Climate changes for company profits

With combined assets worth more than $4 trillion (3.4 trillion euros) under management, the ten companies that make up the "Investment Leaders Group" (ILG) are a force to be reckoned with on financial markets. Among them is Allianz Global Investors from Germany, one of the top five money managers in the world, as well as Standard Life Investments, based in Scotland, and Swiss insurer Zurich.

When these institutional investors decide to buy stocks, they move large amounts of money. But when it comes to picking stocks of energy utilities, oil refiners and producers of natural gas, the money managers have become increasingly wary. After all, it is anyone's guess how companies in these sectors will fare at a time when countries (and indeed the whole world) are looking for ways to lower their carbon emissions.

At the climate summit in Paris last year, the international community has agreed to take action to combat climate change. In Europe, the EU has agreed on climate and energy-saving targets for 2030, China is experimenting with a national carbon market, and in the US, the proposed Clean Air Act intends to reduce power plant emissions.

Divest or select?

The big question is how this will affect the profits of power companies. Some funds are "divesting" in fossil fuels, which means they take stocks of companies relying on coal or tar sands off their portfolio. Among them are Norway's sovereign wealth fund, the world's largest, two funds managed by the Rockefeller dynasty, and the German city of Münster.

The Investment Leaders Group (ILG) takes a different approach. Instead of shunning fossil fuel companies across the board, they prefer to look at each individual company. "We think this approach is more nuanced," Andrew Mason, an analyst at Standard Life Investments, told DW. "Companies that are doing well to reduce their impact [on the environment] and support a smooth transition will get rewarded if this approach is applied."

Together with researchers from Cambridge University's Institute for Sustainable Leadership, ILG analysts designed a model which is supposed to show the effect of climate and energy regulation on a company's profits. They looked at three sectors - electric utilities, oil refining, natural gas - in five different countries: the UK, Spain, Germany, Canada's province of Alberta, and the US state of California.

Profits at risk

The model contains two scenarios for each country: The "Transition Scenario" assumes plausible changes in national regulations that would come into effect by 2020. The "Carbon Price Scenario" reflects a more aggressive move to curb emissions and adds a carbon price of 45 euros per ton of carbon dioxide.

The findings which were presented on Thursday showed that energy and carbon regulation can have a huge impact - both positive and negative - on profits. "If regulation in favor of green energy starts coming in, then a Spanish utility will do better than a UK utility," said Mason. British utilities tend to rely heavily on coal, while their Spanish counterparts use more renewable energy sources. As a result, profit margins of Spanish utilities could go up by 76 percent, while UK utilities would actually lose money.

The researchers also found that companies can mitigate the risk. Instead of seeing their profits wiped out, utilities in the UK could boost their margins by up to 50 percent if they changed their energy mix, invested in technical improvements, and raised prices for consumers, according to the report.

At the moment, the model is in its early stages. Ultimately, the researchers want to create a tool that helps investors pick the right stocks. Andrew Mason of Standard Life said the model needed "further feedback from the wider industry." There was no date yet when the tool could be used by investors, and at what costs, he added.

The data problem

Another problem is that the model needs to be fed with data that companies are not legally obliged to share with investors. At this initial stage, only ten companies provided access to their data - hardly enough to get meaningful results. "We were not looking at this stage to scale the model across all listed companies," ILG told DW, "but to validate the applicability and relevance of the model at a company level."

The researchers do not even want to give the names of the companies involved. "I'd be happy to endorse companies which are doing well," Mason said. "But that leads to the question which ones are doing really badly. We don't want to name and shame companies on the basis of these results."

However, Mason is confident that eventually, more companies will provide data to be fed into the investor's stock picking model, even if this could expose weaknesses in their attempt to adapt to new environmental regulation. "We are trying to see more so we can judge companies better," Mason said.

Growing pressure

"I think the better companies will start disclosing this, and other companies will have to do the same. Because if you're not disclosing this information, [investors will ask] why is this the case?" Mason calls this "gentle encouragement," and not only by investors. "The EU is looking for further disclosure on what a company's climate impacts are," he added.

The pressure on companies in the energy sector to adapt their business models to the changing times is mounting. But the mixed results presented this week by Germany's two biggest utilities, Eon and RWE, also show that you don't necessarily need a complicated model to see that.