As a result of growing environmental issues, institutional investors are facing a new set of concerns as these industries are hit by regulations to reduce emissions, Elisabeth Jeffries reports
Asset managers were warned to review their energy investments in a report issued in July by environmental NGO WWF and Trucost, a research organisation established to help companies and investors understand the environmental effects of business activities. The report, entitled Carbon Risks in UK Equity Funds, indicates that funds could lose out by investing the amounts held currently in certain energy utilities and fuel producers, because of existing and future regulations likely to hit these industries.
“Institutional investors, such as pension funds, invest money in listed companies, many of which are very carbon intensive. Government policy initiatives to apply carbon charges could lead certain companies to lose market share to more efficient and innovative companies that emit less. As a consequence, the potential exposure of earnings to carbon costs across investment portfolios could have a knock-on effect on pension fund returns,” asserted Trucost’s chief executive Simon Thomas.
Pricing carbon could make energy conservation far more attractive and wind, nuclear and solar power more cost competitive
The analysts looked at 118 funds managed from the UK which hold investments equal to 1.4% of the market capitalisation of 2,380 companies. This, they calculate, accounts for approximately 134 million tonnes of carbon emissions and equates to 22% of UK greenhouse gas (GHG) emissions. Mercer Investment Consulting, supplied data on investment holdings without identifying the asset owners. The survey found wide variations in the emissions from individual companies in the same sectors. Greenhouse gas emissions from the portfolios studied ranged from 209 to 1,487 tonnes per million pounds invested.
Carbon footprint estimates
With reference to the European Emissions Trading Scheme (EU ETS), the company uses two different carbon prices – £12 (the current price) and £57 per tonne – to suggest that the corporate emissions from these portfolios would amount to a total carbon cost of between £1.6bn and £7.65bn respectively. It says energy companies are the biggest contributor to the carbon footprint estimates; nine of the 10 top emitters in the portfolio operate in the utilities and oil & gas sectors. For this reason, and because of further emissions, legislation (such as new emissions trading schemes) in the USA, Australia and other parts of the world, the study indicates that investors should take extra care with their energy investments. Companies to review, it suggests, include E.On, RWE, BP and the American Electric Power Company. Curiously, these may not be the worst performers in their sector in terms of carbon emissions, but they are relatively popular choices among investment managers and as a result have an individually disproportionate effect on the overall investment portfolio.
The German company E.On is a case in point: “E.On is not necessarily the worst performer in its sector but it is the main contributor to the portfolio’s carbon footprint,” stated Trucost senior editor Liesel van Ast. Wolf Bernotat, E.On’s outgoing chief executive, has presided over a large number of changes, not least of which is a doubled revenue since he started the job, amounting to €86.8.bn in the last financial year. This, along with a series of acquisitions, a good profit performance and its dominant position in the European electricity market may be why many fund managers choose to invest in the company, although they gave it the thumbs down this year as a result of its heavy debts and profit crash.
Turning a blind eye
But Trucost suggested that, nevertheless, many may be turning a blind eye to liabilities about to hit the company, stating that, at a carbon cost of £12 per tonne, the company experiences a cut of 18% in earnings before interest, taxes, depreciation, and amortisation (EBITDA). If the carbon price were to amount to £57 per tonne, the company would experience a massive 85% cut in EBITDA, the researchers say. The utilities represented in the 118 portfolios could experience a decline of 26.7% in EBITDA where carbon is at £12 and 127% where it is at £57. Many analysts also no doubt applaud BP’s big cost-cutting programme, launched in the wake of the oil price crash in 2008. When oil prices rise, the company’s shares will no doubt follow suit. But Trucost contends that a carbon price of £12 cuts BP’s EBITDA by 9% while carbon at £57 slashes it by 44% and that the oil and gas industry represented in the 118 portfolios could experience a combined fall in EBITDA of 12% where carbon is at £12 and 31% where it is at £57.
Though these figures sound ominous, the reality is more complex. It is not clear to what extent any lower profit figures in financial statements this year can be attributed to carbon costs. Energy utilities, for example, picked up attractive windfalls when the EU ETS was launched in 2005 because the European Union Allowances (EUAs – the carbon emissions permits bought and sold within the ETS) were supplied free of charge by the European Commission; at the same time, electricity companies were passing some of the costs of the EUAs down to the customer. More recently, European emissions caps have become looser than they would otherwise be because of lower output as a result of the recession; in addition, the cap levels may have been set too low, as New Energy Finance’s head of research Jonathan Malsbury explained:
“People used GDP forecasts assuming that there would be an ongoing need to reduce emissions from 2008 all the way through to 2020 and that further cap restrictions would be needed over that time,” he stated. If events had developed as the economists predicted, the cap would have become tighter over the years and the carbon dioxide price would accordingly have increased. The outcome is that some companies, including utilities, may be in a good position to sell EUAs in future when the price of carbon rises.
Akur Partners, analyst Tom Frost, stated: “Industrial groups able to remain in a long EUA position in the current low cost climate are...likely to benefit. Power generators too should be well placed in a high price environment.” In the highly political world of cap and trade schemes, there is plenty of room for game-playing. Oil and gas companies, meanwhile, will also benefit as oil prices rise, even if their carbon costs increase. But one point, also emphasised in the report, is clear: disclosure of carbon costs in financial statements is still not mandatory and this sometimes prevents analysts from drawing their own conclusions about what is going on in energy companies.
Notwithstanding some of the points in favour of energy companies, Liesel van Ast argued that fund managers need to make their choices more carefully in the light of the carbon agenda. “People can do a lot with stock selections to reduce the impact on their portfolio significantly while still maintaining their sector allocations,” she said, adding: “They can invest in the more energy efficient utilities.” At the same time, carbon regulations will change in future, she stated, pointing out a number of risks: “From 2013, energy utilities have to buy 100% of their EUAs. If they buy more than they need, they will have a surplus...they will purchase more over time and pay more carbon costs accordingly.” It may not be possible to pass all carbon costs to the customer, she warns, citing the case of Drax, a power station which sells on the wholesale market.
Better informed decisions
F&C Asset Management, F&C Asset Management, Vicki Bakhshi, agreed broadly with the principles outlined by the report. F&C run five green and ethical funds as well as several mainstream funds. However, she said the figures describing the total impact on profits were “misleading”. “Electricity bills are going to go up as the carbon price goes up,” she said, conceding however that “heavy emitters will be disadvantaged compared to low carbon emitters.” The more recently favourable position for power companies may be ending, she indicates: “It depends how much they can pass on to the consumer. As demand increases, you also tend to get a stronger carbon price. So it’s possible you would get rising costs in both cases.” However, the company is campaigning for more ambitious, clearer and more consistent policy [in line with G20 targets for 80% cuts in emissions by 2050] to help investors make better informed decisions. Investments in more energy efficient companies and the establishment of a global climate opportunities fund specialising in green business are two of the ways the company is managing the impacts of carbon regulation in its portfolios.
Neither E.On nor BP had anything to say about the report, but BP repeated recent comments made by its chief executive Tony Hayward: “Until energy producers and consumers know and pay the cost of carbon, the uncertainty associated with planning and investing in the transition to a low carbon economy will remain high. Pricing carbon could make energy conservation far more attractive and wind, nuclear and solar power more cost competitive. It will also allow informed investment in fossil fuels and in the technology necessary to reduce the carbon emissions associated with their use.”
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