Tuesday, May 30, 2006

Wall Street Develops Investment Tools for Climate Change

Source: Wilmington Star
[May 30, 2006]

Socially conscious investors long ago hopped on the climate-change bandwagon, putting their money into companies that control greenhouse gases and shunning those that do not.

But now, the pure profit-and-loss players are moving in, potentially raising the level of the game. They are betting that Washington will someday clamp down on emitters of carbon dioxide and other gases that are believed to contribute to global warming. And they are certain that there is money to be made in holding the shares of low emitters and shorting the shares of big ones.

New carbon-tilted rating scales could come in handy, and investment research houses like Sanford Bernstein and Innovest Strategic Value Advisers are busily setting them up.

Innovest, in partnership with UBS, has created a "carbon beta" basket, a fund that will hold 50 stocks in five industries. The fund managers would monitor global warming regulations and would buy and sell the stocks on the basis of how the companies would be affected by those rules.

Each industry grouping of stocks would include an equal number of carbon leaders and carbon dogs, as Doug Morrow, an Innovest analyst, calls them. In the electric utilities industry, the FPL Group, a major player in renewable energy sources like wind, is on the list of leaders; American Electric Power, one of the country's largest generators of power from coal, tops the list of dogs.

Innovest does not know how many investors have bought into the carbon beta basket. UBS, which is selling the basket, refused to discuss it, citing regulatory concerns, and would not explain further.

But Morrow seems certain it will be popular.

"Upside and downside exposure to climate change is not yet priced into the fixed-income or equity markets," he said, "so there is out-performance potential in a product that uses specialized research to address these factors."

Innovest and Sanford Bernstein are both betting that Washington will fully endorse a system for trading carbon credits.

The system would enable companies to avoid fines for releasing illegal amounts of carbon by purchasing carbon credits from companies that are emitting less than the rules would allow.

Such a system plays to the basic math of the carbon beta basket. The companies selling the credits would receive an added source of income and therefore would be deemed "carbon leaders" while the companies buying them will incur a new cost and will be deemed "carbon dogs." Even companies that decide to reduce their emissions could wind up as dogs, from the view of the carbon basket's fund manager, because they must incur costs to switch fuels or buy pollution control equipment.

The idea of grading companies on their carbon emissions is not new, of course. Numerous environmental groups have publicly castigated companies for contributing to global warming.

Innovest itself has for the last three years put together an annual Climate Leadership Index that ranks companies on how well they are controlling greenhouse gases. And this year Ceres, a coalition of environmentalists and investors, ranked 100 companies on the way top management is addressing climate change.

But until now, such reports were meant as guides to socially conscious investors who want to punish companies that pollute and reward those that do not. The latest research puts the question in pure dollars-and-cents terms.

In that amoral calculation, environmentally progressive companies can be on the dog list. And nuclear power plants and other types of companies that raise the hackles of environmentalists can be listed as stars.

The dichotomy is particularly apparent among electric utilities, the industry that most of the carbon-risk researchers are focusing on because it burns so much coal.

"We give a lot of credit to how well companies disclose to shareholders what they are doing, and how they are structured to manage risk, but that doesn't capture emissions exposure the way a financial analyst would want to," acknowledged Dan Bakal, director of electric power programs at Ceres.

Similarly, many environmentalists have fought against nuclear power, saying the risks of accidents and leaks outweigh the benefits. But nuclear plants do not emit greenhouse gases, and in deregulated states, where utilities compete for customers, carbon regulations could give nuclear plants a huge edge over their coal-burning competitors.

Moreover, the continued societal aversion to nuclear plants means that the existing nuclear players would not face added competition and therefore would remain good investments long after any carbon emissions rules are passed.

"Society's antipathy to nuclear plants is hunky-dory with the folks who have them, because they will remain the lowest-cost competitors," said Hugh N. Wynne, a senior research analyst at Bernstein.

That is why Wynne, who issued a report in April looking at potential winners and losers from carbon regulation, listed Exelon, the largest owner of nuclear plants in the country, as a top beneficiary of carbon rules, and thus a good stock to buy.

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