U.S. vertically integrated electric utility greenhouse gas emissions and carbon risk premiums around the Paris Accord

Richard A. Michelfelder and Eugene A. Pilotte

Energy Policy, 2024, vol. 195, issue C

Abstract: We study the pricing of greenhouse gas emissions of vertically integrated producers of electricity around the Paris Accord (PA). We study whether emissions are priced by financial markets, providing a market-based incentive for firms to reduce their carbon footprints and if the heightened attention on climate change post-Paris Accord (PA) impacts the size of the “carbon risk premium.” We focus on electricity generators, because they are responsible for the largest share of emissions and emissions reductions in the U.S. and are highly exposed to regulatory, physical, and stranded asset risks. We find the cost of carbon risk is reflected in the returns of vertically integrated electric utilities. The post-PA period provides the strongest evidence that carbon risk is priced. We find that equity markets provide incentives for power producers to reduce emissions, as reductions in emissions are associated with reductions in required returns on equity (increases in equity market values). The challenge for regulators is how to respond in rate cases. Lowering a utility's regulated return to reflect lower market estimates of the return on equity would dilute the market-based incentive for emissions reductions. Adding a longer-term return incentive for continued investment in emissions reductions would reinforce the market incentive.

Keywords: Carbon emissions; Carbon premium; Climate risk; Cost of capital; Greenhouse gas; Stock returns (search for similar items in EconPapers)
JEL-codes: G10 G12 Q51 Q54 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:enepol:v:195:y:2024:i:c:s0301421524003665

DOI: 10.1016/j.enpol.2024.114346

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