New WRI/Ceres Report Highlights Investor Tools for Assessing Climate Risk
The World Resources Institute (WRI) and Ceres released a report, on June 1st, designed to help investors analyze business risks and regulatory uncertainties associated with global climate change.
Citing the growing prevalence of limits on international greenhouse gas (GHG) emissions and the likelihood that national carbon limits will eventually be adopted in the United States, the report recommends that investors assess climate risk posed to their investments and include climate-risk adjustments when valuing companies due to climate-change policies and other related impacts.
"Investors should be assessing which companies are best positioned to adapt to present and future climate policies in the U.S. and abroad," said WRI senior financial analyst Fred Wellington, who co-authored Framing Climate Risk in Portfolio Management with WRI's Amanda Sauer. "Climate change is increasingly being viewed by leading companies as a competitive issue and investors should be assessing climate competitiveness in their investment decisions."
Today's report comes as more U.S. companies, including General Electric, JP Morgan Chase, American Electric Power and Cinergy, are forging their own policies and strategies to improve their competitive positioning on the climate change issue. Many of the same companies are also calling on U.S. policymakers to end the existing regulatory uncertainty, saying that carbon regulations are inevitable and that U.S. companies are potentially losing new market opportunities and facing unnecessary risk when making investment decisions in such an uncertain environment.
"Financial analysts and stock-portfolio managers who are not factoring carbon costs or potential carbon costs into their assessments of companies and entire sectors are not adequately serving their clients," said Mindy S. Lubber, president of Ceres, a coalition of investors and environmental groups that commissioned the report. "Whether it's a new coal-fired power plant or a new line of engines for the airline or railroad industries, carbon emissions and carbon costs are an important factor companies and investors will need to consider before making such capital investments."
Last month, at a climate risk summit organized by Ceres at the United Nations, two-dozen U.S. and European investors managing more than $3 trillion of assets announced they will require investment managers overseeing their fund assets to describe their specific resources and strategies for assessing financial risks associated with climate change. The group of investors also pledged to stake $1 billion in businesses and technologies that are well positioned to reduce GHG emissions.
While each company's climate-risk exposure is unique, the new report provides investors with an analytical framework to assess how climate risk can affect corporate value. The authors recommend that investors account for climate risk across their portfolios, especially in the electric power, oil and gas and auto industries. These analyses should include:
- Impacts of climate risk throughout a company's value chain
- Scope for passing on costs to customers
- Strategic response to climate policies
But the report makes clear that an assessment of climate risk is limited due to uncertainty about future climate policies in the United States. While the report does not advocate using a specific method, it highlights existing financial tools that investors can use to adjust for uncertainty on climate risk. For instance, in standard discounted cash flow analyses, investors can apply:
Cash flow adjustments. Cash flows likely to be affected by potential GHG regulations can be separated and adjusted to reflect climate risk.
Risk-adjusted discount rates. Discount rates could be adjusted upward to reflect greater uncertainty in GHG intensive sectors.
"In the absence of political leadership, companies such as GE and Cinergy are fine-tuning their strategies and investments to improve their competitive positioning on the climate change issue," Wellington said. "Yet without certainty on U.S. climate policy, investors are having a difficult time clearly differentiating which companies will be best positioned in the future."