Carbon Beta of Securities and their Impacts on Equity Portfolios.

15 NOVEMBER 07INNOVEST STRATEGIC VALUE ADVISORS

Carbon BetaTM of Securities and their Impacts on Equity Portfolios

Pierre Trevet

Managing Director

Innovest Strategic Value Advisors

TBLI 2007

November 15, 2007

Paris - FranceInnovest

STRATEGIC VALUE ADVISORS

Toronto •New York • London • Paris • Sydney • Tokyo • San Francisco


Climate Change is Driving a Global Industrial Restructuring

“There will be a large creation and re-distribution of shareholder value in the transition to a low carbon economy – there will be winners and losers at sector level, and within sectors at company level.

The winners are more likely to be those businesses that take the time to understand and address this complex area.”

Tom Delay, Chief Executive, The Carbon Trust

“Climate Change and Shareholder Value” Report

March, 2006


Climate Change: The Logic for Investors

Companies’ “sustainability” characteristics are becoming increasingly critical to their competitiveness, profitability, and share price performance.

Sustainability analysis can provide additional insights about companies’ strategic management capabilities, organizational agility, and therefore their financial performance potential

Climate change is emerging as the #1 global sustainability risk driver

Climate risk exposure varies widely, between and even within industry sectors; yet those exposures are not fully priced into asset values.

Robust climate risk/opportunity data and analysis are scarce and difficult to obtain; this can create a major information advantage for investors.

Those opportunities can be exploited through a portfolio of major global companies with superior “carbon risk” management, as well as particularly strong exposure to the opportunities being created by climate change.

Combining world-class fundamental and/or quantitative analysis with institutional-quality carbon risk research creates optimal portfolio performance.


What Have We Learned So Far?

The global industrial restructuring towards a “low carbon” future has already begun

Risks are much more broadly –and unevenly—distributed than previously thought

Climate risk has four dimensions, not just one! Analysis must consider:

risk;

risk management;

market-driven upside opportunities

Performance improvement vector

While more & more investors and corporates are now paying attention, most are a long way from integrating the net climate exposure of their assets into actual investment strategies

Investors can make money from climate change – and some are already doing so!


What are the Investment Risks?

Physical

Litigation

Regulatory

Competitive

Reputational

Each of these can affect:

CAPEX

Operating Costs

Cash Flow

Cost of Capital


What Drives Companies’“Carbon Beta”?

Strategic governance (the extend to which companies integrate climate change factors into their business planning impact overall risk)

Product mix – direct, indirect, and embedded carbon intensity (i.e. value chain emissions profile)

Energy intensity, consumption patterns and electricity source mix

Geographic distribution of production assets relative to specific regulatory and tax-related considerations

Business regimes that determine the ability of companies to recoup carbon-driven higher compliance and operating costs from customers

Technology trajectory – level of progress achieved towards adapting and replacing production technologies (some companies can reduce emissions at much lower cost than others)

Ability to identify and monetize revenue opportunities (manufacturing cost efficiencies, new product/service opportunities, emissions trading and clean technology)


Multi-factor Carbon BetaTM algorithms integrate over multiple data points, including:

Core Positioning Liabilities:- Issues faced by industry as whole - Geographic location issues

Core Positioning Liabilities:- Issues faced by industry as whole - Geographic location issues

Financial Risk Management Capacity:- Balance sheet strength - Insurance cover adequacy

Financial Risk Management Capacity:- Balance sheet strength - Insurance cover adequacy

Operating Risk Exposure:- Direct GHG emissions- Indirect carbon risks- Other regulatory

issues- Supply chain management risk

Future Sustainability Risk:- Energy efficiency practices- Carbon intensity per ton of product/$ sales- Product life-cycle durability and recyclability- Exposure to shifts in consumer values- Competitive risks related to core business

Strategic Management Capacity:- Climate change policy

- Core part of env. managementsystems strength

- 3rd party audit/accounting

- Baseline measurement- Supply chain issues- Voluntary charters, working grps

- Mitigation strategy

- Emissions trading work

Sustainable Profit Opportunities:- CDM/JI project involvement- New products, services based on

low carbon profile- Energy efficiency and broader related issues

Carbon BetaTM

RATING


Carbon BETATM Multidimensional Analysis

Carbon Management Strategy: Each company is assessed relative to peers on its carbon management strategy. In particular, we look at stated goals and policies top address climate change challenges.

Carbon Risk Exposure: Risk exposure trends related to climate change are assessed for the sector as a whole, and the company in particular. Three categories of risk are addressed: direct risk, indirect risk (upstream the supply chain) and market related (GHGs emissions related to product in use)

Strategic Carbon Opportunities: Each firm is assessed for its ability to develop and commercialize strategic carbon opportunities relevant for its sector. These may be comprised of anything from direct technical solutions to changes in services and operations management that address climate change and lower emissions.

Improvement Trend: The overall trend for the company vis-à-vis climate change risks and opportunities is assessed.

Scor

esCLIMATE RISK HAS FOUR DIMENSIONS, NOT ONEIt is sometimes (erroneously) assumed that companies’ “carbon footprint” is the paramount or even the only factor to be assessed in determining their risk for investors.


Carbon BETATM: Compliance Cost

Elements that integrate the compliance cost model:• Weighted Average Country Carbon Reduction Target (WACCRT©),

represents the aggregate extent of emissions reductions over the full range of a firm’s industrial activities according to applicable legislations, domestically and internationally.

• Industry Discount Rate, is calculated from the Weighed Average Cost of Capital (WACC) from each specific industry.

• Carbon Cost, is the weighted price for three different scenarios (expected,maximum and minimum price) per emission allowance ($ per ton of CO2equivalent).

• Net Present Value of costs of meeting emissions reduction targets. For calculating this figure we estimate the abatement compliance cost for each year during the commitment period.


Sample Carbon BETATM Profile


CO2 Regulatory Cost of Compliance as Percentage of EBITDA

25.24%

21.45%

10.49%

15.94%

9.72%

7.76%

9.09%

1.23%0.10%

1.42%

3.11%

1.14%

2.92%

0.04%0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Electric PowerCompanies - N.

America

Multi-Utilities &Unregulated Power

DiversifiedChemicals

Specialty Chemicals Metals & Mining Surface Transport Pharmaceuticals

Cos

t of C

ompl

ianc

e as

EB

ITD

A%

Max case Min case

Mylan Laboratories

Johnson & Johnson

CSX Corp.

Union PacificAlcoa

Newmont Mining

Praxair

International & FlavoursFragrances

Du Pont

EastmanChemicals

PG & E

Xcel

Exelon

American Electric Power

“Carbon Beta™” Varies Widely –Both Between and Within Sectors


Disclosure is NOT Enough!

(50)

-

50

100

150

200

250

Jun2

004

Jul20

04Aug

2004

Sep20

04Oct2

004

Nov20

04Dec

2004

Jan2

005

Feb20

05Mar2

005

Apr200

5May

2005

Jun2

005

Jul20

05Aug

2005

Sep20

05Oct2

005

Nov20

05Dec

2005

Jan2

006

Feb20

06Mar2

006

Apr200

6May

2006

Jun2

006

Jul20

06Aug

2006

Sep20

06Oct2

006

Nov20

06Dec

2006

Jan2

007

Feb20

07Mar2

007

Apr200

7May

2007

Jun2

007

Innovest Carbon Performers

MSCI World (Free)

CLI Performers

Difference Cbeta-CLI

Difference Cbeta-MSCI (Free)


Carbon Beta© Performers vs. Laggards Globally

-20%

0%

20%

40%

60%

80%

100%

120%

140%

Jun2004 Sep2004 Dec2004 Mar2005 Jun2005 Sep2005 Dec2005 Mar2006 Jun2006 Sep2006 Dec2006 Mar2007 Jun2007

Tota

l Ret

urn

Wor

ld

Difference Above Average Innovest Rating (World) Below Average Innovest Rating (World)


Carbon Beta© Performers vs. Laggards in North America

-20%

0%

20%

40%

60%

80%

100%


Tota

l Ret

urn

Nor

th A

mer

ica

Difference Above Average Innovest Rating (North America) Below Average Innovest Rating (North America)


Carbon Beta© Performers vs. Laggards in Europe

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%


Tota

l Ret

urn

Euro

pe

Difference Above Average Innovest Rating (Europe) Below Average Innovest Rating (Europe)


Carbon Beta© Performers vs. Laggards in Asia-Pacific

-100%

-50%

0%

50%

100%

150%

200%


Tota

l Ret

urn

Asi

a-Pa

cific

Difference Above Average Innovest Rating (Asia-Pacific) Below Average Innovest Rating (Asia-Pacific)


Carbon Beta© Performers vs. Laggards in the Utilities Sector

-10%

10%

30%

50%

70%

90%

110%

130%

150%


Tota

l Ret

urn

Util

ities

Sec

tor

Difference Above Average Innovest Rating Below Average Innovest Rating


The “Disclosure Quality Premium” is Essentially Zero!

-

50

100

150

200

250


CLI Performers CLI underperformers


Monetizing Carbon Beta in the Fixed-Income Market

The first corporate bond index to address the risks related to climate change

North America Corporate Research

27 February 2007

Introducing the JENI-Carbon Beta IndexThe first corporate bond index to address the risks related to climate change

North America Corporate Research

27 February 2007

Introducing the JENI-Carbon Beta Index

77

80

83

86

89

92

25-Jan-06 25-Mar-06 25-May -06 25-Jul-06 25-Sep-06 25-Nov -06 25-Jan-07

JENI Benchmark Spread (Treasury ) JULI Benchmark Spread (Treasury )

Source: JPMorgan. [update on Feb 25]

Figure 1: JENI-Carbon Beta vs. JULI (spreads over benchmark Treasuries)bps


“Embedded in the challenge of climate change are both dangers and possibilities. Immense dangers for firms and investors who make bad choices, or no choices, about how to respond to the risks, and are then held accountable in the marketplace, the boardroom, or the courts; and immense possibilities for firms and investors to turn challenge into opportunity.”

Dr. John Holdren, Professor; Harvard University

Excerpt from Presentation at the 2005 Investor Summit on Climate Risk

New York City, May 10, 2005


Innovest’s Previous Carbon Finance Work

Carbon Beta Bond Index – Innovest and JP Morgan co-created the world’s first “climate risk-adjusted” bond index – 2007.

Carbon Disclosure Project – selected as the global research provider in each of the CDP’s five years; wrote each report – 2003-2007 inclusive.

Advisory clients have included: U.K. Carbon Trust; U.S. EPA; Natural Resources Canada; U.K. Environment Agency; Australian Greenhouse Office; Electricité de France; Duke Energy; World Wildlife Fund; UN Environment Program.

Innovest has the world’s largest, company-specific research database addressing investment risk – 850 global, high-impact companies covered in-depth; outline profiles of 2300.


Pierre TrevetManaging Director Innovest Strategic Value Advisors

1505 Bridgeway, Ste 106Sausalito, CA 94965USATel: +1 415 332 [email protected]

www.innovestgroup.com

Thank you !

For further information

Perrine DutroncManaging Director - FranceInnovest Strategic Value Advisors

110 Bd de Sébastopol75003 ParisFranceTel: +33 (0)1 44 54 04 [email protected]

Carbon Beta of Securities and their Impacts on Equity Portfolios.

Economy & Finance

Transcript of Carbon Beta of Securities and their Impacts on Equity Portfolios.