Whether analyzing an individual company or an ETF, ESG and sustainability investors must closely examine their portfolio companies. While it may seem redundant, looking under the hood and completing some deep fundamental analysis can help you determine if the company is truly contributing to a more sustainable economy and the planet.
This is especially true within the auto industry. For the past several decades, automakers around the globe must comply with increasing fuel standards, which ultimately decrease pollution and reduce carbon emissions. While compliance with these fuel standards is mandatory, automakers who aren’t currently in compliance can rely on a credit system to stay in compliance with these fuel standards.
Ultimately, ESG investors should have at least some familiarity with carbon credits, as they play a role in both automakers’ compliance with ESG standards and their current profitability.
A Primer on Carbon Credits and Automakers’ Use of Them
As a general principle, you can think of carbon credits as permits that let companies emit certain amounts of greenhouse gases (like carbon dioxide). While the allocation process depends on the specific program and specific automakers’ “footprint,” carbon credits are awarded as participants overcomply with the program. Like cap-and-trade programs, carbon credit programs let participants sell their credits to others who may be undercompliant.
In the auto industry, both NHTSA’s CAFE program and the EPA’s greenhouse gas program are credit-based systems at the federal level. There is also a separate regulatory credit scheme on a state level. The so-called zero-emissions vehicle (“ZEV”) mandates are found in eleven states. The most prominent is California, but other ZEV states include New York, New Jersey, Connecticut, and Colorado. Automakers must comply with these standards (or purchase the requisite number of credits) to avoid extensive fines.
As described in an Axios report, auto emissions credits are like gold for automakers. As you can see in the chart below, automakers have already reserved a large amount of greenhouse gas credit balances.