenario Analysis

Climate transition risks pose significant challenges for equity portfolios, which may contain stocks of firms that could either benefit or be adversely affected by the energy transition (2). Existing climate stress tests often focus solely on carbon pricing's impact on operational costs (3), neglecting revenue fluctuations caused by changes in demand. This study fills that gap by incorporating firm-specific “green” and “brown” revenue into its analysis.

The researchers aim to analyse the price impact of an abrupt shift in investors’ expectations about the future transition of the economy. Given the high degree of uncertainty surrounding the energy transition, they conduct a long-term scenario analysis, drawing on scenarios developed by an international consortium of central banks and financial regulators. (4)

By analysing an equity portfolio comprising the 1,287 largest publicly listed companies (similar to the MSCI World Index) under adverse climate transition scenarios, this study offers novel insights into the key drivers of transition risks. How do transition risks impact firm revenues and operating expenses? How different transition pathways could influence equity portfolio valuation?

Revenue Impact Rivals Operating Expenses

The existing financial literature on transition risks has primarily emphasized the potential impact of rising carbon prices on firms’ operating costs, and the subsequent effects on corporate valuations and the performance of equity portfolios (5).

However, this study reveals that the financial impact of shifting demand toward low-carbon goods and services—manifested through declining revenues for firms unable to adapt—often exceeds the losses associated with increased operating expenses due to rising carbon prices. On average, transition-sensitive sectors such as Utilities and Energy show significant potential losses under the Net Zero 2050 scenario, with total losses reaching 58% for Utilities and 33% for Energy, mostly driven by shift in demands.

Green vs. Brown Activities

Within sectors that are highly exposed to transition risks—those characterized by significant direct or indirect greenhouse gas emissions, such as fossil fuel extraction, electricity generation, transportation, and heavy industry—there is substantial heterogeneity in firms’ vulnerability. This variability reflects differences in emissions intensity, technological readiness, and strategic positioning with respect to the low-carbon transition.

For example, under a scenario aligned with the goal of achieving net zero emissions by 2050, some fossil fuel companies in the Energy sector could face losses of up to 57%, while others, such as low-carbon electricity generation manufacturers, could see gains of up to 85%. This highlights the presence of both ‘winners’ and ‘losers’, depending on their exposure to green or carbon-intensive (brown) activities.

These findings indicate that equity portfolio managers cannot effectively manage transition risks by solely measuring their exposure to climate-sensitive sectors. Instead, they must adopt a more granular approach to identify stocks within these sectors that may either benefit or suffer from the energy transition.

Sensitivity to Scenarios

The study also highlights that the choice of the transition scenario used to conduct the analysis is the main source of variability in conditional transition losses. For example, for the Utilities sector, aggregate loss could reach up to 58% under a net zero scenario, but only 22% in a delayed transition scenario.

Despite these significant differences, analysing multiple scenarios provides a robust approximation of the potential range of portfolio losses. The selection of transition scenarios should primarily reflect their likelihood, as inferred from the current commitments and actions of governments, corporations, and consumers.

However, from a risk management perspective, it remains relevant to consider extreme yet plausible scenarios in order to assess exposure to tail risks and ensure portfolio resilience under adverse transition pathways.

Looking ahead: Bridging the Gap Between Models

The findings emphasize the limitations of relying solely on carbon intensity metrics to assess transition risks. Instead, forward-looking models combined with long-term scenarios that incorporate revenue shifts offer a more comprehensive view.

This study paves the way for combining forward-looking scenario analysis with backward-looking financial factor models. Future research could explore the development of specific transition risk factors that goes beyond the traditional carbon pricing dimension.

References

(1) Beyond Carbon Price: a Scenario-Based Quantification of Portfolio Financial Loss from Climate Transition Risks (2025). T. Lorans, J. Priol, V. Bouchet. Scientific Portfolio (and EDHEC Venture) - https://scientificportfolio.com/knowledge-center/?file=2025-01-beyond-carbon-price-scenario-based-loss-climate-transition-risks.pdf

(2) Basel Committee. (2021). Climate-related risk drivers and their transmission channels. Bank for International Settlements - https://www.bis.org/bcbs/publ/d517.htm

(3) Reinders, H. J., Schoenmaker, D., & Van Dijk, M. (2023). A finance approach to climate stress testing. Journal of International Money and Finance, 131, 102797 - https://www.sciencedirect.com/science/article/pii/S0261560622002005

(4) Network for Greening the Financial System (NGFS) scenarios. More information available at: https://www.ngfs.net/ngfs-scenarios-portal

(5) See for example Barker, R., Raychaudhuri, M., Schaffer, A., Gayer, M., & Al, E. (2015). Stress-Testing Equity Portfolios for Climate Change Impacts. BNP Paribas.

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