Seeing shares through green-tinted glasses

If investment banks are good at one thing, it is sniffing out opportunities to make money. Judging by a sudden deluge of research reports, they now see climate change as the next big thing.

More than a few forests appear to have been felled recently to explain how companies might respond to climate change and how investors should position themselves for what is emerging as one of the dominant investment themes.

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As Lehman Brothers said this week: “While climate change may well be a slow-moving force, asset prices will on occasion move sharply, when new evidence reaches the market or policies are changed.”

The threat to economies, markets and investments are clear. Rising global temperatures are likely to mean more flooding, more droughts and hurricanes, and shortages of food and water in parts of the globe. Policies to cut emissions will affect industry behaviour. Just yesterday the UN climate panel issued its strongest warning yet that human activities are heating the planet. Companies everywhere will be under pressure from politicians, regulation and the media to respond to climate threats.

Sir Nicholas Stern, author of last year’s UK report on climate, has warned that, in a worst-case scenario, unabated climate change could knock 20 per cent off global consumption. Even his lower-end estimate of 5 per cent gives investors and markets little choice but to respond.

There is already an established trend for socially responsible investing (SRI), or investing by environmental, social and governance (ESG) criteria. But Neil Brown, head of governance and responsible investment at Threadneedle Investments, says what is striking about the recent trend in investment banking reports is their mainstream approach – involving individual sectoral analysts as well as SRI specialists. “Traditional SRI reflected the views of specific clients, maybe a church or charity fund expressing its dislike of certain sectors, such as tobacco or arms. A number of analysts are now taking a bigger picture view across all sectors and focusing on climate change’s potential impact on company earnings,” he says.

It may not be long before climate change issues start to affect the profitability – and hence the share prices of certain sectors, specifically oil and gas companies, mining groups, building companies, utilities, airlines, automotive groups and insurers.

Lehman says that the European auto sector could be the first casualty of increased climate change, warning that the industry’s profitability “could suffer markedly within the next five years”. It feels the industry could be made a political scapegoat for a likely failure to meet demanding 2008 carbon dioxide emission targets. By contrast, global capital goods companies, which supply plant and equipment to the power generation industry, are likely to be net beneficiaries of climate change, according to Lehman. “The main technology beneficiaries will be nuclear, wind, hydro, and fore emerging technologies, coal gasification, photovoltaics, and utility scale energy storage (fuel cells),” it predicts. Other industries could be hit hard – cement, for example, accounts for more than 5 per cent of global CO2 emissions. Airlines could also suffer if governments put up taxes to the point where they deter flying. But it is hard to be precise – an airline that markets itself as using a climate-friendlier fuel might benefit.

It is clear that some very big companies are taking the issue seriously: BP has attempted to restyle itself with its Beyond Petroleum agenda; Toyota has made substantial investment in hybrid cars; and Tesco plans to “carbon label” its products, to show how much carbon dioxide is emitted during their production, transport and consumption .

The fact that these companies are making changes suggests they are already coming under pressure from their consumers – or perceive they can gain competitive advantage.

However, the issues for companies and investors are highly complex.

As Citigroup notes, some measures to tackle greenhouse gases are not necessarily green. “Nuclear power plants are completely carbon-free sources of electricity, but they produce radioactive waste that needs to be stored for thousands of years. Palm oil and sugarcane cultivation for the production of biofuels threaten the habitats of rare species in some parts of the world (e.g. orangutans in Malaysia),” it says.

The way ahead is also etched with uncertainties over how governments will respond. One of the major ones is how the European carbon emissions trading system evolves – and indeed whether it ends up being a global system embracing the US, India and China.

The one certainty would appear to be that chief executives are going to be asked about their “climate change” strategy just as surely as they were asked about their internet strategy at the turn of the century. In due course, we can expect “climate change” funds and “climate change” indices to develop.

The process is already starting. Next week, FTSE, the index company, will announce that companies eligible for inclusion in its FTSE4Good index will have to meet climate change criteria.

This will start making distinctions between companies that are managing the climate change agenda effectively and those that are not. Companies ejected from the index for failing to do enough are unlikely to relish the prospect.

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