Global warming deserves its own category in the investment world as an intangible that’s difficult to quantify but impossible to ignore. Scientists and governments around the world agree greenhouse gas (GHG) emissions are causing climate change and need to be curbed but cannot predict a timeline for their potentially disastrous effect. This makes it challenging for firms to anticipate how global warming will affect profits.
With more mainstream investors and analysts interested in the issue, however, there’s a push for companies to improve disclosure in this area. ‘For now, investors would like to see more companies provide the sort of disclosure that some firms already do,’ says Abby Cohen, chief US portfolio strategist at Goldman Sachs.
Companies in large emitting sectors, such as energy and automotive firms, are being the most up front on this issue by releasing information on their carbon emissions and producing sustainability reports. This level of disclosure is sufficient for now because it’s difficult for companies and investors to assess the long-term impact of climate change on financial performance.
‘Some companies don’t know what the long-term liability [of climate change is],’ says Cohen, who likens climate risk assessment to asbestos liability determination in the past. ‘If you had asked companies 40 years ago what the long-term liability of using asbestos was, they would not have known.’
‘We haven’t reached the point where we can link climate change to valuation,’ notes Matthew Taylor, manager of London-based BP’s corporate responsibility team. BP has been reporting on its carbon emissions since 1997 when it pledged to reduce emissions by 10 percent by 2010. The company reached that goal in 2001 and saved $650 mn in the process. Now its goal is to avoid an increase in total emissions before 2012.
Few bites
While clearly committed to talking about this issue, Taylor says the petroleum giant gets few questions from investors about global warming and the risks it poses to the oil business.
In the last year, for example, BP received only around half a dozen questions on climate change – and some of these were directly related to a UK newspaper story (in the Independent) about BP’s lobbying efforts against a US bill outlining mandatory curbs on carbon emissions. ‘We felt the bill was an unworkable solution for the transport sector – and it was that specific element [of the bill] we felt was unworkable,’ explains Taylor.
Ford Motor Company also receives a surprisingly small number of queries from investors on climate change. ‘We get questions about hybrid technology,’ says Barbara Gasper, vice president of IR at the Michigan-based automotive company. ‘That is something US-based investors are picking up on. But in the course of that conversation it usually ends up getting to how much profit we are making on this vehicle. At the end of the day, it all translates to how something contributes to the bottom line.’
European investors, on the other hand, pay more attention to climate change risk and have a longer-term view of the issue, Gasper adds.
Despite seemingly few questions from investors, institutions are getting hungrier for information on global warming and how it relates to financial performance. ‘This subject is something that is moving from the long term to the short term in the way investors are looking at it,’ says Tim Purcell of CO3, a London-based corporate social responsibility (CSR) communications consultancy. ‘It’s also the subject of analysts’ reports because the information is beginning to be quantifiable – but it’s still very much in its infancy’
At a UN summit this past May in New York it was evident mainstream investors are waking up to the fact that climate change will eventually impact valuation. Hundreds of institutional money managers representing more than $3 tn in assets attended the summit on climate risk and an action plan was put together that includes pushing for better research from investment banks on climate change risk.
Investment banking giant Goldman Sachs is getting requests from its institutional clients about climate change and is treating the topic as an investment issue. ‘From an investor perspective, we aren’t looking at it in terms of dollars and cents, but as an equity liability risk premium,’ says Cohen. In other words, climate change is being considered as a factor affecting investor confidence in the company’s long-term viability.
Climate risk doesn’t directly impact investment decisions unless it’s affecting valuation through present or future cash flow, or the fund has a specific socially responsible investment (SRI) mandate, according to a recent study of climate change investor sentiment conducted by Richard Davies Investor Relations for IR magazine. The study polled 51 fund managers, four pension fund consultants and 25 sell-side firms across Europe.
Cohen thinks climate change risk will ultimately affect how the market prices shares. ‘Very often things can be mispriced [with] assets or liabilities not properly valued until enough investors have that eureka moment and say, This is important, and then the price adjusts,’ she says. ‘That’s why it’s important that there is a critical mass focusing on this issue.’
The bottom line
While many companies are fairly good at disclosing information on carbon emissions, it’s very difficult for investors to compare these disclosures. This was one of the conclusions of a recent report from London-based Henderson Global Investors, which shows that less than 50 percent of FTSE 100 companies – representing two thirds of total emissions among this group – disclose their carbon emissions. ‘The real issue is lack of comparability in data,’ notes Vince Chaney, head of commercial development at Trucost, the UK-based environmental research company that conducted the Henderson study.
Universal performance indicators that measure climate change impact are necessary for investors to be able to compare risk across different companies and sectors. ‘It’s something we are working on quite intensely,’ says Chaney. In July Trucost and the UK’s Department for Environment Food and Rural Affairs (Defra) released reporting guidelines for environmental performance for UK companies. ‘There is a convergence on climate change now with people realizing they should be looking at GHG emissions in absolute quantities,’ Chaney adds.
Trucost is seeing an increasing number of investors looking at global warming, and Chaney says the firm is approaching this from two sides. ‘One is the modeling side, which looks at the financial impact, and the other is the engagement side – investors want to know companies are looking at this,’ he explains. Index investors will be engaging companies about disclosing information on this topic, according to Chaney, while stock-picking investors will be trying to avoid companies where the risk from climate change is significant. ‘They’re more interested in the financial aspect,’ he points out.
In Europe there is now a mandate for companies to report connections between environmental risk and financial performance under new operating and financial review (OFR) guidelines. But it will be a while before companies are able to draw a direct link between share price performance and global warming.
The bright side
Still, some companies are trying to gauge the long-term business implications of environmental change. At the end of the year, Ford Motor Company will issue a report looking at the business implications of its reduction of GHG emissions over the next five to ten years. The company decided to prepare the report following a shareholder resolution requesting the information.
‘We think it is important that there is a dialogue on the impact of climate change on our business and industry, and which policies are necessary to address this impact,’ says Niel Golightly, director of sustainable business strategies at Ford.
While stopping short of putting a dollar value on climate change risk, Ford’s report will include more analysis on the impact of a carbon-constrained economy. ‘We can see it as a risk or as an opportunity,’ adds Golightly.
Viewing it as an opportunity is how GE is approaching climate change risk. In May the Connecticut-based mega-cap company announced its decision to double its investment in energy-efficient and environment-friendly technology to $1.5 bn over the next five years.
‘We reached a tipping point where these technologies were affordable for customers and became something we could make money from,’ says Peter O’Toole, director of public relations at GE. ‘So this is not GE changing its stripes as a company that grows aggressively each year – these technologies have become so economically viable, they will all break even or be profitable within the first year.’
The impact on the bottom line is always part of CEO Jeff Immelt’s methodology, adds O’Toole. ‘If it’s green for the environment, it will be green for the bottom line [is Immelt’s thinking]’, O’Toole says.
Notorious shareholder activist Bob Monks, who has invested in Trucost, thinks GE’s approach to climate change is spot-on. ‘Essentially, capitalism is the best way of dealing with the issues,’ he says. ‘[GE’s action] concedes there is a social problem that society demands be answered.’
For now, the greatest incentive for disclosing climate change risk has to do with corporate image. ‘[Disclosing information on this] inspires investor confidence,’ says Lucie Sinclair of CO3. Therefore, even if it’s impossible to put a dollar value on its current or future impact today, companies need to disclose as much information as possible to allow investors and analysts to understand climate change’s business implications. ‘The most important thing is to get the dialogue started with investors,’ concludes Cohen. ‘Those companies that have been forthcoming are in fact being well received by investors.
