Backward-looking measures of greenhouse gas emissions – such as carbon intensity – have a number of flaws if they are to be used as measures of financial risk. For instance, they do not capture the efforts of countries or regions to reduce emissions in the future. In addition, carbon intensity may differ significantly between countries and between individual regions within a country, depending on the type of production involved and the location of the production of goods and services. Nor do backward-looking measures capture risks that are dependent on the country’s or region’s exposure to fossil assets or the costs and/or savings that may be expected to arise as the world transitions to a less fossil-dependent economy.
Despite these shortcomings, there is likely to be a link between carbon intensity and transition risk. The reason for this is that the effects of the climate transition may be more serious for portfolios with relatively higher emissions than for those with lower emissions, which, in turn, may lead to larger losses. See NGFS (2021). The carbon footprint of a portfolio thus not only shows how emission intensive the portfolio in question is, but the footprint can also serve as an indication of the magnitude of the transition risks. The carbon footprint can thus be used both to reduce risks and to improve returns in portfolio management.