Estimating financial risks from the energy transition: potential impacts from decarbonization in the European power sector

Carbon reduction policies adopted by governments could have a significant impact on the profitability of companies. Anticipating these impacts is a growing concern for both investors and regulators. We present an integrated assessment of energy transition risk that links future energy scenarios to a structural economic model. The methodology allows for a comprehensive evaluation of potential financial stresses on firms subject to binding emissions constraints. We pilot the methodology using electric utilities in the 28 European Union member states as our sample. Our results show that aggressive climate mitigation policies affect both net profit margins and the required rate of capital expenditure. We present initial estimates of changes in equity returns and credit quality for these firms, as well as implications for future policymaking.