Carbon Risk – GHG Accounting

Global Investors Call on Energy Companies to Disclose Financial Risks of GHG Emissions

A group of 70 global investors managing more than $3 trillion of collective assets has called on 45 of the world’s top energy companies (including Suncor Energy Inc., Canadian Natural Resources Ltd., Exxon Mobil Corp., Royal Dutch Shell PLC and Total S.A.) to assess the financial risks that climate change poses to their business plans. The investor effort, called the Carbon Asset Risk (CAR) initiative, is being coordinated by Ceres and the Carbon Tracker initiative, with support from the Global Investor Coalition on Climate Change.

In a letter sent to energy companies in September 2013, investors wrote: “We would like to understand [the company’s] reserve exposure to the risks associated with current and probable future policies for reducing greenhouse gas emissions by 80 percent by 2050…We would also like to understand what options there are for [the company] to manage these risks by, for example, reducing the carbon intensity of its assets, divesting its most carbon intensive assets, diversifying its business by investing in lower carbon energy sources or returning capital to shareholders.” Investors signing the letters include California’s two largest public pension funds, the New York State and New York City Comptrollers, F&C Asset Management and the Scottish Widows Investment Partnership. The investors have requested detailed responses before their annual shareholder meetings in early 2014.

Most energy companies produce sustainability reports and use a shadow carbon price to assess the viability of projects, but the financial risks of climate change driven policies are not usually disclosed. According to the report Unburnable Carbon 2013: Wasted Capital and Stranded Assets , the 200 largest publicly traded oil and gas companies collectively spent an estimated $674 billion on finding and developing new reserves in 2012 alone – some of which may never be utilized. The CAR initiative is part of a growing trend to assess the present value of fossil fuel companies and their long-term reserves, based on expectations that government policies will lower demand for the most carbon-intensive energy sources in the longer term. Analysis from HSBC suggests that equity valuations of some oil and gas companies could be reduced by 40 – 60% in a low emissions scenario where a portion of their reserves would become stranded assets. This highlights an opportunity to redirect this capital, rather than investing it in high carbon assets that could become stranded.

Study Finds that Lowering Levels of GHG Emissions can Increase a Company’s Stock Value

A recent study by researchers at the University of California (Davis and Berkeley) and the University of Otago in New Zealand entitled “The Relevance to Investors of Greenhouse Gas Emission Disclosure” has found that the amount of greenhouse gas (GHG) emissions a company produces and whether a company discloses their emission levels or not has a significant effect on the value of the company’s stock. In particular, the researchers found that the greater the GHG emissions, the lower the value of a company’s stock. Likewise, lower emission levels lead to higher stock values, all other factors being equal. Even if companies do not disclose this information, GHG emission levels are estimated by investors themselves, resulting in an even stronger risk discount to the stock value for high level emitters. This trend is particularly strong in energy intensive industry sectors. The study was led by Paul Griffin, a professor in the University of California, Davis Graduate School of Management.

Professor Griffin and his colleagues also discovered that markets respond almost immediately when a company releases information on their GHG emissions, with stock values responding the same day as the disclosure. “It really does appear to be a valuation factor,” Professor Griffin says. “Greenhouse gas emissions are important to investors in assessing companies.”

The findings bolster the arguments of investor groups, environmental advocates and watchdog organizations that have been seeking greater disclosure of company actions that affect climate change. The U.S. Securities and Exchange Commission (SEC) does not require all companies to report GHG emissions, but companies are required to disclose any information that is considered material to stock values. The findings of this study strongly suggest that GHG emissions data is relevant information to investors, therefore it could be argued that all public companies should disclose their GHG emissions to comply with SEC requirements. Approximately 50% of large U.S. firms report GHG emissions through the Carbon Disclosure Project.

The researchers analyzed four years of data (from 2006-2009) on firms listed in the Standard & Poor’s 500, and five years of data (2005-2009) for the top 200 publicly traded firms in Canada. While the researchers found the link between stock values and GHG emissions to hold true in most industries, the correlation was strongest for energy companies and utilities. According to Griffin, “after controlling for normal valuation factors like assets and earnings, we found the value of stocks to be a function of greenhouse gas emissions”.

Investors care about GHG emissions because markets are forward looking. Professor Griffin has indicated that in this case, investors are anticipating a time when companies will face increased costs for climate change mitigation, regulation and taxes.
The full study can be downloaded at Link.