For marketing purposes

For professional / qualified /

institutional investors

The value of a
green transition
UBS Asset Management
A model for including decarbonization in company valuation
Bruno Bertocci, Head of the Global Sustainable Equities team
Adam Gustafsson, Quantitative Researcher, Quantitative Evidence & Data Science (QED) team
2
Contents

Can sustainable investing help drive the low-carbon transition? 4

Carbon emissions permits are becoming widespread—and expensive 6

Green transitions create quantitative and qualitative financial drivers 8

Marginal Abatement Cost Curves help calculate the value of transition 10

Green transitions in heavy industry are essential 11

Case study: HeidelbergCement 12

The important role of engagement 14

Conclusion 15

We would like to thank Per-Anders Enkvist, Anders Åhlén and Gustav Hedengren at
Material Economics for their contributions to this paper. All MACCs and qualitative
comments around abatements are based on their insights.

Lacking a bit of oomph in your climate efforts? Here is a Spotify playlist to get you going.
'Where words fail, music speaks' – Hans Christian Andersen

3
Can sustainable investing help
drive the low-carbon transition?
The world is faced with an existential crisis, manifested by The key is to engage some of the biggest polluters–legacy
undeniable shifts in our planet’s climate system. Driven by sectors that traditionally emit the most carbon, but that are
this crisis, the financial community is rethinking its purpose. vital to society. They must find efficient ways to reduce their
Greenhouse gas emissions are largely corporate, so what part emissions, typically at their own expense, a process referred
do we play as asset owners? to as a ‘green transition.’ At UBS, we want to support these
transitions while meeting investment goals.
At UBS, we are actively seeking to reimagine investing–this
is explicitly part of our Purpose Statement.1 We want our
investments to deliver financial returns, but also to deliver
solutions to the climate crisis. Therefore, we are looking
beyond superficially ‘greening’ portfolios to greening the
assets in them.

As a planet, we are still moving fast in the wrong direction

Figure 1: Atmospheric CO2-concentration measured at Mauna Loa, aka The Keeling Curve
Almost 30% increase over the last 50 year and no sign of slowing down.

450
Atmospheric CO2 concentration (ppm)

425

400

375

350

325

300
1970 1980 1990 2000 2010 2020

Source: gml.noaa.gov/ccgg/trends/data.html
Data as of 30 April 2021

1
www.ubs.com/global/en/our-firm/our-purpose.html

4
In this white paper, we present a new valuation framework We believe investing in companies that aggressively transition
that embeds the cost of emissions and a systematic approach is a commercial opportunity, well-aligned with our fiduciary
to emission abatements developed in collaboration with duty to deliver returns and manage risk. From an investor
Material Economics. The purpose is to quantify valuation point of view, tackling transitions requires the full package:
impacts of green transitions, and engagement with companies world-class investment capabilities, impactful company
on specific steps for emission reductions. A science-based engagement and a will to go above and beyond. The
framework, demonstrating the economic cost vs. benefit of framework presented in this paper provides the foundation for
reducing emissions, should help companies to become more UBS's efforts in supporting mission critical green transitions.
confident and ambitious in their climate efforts.

Figure 2: NOAA global surface temperature.

The earth has already reached around 1°C warming.

1.5
NOAA temperature anomalies (Ta [K])

1.0

0.5

0.0

-0.5
1970 1980 1990 2000 2010 2020

Source: www.ncdc.noaa.gov/monitoring-references/faq/anomalies.php#anomalies
Data as of 30 April 2021

5
Carbon emissions permits are
becoming widespread–and
expensive
Pricing negative externalities is a critical incentive tool in Today, far from all sectors carry the full cost of emissions.
addressing the climate crisis. A total of 64 carbon pricing The European Union maintains a ‘carbon leakage list’ with
instruments are currently operational around the world, 63 sectors, among them steel and cement. Seen as at risk of
covering over 20% of global emissions and generating relocating if held responsible for the full cost, these sectors
USD 53 billion in revenue.2 EU’s emissions trading system get emission permits for free, so-called free allowances. As a
(EU ETS) is the oldest and most established scheme for rule of thumb, 100% of emissions are covered but the reality
emission permits. One permit gives the holder the right is more complicated.
to emit one metric ton of greenhouse gas and all scope 1
emissions must be covered. A benchmark based on the most emission-efficient companies
within each sector is used to allocate free allowances. The
Phase four of the EU ETS runs from 2021 to 2030, the longest European Commission is to reassess the benchmarks for
period so far. In December 2020, the European commission technology progress in 2025, and then again before launching
announced an updated 2030 emission reduction target of phase five post-2030. These assessment points represent a
55%.3 To achieve this monumental target, the EU ETS is likely material risk to emission-laggards, as they may end up with
to only become more important. insufficient free allocations to cover their emissions.

Figure 3: The emission permits market is getting richer

In May 2021, the EU ETS traded above EUR 50 for the first time.

60

50

40
EUR

30

20

10

2016 2017 2018 2019 2020 2021

Source: Bloomberg, EECXSYR1 TNRG Index. Data as of 15 June 2021.

2
www.worldbank.org/en/news/press-release/2021/05/25/carbon-prices-now-apply-to-over-a-fifth-of-global-greenhouse-gases
3
www.eea.europa.eu/data-and-maps/indicators/greenhouse-gas-emission-trends-7/assessment

6
 The global ETS map is still fragmented and
constantly evolving as more regions put a
price on companies’ externalities

The ICAP ETS world map depicts emissions trading systems currently in force, under development or under

EMISSIONS TRADING WORLDWIDE consideration. As of 31 January 2021, there are 24 ETS in force. Another eight are under development and
expected to be in operation in the next few years. These include ETS in Colombia and the Transportation
and Climate Initiative Program (TCI-P) in northeastern US States. 14 jurisdictions including Chile, Turkey
The state of play of cap-and-trade in 2021
Figure 4: The state of play of cap-and-trade in 2021 and Pakistan are also considering the role an ETS can play in their climate change policy mix. If a jurisdiction
has multiple systems in force or has a system in force but is at the same time developing or considering an
additional system, it is depicted in blue.

UK
Transportation and Climate Initiative (TCI-P) launched in 2021 following the end of
in February 2021, massachusetts, connecticut, uK’s participation in the eu ets. the
rhode island, and Washington D.c. have signed a new system mostly mirrors the eu ets
final memorandum of understanding to establish Québec phase 4 design.
a regional transport sector ets, the transpor-
tation and climate initiative program (tci-p)
starting in 2023. Finland
Regional Greenhouse Gas Initiative (RGGI) • connecticut
virginia adopted legislation in 2020 to establish • massachusetts
• rhode island
an ets and participate in rggi from 2021.
• Washington D.c.
• connecticut Germany
• Delaware launched a national ets for heating and transport fuels in
• maine 2021, complementing the eu ets. the system starts with a
• maryland fixed price that increases annually.
• massachusetts China
• new Hampshire
• new Jersey Fully launched its national power
• new York Nova Scotia sector ets in 2021 bringing the
• rhode island Held its first auction in world’s largest carbon market
• vermont June 2020, selling all online after three years of
• virginia allowances on offer. preparation.

Kazakhstan
Ukraine
Sakhalin (Russia)
Washington
Oregon
Massachusetts
California Pennsylvania Turkey Japan
New York City
New Mexico North Carolina Pakistan Saitama
Tokyo
Montenegro
Republic of Korea
Mexico Switzerland Taiwan (China) third trading phase will commence
Chinese Pilots in July 2021 extending the scope,
increasing auctioning and intro-

inFograpHics – emissions traDing WorlDWiDe

EU ETS • Beijing ducing financial intermediaries to
• chongqing Thailand its market.
phase 4 commenced in 2021 Philippines
establishing a new cap, introducing • Fujian Vietnam
Colombia new provisions on free allocation, • guangdong
auctioning, mrv and the union • Hubei
Brazil • shanghai
registry, as well as operationalizing
• shenzhen
the innovation Fund. Indonesia
• tianjin
• eu member states
• iceland
• liechtenstein
• norway

02
In force Chile

icap status report 2021

New Zealand
Under development
a new legislative framework for the 2021–2025
period establishes a cap on emissions from 2021
for the first time under the nZ ets.
Under consideration

05

The ICAP ETS world map above depicts emissions trading systems currently in force, under development or under consideration.
Source: International Carbon Action Partnership (ICAP)©

To level the playing field with regions not applying an ETS, This paper will focus on the EU ETS. The global ETS map is
and eventually withdraw the free allowances, the EU is still fragmented and constantly evolving as more regions put
working on a carbon border adjustment mechanism (CBAM). a price on companies’ externalities.4 Companies in regions
without an ETS can be modelled with a theoretical cost,
usually referred to as a ‘shadow price’.

4
icapcarbonaction.com/en/ets-map

7
Green transitions create
quantitative and qualitative
financial drivers

The discounted cash flow (DCF) model has been around for hundreds of years and
still rules the world of active investing.

By adding three extra line items to the financial statements, Estimating the impact of these is difficult and we deliberately
the valuation impact of a green transition can be assessed. leave them out of our analysis, which means that our
valuation impacts are on the conservative side.
Our framework allows us to model the offsetting effects of
investing in mitigation, which is a drag on near-term free We believe the additional factors will be material – a market
cash flows, against the long-term financial benefit of lower for green aluminum is in the making and we see a clear
emission costs. Also, when companies reduce their emissions, valuation premium for green utilities. Arguably, this is the
they can profit from selling unneeded emissions permits. real investment case for businesses with GDP-type growth
and tight margins, but they need to go green to unlock
There are some additional factors that we believe will produce them. We expect a significant first-mover advantage and that
value gains: green premiums diminish as green becomes the new norm.
Laggards will likely be exposed to unforeseen risks, perhaps
– Sales growth: there is a higher demand for green products leading to climate driven consolidation over coming years.
– EBITDA margin: ability to charge a premium for green products
– Discount rate: lower risk premium demanded by investors In our framework, a green transition budget determines
the ambition level, how much of the green transition can
be achieved in any given year. First, any green OPEX from
previous investments must be covered, what is left is put to
work on new transition levers in form of green CAPEX.
For illustrative purposes, this is how these drivers enter the
financial statements:

8
 Laggards will be exposed to unforeseen
risks, perhaps leading to climate driven
consolidation over coming years.

Figure 5: Illustrative financial statements with emission cost and green investments

2021 2022 2023 2024 2025

Sales 100 120 140 160 180

COGs 50 60 70 80 90

Total SG&A 25 30 35 40 45

EBITDA 25 30 35 40 45

EBITDA, % Margin 25% 25% 25% 25% 25%

Emission Cost -5.0 -2.5 -0.5 2.0 4.5

Green OPEX -1.0 0.0 0.5 1.0 1.5

EBITDA (Adjusted) 31 33 35 37 39

EBITDA (Adjusted), % Margin 31% 27% 25% 23% 22%

Illustrative example of a scaled back income statement. EBITDA Margin is a key driver in the DCF and for that reason the emission adjustments
are entered below. Note that emission cost and green OPEX can go both positive (cost) and negative (income). Data as of 15 June 2021.

2021 2022 2023 2024 2025

PP&E CAPEX 3.0 3.6 4.2 4.8 5.4

PP&E CAPEX, % Sales 3% 3% 3% 3% 3%

Green CAPEX 1.0 1.4 2.3 2.2 2.1

Total CAPEX 4.0 5.0 6.5 7.0 7.5

Illustrative example of the CAPEX calculation. The green transition budget is first used to support green OPEX from previous investments and
what’s left is used as CAPEX towards new projects. Green CAPEX is added to regular PP&E CAPEX and capitalized on the balance sheet. Data
as of 15 June 2021.

9
Marginal Abatement
Cost Curves help calculate
the value of transition

The Marginal Abatement Cost Curve (MACC) is at the heart of We have commissioned an updated set of MACCs specifically
the framework and enables us to assess the valuation impact developed for our valuation framework. Figure 6 shows one of
of mitigation efforts. We follow an approach developed by the eight green levers that can be taken by the cement sector
Per-Anders Enkvist during his time at McKinsey & Company to reduce emissions. Assumptions made in our MACCs are:
(1999 to 2015). Per-Anders Enkvist has since left to found the
practice Material Economics. This part of the framework is – Abatement costs and potentials are based on global sector
developed in collaboration with Per-Anders and his team at averages.
Material Economics. – All levers are expected to be commercialized no later than
2030.
MACCs are sector relevant collections of green actions, – All CAPEX and OPEX is stated as incremental to business as
referred to as levers, their associated emission abatement usual (BAU).
potential and costs.
The last assumption above removes any need for adjusting the
baseline forecast – abatement costs can be layered on top.

Figure 6: Sample MACC assessment for an abatement in the cement sector

MACC Cement

Lever Clinker substitution by slag

Abatement Potential 14%

Upfront Cost (CAPEX) EUR 161 per ton CO2 abated

Ongoing Cost (OPEX) EUR 2 per ton CO2 abated

Technical Asset Life 20 years

Abatement Cost EUR 19 per ton CO2 abated

Source: Material Economics. Example of one lever from the cement MACC.
Data as of 15 June 2021.

10
Green transitions in heavy
industry are essential
Heavy industry products (aluminum, cement, chemicals and For most of these sectors, our MACCs suggest abatement
steel) are commoditized but essential to our society. Without potential, at reasonable cost, of around 30% by 2030. In
any commercial substitutes in sight, an end to our cement or Europe, these sectors are on EU's carbon leakage list. When
steel dependence is, today, unthinkable. To produce these abatements are achieved, free allowances no longer needed
products sustainably is critical to reach our climate targets. can be sold and turned into profits. This is how the EU ETS
is intended to incentivize green actions. We believe that
The good news is that substantial abatements are not only not realizing these abatements is economically suboptimal
possible, but value accretive. We believe this is one of the and leaves companies exposed to unnecessary risk. Pushing
most misunderstood opportunities in today’s markets, both forward with aggressive green transformation programs is in
from an investor and climate point of view. the interest of companies, investors and the climate.

Figure 7: Valuations and abatements grow as the EU ETS price rises

EU ETS: EUR 30 EU ETS: EUR 50 EU ETS: EUR 75 EU ETS: EUR 100

60%
Valuation impact at optimal transition

50

40

30

20

10

0
Median Transition Budget: 0.2% Median Transition Budget: 0.5% Median Transition Budget: 1.7% Median Transition Budget: 2.0%
Median Emission Abatement: 8% Median Emission Abatement: 15% Median Emission Abatement: 26% Median Emission Abatement: 31%

This chart is based on 14 European cement and steel companies. The 'violins', Barbapapa-lookalike charts, show how valuation impacts are
distributed under different EU ETS price expectations for 2030. We have combined steel and cement companies, they are in many ways
similar but cement tends to have a higher impact. If we assume the EU ETS will reach EUR 75 by 2030, the median company should invest an
additional 1.7% of annual revenue in green transition levers allowing them to abate 26%. Source: UBS QED. Data as of 15 June 2021.

Figure 7 shows valuation impact distributions, from optimal a significant risk. Laggards may end up with lower free
green transitions, under different EU ETS price scenarios. allocations when benchmarks are reassessed.
Transitions may come at a significant cost, but when
abatements are realized companies can resell any emission It is important to note that these valuation impacts are
permit no longer needed. We believe the income more than completely driven by EU ETS dynamics, green CAPEX and
compensates for the transition costs; this holds true in all our OPEX. We expect ‘going green’ to unlock higher sales growth
EU ETS scenarios. The valuation impact increases if the EU and margin expansion, and therefore for investors to rerate
ETS continues to rise. For companies on EU's carbon leakage these companies.
list, falling behind the competition on abatements presents

11
CASE STUDY

HeidelbergCement

It’s hard to imagine a world without concrete, one of the most German HeidelbergCement, one of the world’s largest
widely used materials. But the chemical and thermal processes manufacturers of building materials and a top player in
involved in the production of cement, the key input, are a cement, has taken such a leadership position. In June 2021,
major contributor to climate change. Cement is the glue that the company announced plans to upgrade its Cementa Slite
represents around 15% of concrete by weight, but 95% of facility (Sweden) to become the world’s first carbon-neutral
the emissions. According to Chatham House, an independent cement plant. This will be achieved by capturing the plant’s
policy institute, the cement industry accounts for around 8% total emissions, up to 1.8 tonnes of CO2 annually from 2030
of global carbon dioxide emissions.5 onwards.6

Some major players in the cement industry are developing

plans to substantially reduce their carbon emissions. We
believe the leaders in this effort will realize substantial
benefits, for investors and the climate.

Figure 8: MACC – Cement

Electrification of
process heating
Abatement cost compared

Clinker substitution with other materials

150
to BAU, EUR/t CO2

Waste heat recovery

100 Optimised concrete use:

Biofuels Pre-cast and advanced construction CCS

50
Clinker substitution by slag

0
0% 5% 10% 15% 20% 25% 30%
Abatement potential compared to BAU, % of BAU emissions

Source: Material Economics. Data as of 15 June 2021.

5
“Making Concrete Change: Innovation in Low-carbon Cement and Concrete.” Chatham House, June 2018.
6
“HeidelbergCement to build the world’s first carbon-neutral cement plant,” HeidelbergCement, 2 June 2021.

12
Figure 9: Abatements driving value: HeidelbergCement

EUR 30 EUR 50 EUR 75 EUR 100

40%
Valuation impact

30
20
10
0
-10
Biofuels
0
Relative emission reduction

Clinker substitution by slag

-10

-15
Optimised concrete use: pre-cast and advanced construction
CCS Clinker substitution with other materials
-20
Waste heat recovery
-25

-30
0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0%
Green transition budget, percentage of annual reserve

The top chart shows valuation impacts for increasing levels of green transition budgets. We assume that a flat price of EUR 30 and no green
transition are priced in today (the red line starts at 0% valuation impact). The vertical markers show the optimal green transition budget given the EU
ETS price. The bottom chart shows the abatements achieved with a given budget and where investments in different levers are initiated.
Source UBS QED. Data as of 15 June 2021.

Cement manufacturers will have to incorporate a range of Valuation impacts in figure 9, produced with our systematic
abatement technologies to achieve carbon neutrality. Cement framework, are for illustration purposes only. They provide a
is typically manufactured by heating a mixture of clay, sand reliable starting point, but assumptions should be fine-tuned
and finely ground limestone, in a kiln reaching temperatures when analyzing individual companies. Our results suggest
of over 1500°C. Emissions are split between fuel combustion that so long as emissions are covered by free allowances, the
to generate heat, and 'process emissions' from superheating valuation downside risk is limited. A material upside potential
the raw materials which then releases CO2. Both are addressed can be realized through aggressive emission abatements
by the cement MACC (see figure 8). The most material lever that allow HeidelbergCement to resell their emission permit
is to substitute clinker, the primary material, with slag, a surplus. If we assume the EU ETS will reach EUR 75 by 2030,
by-product from blast furnaces. Carbon capture and storage HeidelbergCement should abate 27% of their total emissions
(CCS) will also play an important role given that cement’s by 2030, leading to 25% valuation upside. But it will require
process emissions cannot be fully abated, and instead must be significant investments at over 3% of annual revenue.
captured and stored.
We believe there is more to come on HeidelbergCement’s
long journey towards net zero.

13
The important role of
engagement

The primary purpose of engagement on climate issues is to CCS provide an opportunity for some high emissions sectors
bend the curve, to induce the public companies to change to be transformed into a much cleaner form. Many of these
their business practices and business models. Emission- technologies are available today, but investment is crucial
intense companies must significantly reduce emissions to for them to be implemented. Cement manufacturing is just
avoid destruction of the world we live in. But while the world one example. Steel production is another, and agriculture is
at large is free to engage anything and everything, asset a third. For many of these companies, shifting from fossil-
managers must abide by their fiduciary duty, which is to fuel derived power to hydroelectric, solar or wind power will
produce returns and to mitigate risk. Thus, everything that we change the emission profile completely. At UBS, we want to
do with respect to climate engagement has to connect to our get involved and drive positive change.
primary investment function. Our decarbonization framework
links environmental and financial analysis. How can we make the distinction between companies that
can be saved and those that cannot? We need to assess the
Investing in emission-intense companies may be controversial. value of a green transition. Our framework provides important
It is naturally easier to be associated with solutions, low- insights for us as investors into companies that are not low-
carbon sectors, alternative power and other investment carbon today but can be in the future by decarbonizing in the
themes that have a positive image. But we believe the most optimal way.
development of sophisticated abatement techniques, such as

At UBS, we want to get involved

and drive positive change.

14
Conclusion

Although sustainable investors may This paper has presented a valuation framework incorporating
decarbonisation as a key value driver. We have shown that
reflexively exclude sectors that are heavy significant abatements are economical given an ETS, in our
contributors to greenhouse gas emissions, case illustrated through a case study based on the EU ETS.
In Europe, we believe that sectors receiving free allowances
by engaging them, we believe that have limited downside risk for now, but more importantly an
investors can play a more meaningful role upside potential that is widely misunderstood. Demand for
greener products may drive volume and green price premiums
in solving the climate crisis. may drive profitability, both leading to further upside.
Solving the climate crisis through green transitions is a great
In addition to supporting companies that provide climate commercial opportunity. By illustrating this to companies, we
solutions as their core business, we see that it is critical to can enable more forceful actions earlier.
enable green transitions in emission-intense sectors. By
engaging, investors may influence these transition companies Recent steps by leading cement and steel companies suggest
in the right direction. Today, engagements tend to be that heavy industry may no longer be ‘hard-to-abate.’ Success
values-based and non-technical in nature. Supported by a by these early adopters could put pressure on peers to act.
comprehensive quantitative framework illustrating the value We expect the net zero race to accelerate and become the key
of green transitions, engagements become more credible and performance differentiator in emission-intense sectors. We
impactful. believe that our decarbonization framework is an important
step in encouraging the transition in industries that are too
important to discard.

We believe this is sound investing, with our clients and the

climate as the ultimate beneficiaries.

15
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