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green@work : Magazine : Back Issues : Jan/Feb 2007 : SRI

SOCIALLY RESPONSIBLE INVESTING

A Climate for Change
Wall Street, take note: Climate change will have profound impacts on the financial performance of companies, and the risk and return characteristics of investment portfolios.

by Julie Fox Gorte & Devin Zeller


Sometimes extraordinary events can feel very normal, and only seem remarkable with hindsight. We are living at a very extraordinary moment—for the first time in our lifetime, one species has the power to knowingly change the climate and ecological engine of the entire planet. This will affect everything: commerce, culture, markets, societies. And it will surely have investment implications.

Investors are rarely the first movers on any social or environmental issue, and this one is no exception. However, once the investment community does focus on an issue, action is often powerful. Indeed, investors are one of the few groups of people capable of creating their own reality; if we all believe that climate (or any other issue) is important, and invest that way, then companies with good management of climate risks and opportunities will be more valuable than competitors without them. That is, if we act like something is important to stock prices, then it is—and vice-versa.

Climate change will have profound impacts on the financial performance of companies, and the risk and return characteristics of investment portfolios. New risks and opportunities have appeared, and these will grow as the climate continues to change, as it assuredly will.

What climate change will do is make severe weather events more frequent. The impact of severe weather can leave a deep imprint on corporate financial performance. For example, Calvert recently examined the 10-Q (quarterly financial reporting) statements covering the third and fourth quarters of 2005 of the largest 100 companies in the S&P 500. Nearly half reported measurable impacts from the hurricanes of 2005 (and, in some cases, 2004 as well). While several companies—mostly big-box retailers like Walgreens, Wal-Mart, and CVS—reported that the impacts were not material, many others recorded more significant effects, almost all of them losses. It is not particularly surprising that the oil and gas producers and oil and gas services companies experienced significant damage from the Gulf hurricanes; nor is it particularly shocking that companies with major refineries or production facilities depending on petroleum feedstocks—such as Dow and DuPont—were injured financially. Insurance companies such as AIG, Allstate, Metlife and St. Paul Travelers were hit hard as well. Sample quotes from 10-Q reports include the following:

• “Losses in the third quarter of 2005 include estimates of $3.68 billion related to Hurricane Katrina and $850 million, net of reinsurance recoverable of $205 million, related to Hurricane Rita.” (Allstate 2005 third-quarter 10-Q)

• “The Company’s pretax cost of catastrophes, net of reinsurance and including reinstatement premiums, totaled $1.52 billion ($1.01 billion after tax) in the third quarter of 2005, all of which resulted from Hurricanes Katrina and Rita.” (St. Paul Travelers 2005 third-quarter 10-Q)

• “AIG currently estimates that its after-tax insurance-related losses, net of reinsurance recoverables and including net reinstatement premium costs, from Hurricane Wilma will be approximately $400 million.” (AIG 2005 third-quarter 10-Q)

• “Profits in the third quarter of 2005 were adversely affected by hurricanes in the Gulf of Mexico, which required the company’s refinery in Pascagoula, Miss., to be shut down on two separate occasions for about 40 days during the quarter, and normal operations were not restored until mid-October. The storms also caused disruptions to the company’s marketing and pipeline operations in the area. ... Average margins for refined products improved from the year-ago period, but the effects were partially offset by increased refinery downtime and operating costs relating to hurricanes. Earnings for the first nine months of 2005 were $595 million, compared with $889 million in the corresponding 2004 period.” (Chevron 2005 third-quarter 10-Q)

These are the impacts that many informed investors expected to see. The Gulf of Mexico is rich in oil and gas, and thus home to the operations of companies dependent on fossil fuels and petrochemical production.

But the effect of severe weather was felt much more widely than in just the energy and chemical businesses. Infrastructures suffered; electric utilities like Duke, Dominion Resources and TXU all reported damage. BellSouth recorded a loss of $102 million after tax for asset impairment (damaged facilities), as well as reduced revenue of $51 million in proactive billing credits for service outages, an increased allowance of $31 million for uncollectible accounts from displaced customers, and $83 million in expense and $22 million in capital needed for network restoration. Coca-Cola, PepsiCo, Target, McDonald’s and Carnival were all hit with losses, and nearly all the financial services companies (Morgan Stanley, Merrill Lynch, Citigroup, Bank of America, JP Morgan Chase and Wells Fargo) reported significant impacts. In the consumer staples sector, Kimberly Clark, Anheuser Busch, and Procter and Gamble took hits, as did Boeing, Lockheed Martin, Honeywell and FedEx, among industrials.

It is important to remember that these impacts, deep and widespread as they were, were only from hurricanes, and many of the reports only concerned the hurricane season of 2005. Although not yet a consensus, there is persuasive evidence that hurricanes have been made more severe by climate change, or specifically by the warming of the oceans, whose warmth is the engine of a hurricane’s power. According to the National Climatic Data Center of the National Oceanic and Atmospheric Administration (NOAA), there have been 67 weather disasters in the United States alone that caused at least a billion dollars’ worth (costs normalized to 2002 dollars) of damage since 1980—and of those, 19 occurred between 2000 and 2005. All together, these 67 events cost more than $546 billion and claimed more than 22,300 lives, just in the United States. Global figures are much higher; Allianz, for example, reports that climate change is responsible for about 160,000 deaths per year, and that total is likely to increase sharply. The number of European floods has increased from one per year to 15 per year in recent decades, and UK flooding could exact annual costs of as much as €30 billion.

Like everything else in investment, information is the key to emerging risks and opportunities. Because the impact of climate change is so pervasive, the information demands are unusually heavy. Investors must begin to grasp the basics of climate prediction and its effects on the weather, pinned down to the degree possible in space and time. It is also important to understand the shifting map of greenhouse gas (GHG) emissions regulation, and how that affects corporations. As the losses mount, it is entirely likely that the victims will seek recourse in the courts, leading to increasing risks of litigation, which can be costly to companies and their investors no matter what the outcome of any specific lawsuit.

While metrics for climate risk and opportunity management are still being developed, investors can still make distinctions between companies based on their disclosures. While there may be much happening behind the scenes, information that companies make publicly available is essential to aiding investor judgments, and climate change risk and opportunity disclosure is no exception.

The oil and gas services industry has long been thought of as an industry without significant exposure to climate change risks and opportunities. Since most oil and gas services companies are not large direct emitters of GHGs, many climate change analysts did not consider the companies within the relevant at-risk industries. Recently, we have learned something different altogether.

Noble Corp. is one of the largest and oldest oil and gas services companies in the world. Noble operates contract drilling services with 62 offshore drilling units located in key markets worldwide. As many would correctly assume, the company is not a large direct emitter of GHGs, but Noble is still managing GHGs. While the company’s emissions are much less than that of the energy-intensive companies in the Electric Utilities industry, Noble has reduced its GHGs when adjusted for increased operations.

More importantly is Noble’s climate change exposure to increased frequency and storms. Offshore oil rigs are at serious physical risk from the increased frequency and severity of storms, and many rigs suffered during the 2005 hurricane season. Noble recognizes the importance of this increased frequency in its 2005 Sustainability Report. Noble’s response has been to increase the strength and number of rig moorings along with improved GPS rig tracking systems that help the company avoid potential rig movements and track those movements if they should occur.

Investors look for this type of disclosure and could potentially red-flag companies that do not discuss the impending and significant risks and opportunities associated with climate change. This company example is only one of the many positive indicators for what is to come from climate change strategic management.


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