Carbon is new investment metric

Felicia Jackson examines the impact carbon reporting and Government targets for reducing CO2 emissions will have on investment strategy

In July, the Government announced that all businesses listed on the London Stock Exchange will have to report their carbon footprint from April 2013, making the UK the first country to mandate emissions reporting in annual reports.

With an estimated four million tonnes of CO2 emissions set to be cut by 2021 as a direct result, the UK is now focused on meeting its 2025 target of reducing emissions by 50 per cent.

One of the most important impacts will be an increase in transparency. James Close, sustainability and cleantech services partner at Ernst & Young, says: “Analysts are still driven by short-term metrics, but there is a growing realisation among investors that high-carbon emitters are creating liabilities. They want to know their exposure both to higher energy prices and to the impact of future carbon prices.”

There is a growing body of evidence which suggests companies that report their emissions are outperforming the market. Richard Mattison, chief executive of Trucost, says: “Our analysis of industrial companies in the FTSE All-Share shows companies that report carbon emissions in line with the Government’s 2009 reporting guidelines are 40 per cent more profitable than those that don’t disclose their carbon emissions.”

The FTSE CDP (Carbon Disclosure Project) Carbon Strategy Indices have outperformed their UK benchmarks by 1.5 per cent over a three-year period, while keeping a low-tracking error.

Jonathan Grant, a director at PwC, which is global adviser to the CDP, says: “Carbon leaders delivered approximately double the total return of Global 500 companies between 2005 and 2011.

“We’ve found a strong correlation between good carbon management and higher financial performance. Both will be influenced by a range of factors that probably include the quality of the company’s management team and their approach to capitalising on opportunities and managing risks.”

Investors should consider carbon, as well as energy and other resource-efficiency numbers, as investment metrics

CDP chief executive Paul Simpson says: “Financial outperformance is generally correlated with management efficiency and carbon efficiency is a good proxy for management efficiency.”

The challenge to standardise reporting of sustainability and resource efficiency is what Jenny Harrison, director of assurance and advisory services with Deloitte, describes as “a lack of consistent definitions and descriptions”. Voluntary reporting to date has allowed a range of approaches in how to report emissions. Companies have reported sustainability performance under CSR (corporate social responsibility), ESG (environmental, social and governance) or citizenship, and this in turn has made it difficult for investors to compare and contrast the performance of companies, even in similar sectors.

One of the most obvious uses that investors can make of consistent and transparent reporting of carbon emissions is the direct link between energy use and emissions. Peter Young, chairman of the Aldersgate Group, says: “Mandatory reporting of carbon emissions is a good indicator of efficiency,” adding that efficient companies tend to be more competitive. This competitive edge is especially important when looking at opportunities in the low-carbon goods and services markets.

Guy Battle, lead partner of sustainability services at Deloitte, sees the real challenge in the amount of energy companies use and that the vast majority are not managing the issue at board level. Yet, if energy costs in manufacturing are 2 to 4 per cent of the end product, an increase to 6 to 8 per cent could have a significant impact on overall margins.

While Mr Battle believes legislation is unlikely to drive much opportunity in the short term, the introduction of mandatory reporting, combined with the advent of zero-carbon homes regulation in 2016, means that there will be increasing demand for low-carbon goods, such as energy efficient appliances and low-carbon materials.

The immediate impact of mandatory carbon reporting, says Mr Simpson, “is that it will increase carbon intelligence and knowledge, it will focus companies on the need for measurement”. Such intelligence supports the implementation of a low-carbon strategy, which has a direct impact on the bottom line.

Neil Tonge, global director of environmental, health and safety & sustainability at brewers Molson Coors, explains: “Carbon is cash. To emit carbon we have to consume fuel and it’s expensive. By increasing our efficiency we can make the right decisions today and for the future.”

Will Archer, global sustainability manager for SC Johnson, agrees. He says that, by basing investment decisions on the needs of people, profit and planet, “we can reduce emissions, help profitability and increase control, instead of being subject to the fluctuations of energy supply”.

There is, of course, a long way to go. The new draft regulations do not demand companies make a full assessment of climate-change risk and only require that direct emissions are reported. Although the legislation is set for review in 2016, Mr Simpson says: “The legislation doesn’t cover Scope 3 [emissions within the supply chain], so there is no narrative on how these companies are addressing risk from the supply chain.”

Another challenge is that a low-carbon price can limit the impact of carbon reporting and strategy. But, as Aled Jones, senior associate at Mercer points out, the introduction of the carbon price floor should change this. Mr Jones says that with the introduction of the carbon price floor, analysts can start modelling for different scenarios. “While it’s hard to see a discernible impact in the short term, medium to long term, the pressure is only going in one direction,” he adds.

For Nathan Goode, partner and head of energy, environment and sustainability at Grant Thornton, the most important effect of mandatory reporting will be forcing carbon on to the board agenda. It should also see investors consider carbon, as well as energy and other resource-efficiency metrics, as investment metrics.

He says: “The key lies in understanding how far action has been embedded in particular organisations; some are simply tweaking existing business models, while some are being transformational in their approach. If you’re in a business which is resource-dependent, then there’s a strong argument that your approach should be transformational.”

As Jonathan Maxwell, chief executive of Sustainable Development Capital, concludes: “Shareholders should be concerned about why companies aren’t already working out what they can do to reduce waste and use of resources, such as energy and water, in their footprint and supply chain.”