Investing for the Coming Carbon Crunch

Investing for the Coming Carbon Crunch

The introduction of the European Union Emissions Trading Scheme has made the imperative of confronting rising emissions of greenhouse gases tangible in ways that endless exhortations by environment ministers could never do.

This dawning awareness is, of course, no surprise for many in the socially responsible investment community, which has been targeting companies providing low carbon solutions for many years. Socially responsible investors have also been in the vanguard of efforts to ensure greater transparency from companies to ensure that informed investment decisions can be made in light of climate change.

The increased urgency of the financial case means that investors need to deepen their understanding of how their investments could be affected by the shift to a low carbon economy. To this end, Henderson commissioned environmental research organization Trucost to conduct a carbon profile of the U.K.'s equity market and to carry out a carbon audit of one of our socially responsible investment funds.

Carbon Costs High

The Carbon 100 report evaluates the carbon emissions of Britain's largest listed companies -- those in the FTSE 100 index. Trucost used published data for the financial year up to September 2004 but found that less than half of the FTSE 100 reported their emissions.

So, it supplemented this public data with estimates provided by its environmental profiling model. In terms of carbon dioxide equivalents (CO2e), Trucost found that these 100 companies accounted for 1.6% of the world total. Just five of these companies -- Shell, BP, Scottish Power, Corus and BHP Billiton -- generated more than two-thirds of FTSE 100 aggregate. Trucost also estimated that the emissions from products sold by five U.K. oil and mining accounted for more than 10% of total global emissions from fossil fuels.

Going beyond absolute emission levels, the report examined the rate at which companies produce carbon for each unit of turnover and earnings. On average, 1,126 metric tons of carbon were generated for each £1 million of turnover in the FTSE 100. This rose to over 9,000 tons for power utilities, and fell to under 100 tons for banks.

Trucost also modeled some of the financial implications of possible measures to internalize carbon into market prices. If companies had to pay the U.K. government's estimate of the economic damage done by a ton of carbon -- about £20 a ton -- then more than 12% of the FTSE 100's earnings (in terms of earnings before interest, taxation, depreciation and amortization) would be at risk. For some companies, well over 50% of earnings would be exposed to carbon costs.

Ethical Investments Pay Off

As well as looking outwards to the U.K. equity market, Trucost also evaluated the carbon performance of one of Henderson's own socially responsible investment funds, Global Care Income. The results are published in a short report, How Green is My Portfolio? which concludes that the fund is 32% less carbon intensive than its benchmark, the FTSE All Share.

For us, this shows that an active approach to socially responsible investment can deliver real environmental benefits for investors. We hope that other socially responsible investment funds carry out similar studies to increase transparency on their performance in this critical area.

Carbon is set to become a critical factor in business strategy, for example, influencing the pattern of corporate acquisitions and divestments. There should be no surprise when the first carbon-driven profits warning is issued. For investors, getting standardized, comparable carbon data from companies is now an imperative, particularly in the U.K., with the new Operating and Financial Review disclosure requirements. But there are also opportunities to be had for those who understand the dynamics of the coming carbon crunch and invest in the industries of the future.

Nick Robins is head of socially responsible investment Funds at Henderson Global Investors.

This column has been reprinted courtesy of Ethical Corporation. It was first published on July 21, 2005.