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Working Paper | Pricing Climate-Related Risks of Energy Investments

Soh Young In
John P. Weyant
Berk Manav
Sustainable Finance Initiative
2021

This paper presents a framework for pricing the climate resilience of an energy infrastructure project through assessing the value of its required debt and equity investments. Integrating climate scenarios into an asset valuation model provides useful and specific insights for risk management, but there is a lack of academic and market tools that effectively address this need. The critical barrier is that climate-related risks (physical and transition) are typically indirect variables in the cash flow calculation, and they should be computed based on the direct variables such as revenue, capital expenditures (CAPEX), operating expenses (OPEX), and financing costs. The implementation of this framework shows how to delineate climate-related risks that are assetspecific and transforms them into financial risks. Using cash flow simulation and scenario analysis, it estimates an energy infrastructure asset’s probability of default due to climate-related risks and the size and timing of the losses for any given default. To demonstrate the framework's application, we simulate the price climate-related risks of a utility-scale electricity generation facility (i.e., a downstream energy asset) powered by natural gas.