MSCI

Renewable Energy: 2009

Clean Domestic Energy, with a Catch: The Promise and Problems of Shale Gas

An interesting coalition of groups joined together for a side event at the Copenhagen climate change summit on Dec. 12. Gathered were the Worldwatch Institute, a respected think tank represented by its leader, Christopher Flavin; the United Nations Foundation, established by Ted Turner, and represented by its head, Tim Wirth, a former Senator and the main US negotiator for the Kyoto Climate Conference during the Clinton administration; and the American Clean Skies Foundation, which promotes natural gas as a clean alternative to coal, represented by its CEO, Gregory Staple.

Their three-hour conference was about a low-carbon energy source that could reduce US dependency on both imported oil and domestic coal: shale gas.

One of the lead speakers was Aubrey McClendon, CEO of Chesapeake Energy, a large natural gas producer. He stated that he was in Copenhagen to drive home the point that shale gas production was a game changer in "de-carbonizing" the US economy.

Mr. McClendon explained the potential of shale gas:

  • New technologies, such as hydraulic fracturing ("fracking") and horizontal drilling, have made it feasible to extract vast "new" reserves of gas from underground formations of shale;
  • Natural gas emits about 25 percent less CO2 than oil and 50 percent less than coal;
  • Installed natural gas electricity capacity is already in place, and could meet current U.S. energy demands (unlike nuclear, wind, solar, or "clean" coal plants equipped with carbon capture and storage, or CCS);
  • The steady output of gas plants can help balance the irregularity of solar and wind power; and
  • Unconventional US gas would reduce the nation's dependency on foreign (OPEC) hydrocarbons.

While this message has been delivered consistently to investors by many of the US's independent gas players, the industry could do more to make its case to Congress and the public. The coal, electric utility, and railroad industries have employed top lobbyists to represent their interests, but the natural gas industry has been much less involved in the drafting of US climate change regulations.

Natural Gas Share of US Energy Use to Grow

Still, in its assessment of the American Clean Energy and Security Act of 2009 (also known as ACES, and the Waxman-Markey bill), the Energy Information Administration (EIA) projected that the share of natural gas in US electricity production could increase to 31 percent by 2020 from a 2007 level of 21 percent. EIA further projects a 39-percent contribution to the electricity supply from natural gas by 2030. This would lift the share of natural gas in the overall US energy supply to 26 percent in 2020, up 3 percentage points from 23 percent in 2007, and to 28 percent by 2030.

These projections, however, assume that the US will be unable to take advantage of overseas offsets for its domestic carbon output. EIA also assumes limited deployment of other low-carbon technologies, such as CCS and new nuclear plants.

Gas Industry Seeks Higher Profile

The US natural gas industry believes that ACES should have included greater explicit support for gas in the draft carbon regulation, and also taken a less lenient approach to coal, particularly in the allocation of emissions allowances. The gas industry's presence in Copenhagen is an attempt to raise its public-policy profile, as is the decision by 28 of the largest natural gas independents to form the "American Natural Gas Alliance," which is charged with promoting the benefits of natural gas to the public.

Big Oil Moving into Gas in a Big Way

In a sign of great expectations for the gas market, ExxonMobil recently announced a $41 billion, all-stock acquisition of XTO Energy, an offer price that represents a 25 percent premium above XTO's Dec. 11 closing share price. XTO has the largest proved natural gas reserves among the US independents, and Exxon's commitment to natural gas production in the U.S. not only will offset some of the carbon risks inherent in Exxon's portfolio, but it will also bolster the industry's ability to lobby Congress as it takes up climate change legislation in 2010.

The Impact of "Fracking"

While natural gas is set to play a more significant role in the US energy mix, increased domestic production will carry environmental costs. The industry will need to spend as much political capital on addressing these concerns as it will on improving the position of natural gas in carbon legislation. High on the list of these concerns are the environmental impacts of "fracking."

The Sustainable Investment Research Analyst Network (SIRAN) recently conducted a seminar on the implications of expanded fracking operations. In a follow-up to this article, Alan Petrillo will explore SIRAN's perspective on how the fracturing of shale formations could affect the environment, including the nation's water supply. The process of extracting the fossil fuel with the least impact on the atmosphere could have a big impact on the American landscape.

Despite Setbacks, Some Signs of Progress at the Copenhagen Climate Summit

[Ed. Note: RiskMetrics analyst Mario Lopez-Alcala is attending the Copenhagen summit as an official observer.]

As the Copenhagen climate summit draws to a close, many are disappointed by the lack of progress being made here. The biggest announcement is likely to be a plan to compensate countries that preserve forests and other natural landscapes that store carbon dioxide, the main greenhouse gas tied to global warming.

While other agreements could be reached to place carbon regulations on aviation and shipping, other goals to curb industrial emissions of greenhouse gases and set new financing mechanisms to help developing countries mitigate and adapt to climate change remain elusive. Now the hope is to reach a legally binding agreement sometime next year.

Different World From a Year Ago

Still, as US Deputy Special Envoy for Climate Change Jonathan Pershing observed at Copenhagen's Bella Center last week, today's world is very different from the one we lived in a year ago when it comes to climate politics.

The Copenhagen summit has brought developing countries to the fore, with progressive proposals on mitigation, adaptation, and finance. The United States has also undergone a sharp policy reversal, with President Barack Obama here to underscore the US administration's commitment to tackling climate change. This sets the stage for a changing global regulatory environment that will benefit low-carbon investments.

The road ahead will be bumpy, however. In Copenhagen there have been heated debates on the legal outcome of two parallel negotiating paths: one under the Framework Convention on Climate Change, in which the US is a party; and one under the Kyoto Protocol, in which the US is an observer.

A bloc of Small Islands States led by Tuvalu has proposed developing a new negotiating group to work toward a binding treaty to succeed the Kyoto Protocol with even more ambitious targets. The U.S. regards this extension of Kyoto as a non-starter. Another proposal forged by the Mexican and Norwegian delegations would substantially increase the amount of predictable funding available for climate change actions in developing countries. However, beyond a commitment by the European Union to provide $10 billion annually in such funding as a down payment toward larger giving, the pledges have been few.

Significant Forest Protection Program

In any event, the forest protection program expected at Copenhagen (formally known as Reducing Emissions from Deforestation and Forest Degradation, or REDD) should not be overlooked for its significance.

Rainforest destruction and land conversion are responsible for about 20 percent of annual emissions that contribute to global warming. The REDD program puts financial incentives in place for developing countries to preserve these natural habitats effectively as a carbon-storing bank. Industrial countries would be able to purchase credits from this bank to offset emissions that exceed their own reduction targets.

The current U.S. legislative proposal as passed by the House of Representatives would allow up to one-quarter of the nation's emissions to be offset by such credits from international providers. REDD would help assure that a large bank of credits would be available at affordable prices, easing the pressure on domestic industries to achieve emissions cuts from their own operations.

REDD also could be a shot in the arm for the Clean Development Mechanism (CDM), a project-based source of carbon credits that can be used in emissions trading schemes established under the Kyoto Protocol. So far, the CDM has suffered from heavy bureaucratic oversight and limited geographic scope. However, new measures potentially could arise from talks seeking ways to lessen these drawbacks for CDM projects.

By virtue of the location of the world's rainforests, REDD could help disperse funding assistance across Asia, Latin America and Africa. Some representatives at Copenhagen are even lobbying to extend REDD's provisions to northern boreal forests, which also provide a substantial sink for carbon.

However the REDD program works out, it will be a while before the aid starts flowing. Details that remain to be worked out include setting exact targets and timetables for emissions reductions, and what systems should be used to measure and verify carbon storage of various habitats.

Climate Clock Keeps Ticking

Meanwhile, the climate clock keeps ticking. Scientists presenting at Copenhagen stressed the importance of bringing global emissions to a peak within the next decade and then starting a fast decline, led by a 25- to 40-percent reduction by industrial countries from 1990 levels by 2020. Each year of delay heightens the pace at which emissions reductions must be achieved thereafter.

United Nations Secretary General Ban Ki-moon admonished Copenhagen delegates in an address on Dec. 15 as they moved into their final days of negotiations. "We do not have another year to deliberate," he reminded them. "Nature does not negotiate."

Mario Lopez-Alcala is a member of RiskMetrics Group's Climate Risk Management team.

The climate change scientists whose emails were recently hacked are living their worst nightmare. Like many of their colleagues, these scientists had long been frustrated by a handful of vocal global warming skeptics. The hacked emails gave skeptics a new opening to sow doubts about global warming, just as media attention turned to the Copenhagen climate summit.

These scientists spoke in some private emails of resisting Freedom of Information Act requests and boycotting journals that provide an ongoing platform for the skeptics' views. Neither the hacking nor the censorship should be condoned. But when this dust-up settles, these things will be certain:

  • The evidence of human contributions to global warming is so overwhelming that this media sideshow will have no impact on the outcome of the Copenhagen meeting.
  • The real issue to be addressed at Copenhagen is how to pay for the ballooning costs of climate change. These costs now include not only trillions of dollars of investments in carbon mitigation, but also spending on adaptation measures, to address warming that will continue throughout our lifetimes. By some estimates, these adaptation costs will rise above $100 billion a year.

The Impact of Dumping "Coal Mines into the Air"

Global warming is a scientific fact. The debate now is at the margins of just how fast and dangerous the warming will be.

Svante Arrhenius won a Nobel Prize in 1896 for his theory that "evaporating our coal mines into the air" would eventually double the atmospheric concentration of carbon dioxide and raise the Earth's temperature by 5 to 10 degrees Fahrenheit. That's still the basic forecast today, except what Arrhenius thought would take a thousand years could well happen in this century.

The World Meteorological Organization has reported that the first decade of the 21st century will be the warmest since modern temperature records began in 1861. The Earth's temperature has risen nearly 1.5 degrees F since then, with another 1 degree F of warming expected within the next 30 years as the warming trend accelerates. By 2100, the Earth could be as much as 8 degrees warmer - a level not seen since the Age of the Dinosaurs 65 million years ago.

While skeptics point out that the global temperature has not exceeded the peak set in 1998, this does not change the fact that the Earth has caught a fever and so far has done nothing to stop it. In fact, all of the years since 1998 rank among the warmest on record; 2009 is expected to go down as the fifth warmest year.

If one wants other physical evidence of this warming, look no further than the North Pole, where the Arctic Ice Cap–a permanent fixture of the Earth over the last 3 million years–is melting so fast that it could disappear entirely during summer months within the next five to 10 years.

Official Scientific and Governmental Consensus

Since 2000, many of the world's most reputable scientific organizations have issued reports or statements supporting the human link to global warming, and the dangers it poses:

  • In 2001, the U.S. National Academy of Sciences issued a report at the request of the Bush administration that concluded rising global temperatures in recent decades were "likely mostly due to human activities" (and issued a much more strongly worded report in 2009).
  • In 2003, the American Geophysical Union concurred, saying, "Scientific evidence strongly indicates that natural influences cannot explain the rapid increase in near-surface temperatures observed in the second half of the 20th century."
  • In 2004, the American Meteorological Society issued its own warning, describing human-influenced climate change as "a global climate experiment, neither planned nor controlled."
  • In 2007, the Intergovernmental Panel on Climate Change (IPCC) issued its fourth assessment since 1990 on the state of climate change science. It concluded that there is greater than 90 percent certainty that most of the warming over the past 50 years has been caused by human activities, and that 3.4 degrees F to 8.3 degrees F of warming is likely with a doubling of atmospheric CO2.
  • In March 2009, the IPCC provided a disturbing update to its forecast, warning that "[r]ecent observations show that greenhouse gas emissions and many aspects of the climate are near the upper boundary of the IPCC range of projections." Simply put, "the worst-case IPCC scenario trajectories (or even worse) are being realized."
  • And on Monday, the U.S. Environmental Protection Agency issued a final ruling that greenhouse gases are endangering the environment and human health, triggering the need for regulatory controls. This finding, too, was driven by the weight of scientific evidence that human activity is largely responsible for the warming taking place.

"We know that skeptics have and will continue to try to sow doubts about the science," remarked EPA administrator Lisa Jackson at the announcement. "It's no wonder that many people are confused. But raising doubts – even in the face of overwhelming evidence – is a tactic that has been used by defenders of the status quo for years."

Academic Consensus

That is why responsible climate scientists find it so frustrating that public doubts persist, even though the basic premise that human activity is contributing to climate change has not been seriously contested for years or even decades:

  • One literature review of 928 peer-reviewed articles published in the 1990s and through 2002 found that 75 percent either explicitly or implicitly accepted the consensus view that human activity is contributing to global warming. The remaining 25 percent of these studies dealt with other facets of the climatological issue, stating no position on this key question, according to the review by the Program in Science Studies at the University of California.
  • In another recent survey of more than 3,000 Earth scientists, 82 percent agreed that human activity is a "significant contributing factor" in changing global temperatures. Specialists in the field who actively publish on the issue were in almost total agreement: 75 of these 77 climate scientists–about 97 percent–agreed with the statement.

Fundamentally, responding to climate change is sound risk management. While the chance of our house burning down is highly remote, we still take the precaution of buying fire insurance. Why then would we not take out insurance when there is a greater than 90 percent chance that our world is catching fire?

That is what the Copenhagen summit is really about. The longer we postpone real action to bring down greenhouse gas emissions to address global warming, the higher our premium costs will go.

...

For another review of skeptics' claims and scientists' rebuttals, see this December 7th Wall Street Journal article: "What global warming? A look at the arguments the skeptics make–and how believers respond"

...

Doug Cogan is Director of Climate Risk Management for RiskMetrics Group. His 1992 book, The Greenhouse Gambit, was one of the first to address the business and investment implications of climate change. He has since written many other reports and articles on climate and energy topics and helped develop a Climate Change Governance Framework to analyze corporate and fund manager responses to this issue.

This week, Congress and the Obama Administration are discussing the future of American energy policy. The outcome of these efforts is unknown, but forward-thinking investors already expect big changes in the energy sector. The markets' preparation for a less-polluting future includes the October announcement that First Solar, a solar-power technology firm, will soon join the benchmark Standard & Poor's 500 index.

Investors expect a bright future for First Solar, a FTSE KLD Index constituent since 2007, partly because they assume that governments will eventually tax carbon emissions. If the carbon output of producers and consumers is taxed, then the relative cost-efficiency of solar and other renewable energy sources will increase.

Dirty Fuels Are Expensive, Even Without a Carbon Tax

To tax carbon, or not to tax? Is that the question?

It's not the only question to ask about our fuel mix. The status quo may be economically unsustainable even before we put a price on carbon: New government research finds that non-carbon emissions annually impose over $100 billion in unaccounted-for costs on our economy.

Keith Johnson of the Wall Street Journal has written about a massive federal study of the unpriced costs, or externalities, of American energy. "Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use" is a 374-page inquiry into this issue by the National Academy of Sciences.

Mr. Johnson writes that while the Academy quantified the impact of particulate and other emissions, they declined to assign a price to carbon. Investors and policymakers should note that, even if we assume that carbon emissions are "free," fossil fuel consumption is not:

"America's current energy mix carries a 'hidden cost' of about $120 billion a year, the report found. And that number doesn't include any tally for the cost of greenhouse-gas emissions or climate change–estimates for climate costs range from $1 to $100 a ton of carbon dioxide emissions, but are so variable the report didn't quantify them. … "The $120 billion figure boils down to coal and cars. Transport costs the country $56 billion. Coal-fired electricity costs the country $62 billion per year, largely in health impacts from particulate matter. Natural gas for power generation, in contrast, adds about $740 million a year in hidden costs. "Looked at another way, coal's hidden price tag adds up to 3.2 cents per kilowatt hour. Compare that to the 2 cents per kilowatt hour that wind power gets from the government–that's less a subsidy than a partial attempt to level the playing field."

The Price of Particulates, SO2, and NOx

"Hidden Costs" lists the pollutants accounted for by the 3.2 cents per kilowatt hour price:

"Regarding Comparisons Among Fuels for Electricity Generation: In 2005 damages per kWh from SO2, NOx, and PM (particulate) emissions were an order of magnitude higher for coal than for natural gas plants: on average, approximately 3.2 cents per kWh for coal and 0.16 cents per kWh for natural gas (2007 USD). SO2, NOx, and PM emissions per kWh were virtually nil for electricity generation from nuclear, wind, and solar plants and not calculated for plants using biomass for fuel."

The Academy also admits that current research does not sufficiently account for environmental impacts beyond combustion emissions:

"Continued improvement is necessary of methods to quantify and monetize ecological impacts of all stages of the life cycle of electricity generation, especially of fuel extraction, emission of pollutants, and land-use changes. Similar needs exist for other types of energy production and use. "For fossil fuel options, more research is needed to quantify and monetize the ecological and socio-economic impacts of fuel extraction, e.g., of mountaintop mining/valley fill."

Coal is Costly, Believe in Climate Change or Not

The Academy concedes that the study hasn't revealed all the "Hidden Costs" of the American energy sector. Still, their work is a valuable policy tool. By reaffirming that carbon isn't the only costly externality of fossil fuels, "Hidden Costs" could support a more productive discussion of our energy future. Even those who don't believe in man-made climate change would concede that $120 billion is a lot of money to send up in smoke every year.

As KLD President Peter Kinder told an investors' forum on energy last spring, "We should be careful not to let 'carbon' become a proxy for 'environment.' Carbon is only one part of the case for change."

On August 11, the Financial Times reported on the promise of "synthetic biology," including the development of algae that generates biofuels. In July, ExxonMobil entered into a $600 million venture with Synthetic Genomics, a firm founded by biotech pioneer Dr. Craig Venter. "Synthetic Genomics has already engineered strains of algae that secrete oil from their cells," writes the FT's Clive Cookson.

Will oil companies transform themselves into algae companies? Or, a few years from now, could the makers of "Who Killed the Electric Car?" film a sequel about algae?

The Most Promising Biofuel

Algae is a photosynthetic organism, which typically survives under water in much the same way that plants survive on land–by consuming carbon dioxide and sunlight and expelling oxygen. One of the fastest-growing organisms on earth, algae presents remarkable potential as a replacement for fossil fuels. Most notably, it consumes CO2 while it grows and can produce oil that can be burned in ordinary diesel engines.

Algae also has distinct advantages over other biofuels. First, the US Department of Energy reports that algae yields 30 times more energy per acre than land crops. Second, since it can grow in saltwater, and can even be grown vertically, it does not compete with food crops for arable land, unlike ethanol from corn, sugarcane, and soybeans. Third, algae growth does not demand limited resources, like soil or potable water.

As of today, algae's only disadvantages are its cost and suitability for large-scale, industrial use. There are several industry organizations devoted to reducing these disadvantages, such as the Algal Biomass Association. Many small biotech startups are also seeking ways to lower cost.

Algae for Airliners and Power Plants

Though algae has been studied as an energy source for over 35 years, interest has taken off recently – led by the aviation sector. After the world's first biofuels test flight in February 2008, in which Virgin Airlines used a blend of 20% babassu and coconut oil, the airline industry has committed to algae. By early 2009, Continental Airlines and KLM-Air France had operated test flights using 50% algae-blend biofuels. KLM ambitiously plans to fuel 50 of its planes with algae by 2010, and Lufthansa plans to fuel at least 5% of its planes with biofuels by 2020. Aerospace giant Boeing founded the Algal Biomass Organization, which is chaired by Boeing executive Billy Glover.

Algae could also help reduce CO2 emissions by power plants. Utilizing technology created by GreenFuel Technologies, an MIT-based firm, Arizona Public Service has experimented with this since 2006. Algae flourishes when fed CO2 from a power plant's exhaust stack.

A number of firms are researching algae for automotive use. Solazyme, a California-based startup, uses yeast and fermentation to grow its algae. Solazyme is working with Chevron, the second largest oil producer in the United States. Sapphire Energy, a company funded by Bill Gates' investment firm, also plans to turn algae into automobile fuel. And as mentioned above, ExxonMobil has entered into a joint venture with Synthetic Genomics.

"Green Company of the Year"

In August 2009, Forbes magazine awarded ExxonMobil its "Green Company of the Year" award, but that was primarily for its interest in liquefied natural gas (LNG). In a gushing article mostly focused on Qatari gas fields, the magazine described ExxonMobil's algae investment as a "purely political" step to "buy some peace with environmentalists."

Perhaps. It's also possible that oil companies could be purchasing algae-related patents to suppress their application. "Who Killed the Electric Car?" provides an example of how a large corporation could squash technology that it perceives as a threat. In the 1990s, General Motors developed an electric car, but refused to widely market the product despite heavy demand. The company cited high production costs as the reason for discontinuing its EV1, before literally crushing the vehicles.

Today, a post-bankruptcy GM is betting its future on the electric car. There is evidence that ExxonMobil may also be sincere in preparing for a post-petroleum future. In a 2008 KLD Blog article, Alan Petrillo noted that ExxonMobil has sharply reduced its spending on oil exploration. Forbes says plainly that the firm "is running out of oil."

As states control more and more of the world's oil fields, ExxonMobil may be buying algae to protect itself as a refiner and marketer. Forbes emphasizes ExxonMobil's good relations with its Qatari LNG partners, but no major oil firm can rely on only one source. By working with Craig Venter, Exxon Mobil could reduce its dependency on the Hugo Chavezes of the world.

Still, as the firm whose name is forever attached to Valdez, ExxonMobil will always inspire suspicion from some observers, who fear we may someday ask: "Who Killed the Algae?"

As the Senate deliberates over the House's Waxman-Markey cap-and-trade bill, Politico has presented a debate on the bill's potential impact on the US economy. Mindy S. Lubber, of the environmental coalition Ceres, argues that Waxman-Markey "deserves our support." In response, William L. Kovacs of the US Chamber of Commerce tells why he believes the economy will be harmed by the bill's provisions.

Their discussion is a useful summary of pro- and anti-Waxman-Markey arguments. It also shows that a productive public policy debate depends on data. While both sides marshal projections and estimates to make their case, neither can present hard numbers on the cost of carbon emissions by American business. Many companies disclose some data, but without standardized, economy-wide reporting, no one can know the real costs or benefits of a cap-and-trade scheme.

To fill this void, Federal regulators are considering a plan to force "public companies to report the dangers they face from releasing carbon dioxide and its warming aftermath," according to Evan Lehmann in the New York Times. He cites Ceres research that found "76 percent of Standard & Poor's 500 companies failed to mention climate change in their annual reports to the [Securities and Exchange] Commission last year."

Mandatory, comparative reporting is essential to the business case for – or against – Waxman-Markey, or any future attempt to set a price for carbon emissions.

The Business Case, Pro and Con

In their arguments, both Ms. Lubber and Mr. Kovacs focus on the societal cost of carbon pricing. Ms. Lubber cites a Congressional Budget Office estimate that the direct costs of Waxman-Markey will "average about $175 annually per family by 2020." She argues that this cost would be justified by the growth of a "clean energy economy," and that opponents are discounting "the costs of doing nothing":

"Perhaps the most maddening aspect of debate over the Waxman/Markey bill has been the consistent omission by opponents of the costs of doing nothing -- the enormously high and disruptive price science tells us we'll pay if we don't act now. Disrupted agricultural patterns, more and stronger storms, rising sea levels, a scramble for dwindling resources -- all propelling population shifts and requiring massive emergency spending as we try to cope."

Mr. Kovacs, representing the US Chamber of Commerce, accepts that "a feasible cap-and trade system might work." His rebuttal focuses on the flaws he sees in this particular bill, arguing that it will create unfair burdens on consumers and businesses. "Carbon-based fuels are and will remain for decades the backbone of the U.S. energy system," he says, and he believes that carbon caps would hurt US competitiveness:

"Imposing limits on our own energy use and driving up our own costs – while developing nations like China and India pollute with abandon – will neither reduce global greenhouse emissions nor improve America's competitive position. … "Now, regarding the cost, let's go to the CBO pricing mentioned: 'The resource cost does not indicate the potential decrease in gross domestic product (GDP) that could result from the cap.' … In other words the $175 figure is merely a fraction of the cost, as it does not include economic impact."

The Hidden Costs of the Status Quo

Ms. Lubber takes issue with many of these contentions. She also says that not assigning a price to carbon distorts our analysis of its cost:

"This bill, even in its present form, is not about distorting the workings of the carbon market, as Mr. Kovacs says. In fact, it's very much about correcting a massive existing distortion long-embedded in our current market system -- the fact that the price of emitting global warming pollution has been zero. "Why doesn't a business group see this distortion? Once polluting costs are honestly counted we'll innovate our way to less polluting – transparency and honest accounting make markets work."

The Investors' Case for "Honest Accounting"

Evan Lehmann, in explaining why the SEC is taking a "a very serious look" at mandatory disclosure of exposure to climate-related risk, sums up investors' concerns:

"Institutional investment groups with trillions of dollars in assets could use the disclosures as the basis for withdrawing money from companies they consider unprepared for rising risk related to regulation and climatic convulsions. " 'It's reasonable to expect that companies would fail to focus on long-term risk posed by climate change, and more forced disclosure would correct a potential market failure,' said John Echeverria, executive director of Georgetown University's Environmental Law and Policy Institute. 'That seems like incredibly important information that investors might have.'"

Argue from the Facts

The Chamber's essay suggests that business presents a unified opposition to Waxman-Markey, but the Wall Street Journal has reported that some companies have charted their own path. Mindy Lubber notes that many major firms support "carbon reduction targets, carbon caps and immediate steps to improve energy efficiency." Also, while Ceres and many environmental groups support Waxman-Markey in its current form, Friends of the Earth, Greenpeace, and Public Citizen oppose the bill for not being strong enough.

This diversity of opinion is welcome, especially if all sides can agree on the terms of debate. In moving to require uniform disclosure of climate risk, the SEC recognizes that sound investment – like productive policy debate – is founded on facts. Mindy Lubber quotes the late Senator Patrick Moynihan: "While people are entitled to their own opinions, they're not entitled to their own set of facts."

For more on this topic, see The Risks of Climate Change are Already Material: New Ceres/EDF Study Calls for SEC to Mandate Better Disclosure

Carbon Counts USA, a new report from research firm (and KLD partner) Trucost, studies the "carbon intensity" of 91 major mutual funds. Trucost found wide variation in funds' carbon footprint, as the highest-carbon fund they studied was 38 times as carbon-intensive as the best performer.

Perhaps due to the Obama Administration's stated commitment to a national carbon emissions market, Carbon Counts USA (available here) has attracted attention from the business press. Dow Jones' Daisy Maxey writes that major fund managers are "responding cautiously" to the implication that they should consider companies' carbon footprints:

"In carefully worded statements, some companies shied away from ideas like explicit environmental screening but contended that, to the extent that carbon emissions are affecting a company's profits, it would be included in a fund manager's evaluation."
What about investors who embrace "explicit environmental screening"? Carbon Counts USA studied 16 funds that incorporate environmental, social, and governance (ESG) factors into their strategies:
"Of the 91 analyzed funds, 16 include sustainability or socially responsible investing (SRI)considerations. These 16 funds comprise holdings valued at over $24 billion and have the smallest aggregated carbon footprint [of any researched fund style]..."
While the overall carbon efficiency of SRI funds is welcome news, Trucost found some notable outliers:
"…Sustainability/SRI funds have the smallest carbon footprint. However, within this category, carbon efficiency varies widely – some of the largest SRI funds are more carbon intensive than the S&P 500."
Why do some funds that seek to hold strong environmental performers actually deliver worse-than-average carbon efficiency? To understand this, consider how Trucost constructed its study, and also note that there is more than one way for investors to support lower global carbon emissions. Some companies' products and services may reduce their customers' carbon output – but not their own. How Trucost Measures Carbon Intensity Carbon Counts USA presents a concise summary of Trucost's methodology:
"The equity fund carbon footprint is calculated by measuring each constituent company's GHG emissions. Quantities of each GHG are converted into their carbon dioxide-equivalent (CO2-e) emissions. CO2-e emissions associated with a company are allocated to the fund in proportion to ownership. The carbon footprint is expressed as metric tons of CO2-e emitted by the companies within each fund per million dollars of revenue."
By this measure, a fund's carbon intensity reflects the business models of its constituents. Trucost notes that the five most carbon-efficient funds all avoid energy-intensive businesses like mining, energy generation and food production:
  • "Four of the funds do not invest in the Basic Resources sector.
  • The top three do not invest in the carbon-intensive Utilities and Oil & Gas sectors, and have 80%+ invested in low-carbon sectors such as Financial Services, Banks, and Healthcare.
  • Three of the funds are underweight in Food & Beverage companies relative to the S&P 500; the other two do not invest in the sector."

Portfolio Footprint vs. the Economy's Footprint

To their credit, Trucost acknowledges that its carbon intensity metrics may not account for the ancillary benefits of a "dirty" company's work:

"Where climate change criteria are included in stock selections, managers may focus on clean technology or renewable energy developers rather than carbon performance from operations. Since operations to develop environmental 'solutions' generate greenhouse gas emissions, these production processes are exposed to carbon costs which are likely to apply across industrial sectors and energy users. [emphasis added]…"

KLD Senior Analyst Andrew Brengle cites the Global Climate 100 index as an example of a solution-driven environmental investment strategy:

"The GC100 is not a carbon-intensity index. Its objective is not to seek out a 100-constituent group with the smallest carbon footprint. Instead, it identifies companies that are pushing the global economy toward a less carbon-intensive state.

"It certainly includes companies with small carbon footprints. But it also includes those with large footprints who are leading the way in carbon intensive industries, such as utilities who have committed to wind and solar power.

"These 'big-footed' companies make a big impact, because they offer leadership where it's needed most."

Investors Look to Government

While some investors already seek to reduce our economy's carbon intensity, many more are concerned with emissions' potential impact on the bottom line.

In assigning a dollar value to companies' carbon output, Trucost assumed a price of $28.24 for each metric ton of greenhouse gas emissions. This cost is, in the US in 2009, purely hypothetical. A national carbon emissions market will make the need for proper accounting more acute.

Though major carbon producers remain politically powerful, the Obama Administration has reaffirmed its commitment to a "gradual, market-based cap on carbon pollution." Even though Congress has blocked the President's attempt to include cap-and-trade in the budget, he continues to promote the idea. Here, thanks to Chris Fox of Ceres, is a portion of the President's April 14 address:

"Some have argued that we shouldn't attempt such a transition until the economy recovers, and they are right that we have to take the costs of transition into account. But we can no longer delay putting a framework for a clean energy economy in place. If businesses and entrepreneurs know today that we are closing this carbon pollution loophole, they will start investing in clean energy now."

On February 11, a team from American Electric Power (AEP), including CEO Mike Morris, spoke to KLD about its preparations for a carbon-constrained US economy. The KLD Blog article "Coal is Still King, For Now" presented an overview of AEP's presentation, including the company's positions on utilities regulation, carbon credits trading, and the prospects for "clean coal" technology.

As Alan Petrillo wrote in "Part One":

"AEP's multibillion-dollar cleaner energy initiatives show that the company takes sustainability seriously, as does its willingness to engage stakeholders such as Ceres, KLD and our clients. AEP's ongoing commitment to coal, however, is a bet on future technological and political developments that are by no means certain."

This article will consider AEP's positions in the context of a broader political perspective. While the regulatory environment in AEP's service area has been favorable for coal interests, the industry's future may hinge on federal policies, and federal tax dollars.

Coal States, Coal-Friendly Regulation

The Obama Administration plans to set national goals for reducing carbon emissions, but the states have been in charge of emission reduction programs thus far. The Pew Center on Global Climate Change reports that as of January 2009, 35 states had developed climate action plans. As of February 2009, 21 states had set specific targets to reduce emissions.

Mike Morris told the KLD forum that AEP offers "zero resistance to the idea of state-by-state renewable energy standards."

Mr. Morris's support for this approach is understandable. While many states pursue aggressive carbon dioxide (CO2) reductions and renewable portfolio standards (RPS), the states in which AEP operates are not among them. Of the 11 states in AEP's service area, only Michigan, Ohio, Texas, and Virginia currently have any RPS. Only Virginia has set specific emissions reduction targets.

Protecting the Status Quo, 1: AEP's Position on Cap and Trade

President Obama proposes more stringent federal standards. He has stated plans to increase the US market share of renewable energy to 10% by 2012 and 25% by 2025. Obama's plan also calls for a reduction of greenhouse gas (GHG) emissions to 1990 levels by 2020.

To meet its ambitious goals, the Obama Administration seeks to expand the market for carbon emissions credits. The President calls for a cap-and-trade system to support an 80% reduction in GHG emissions by 2050.

Mr. Morris told his KLD audience that "I'm not against a carbon cap," but he does have reservations about the auction of carbon credits. "An auction would be a massive revenue machine," Mr. Morris said, and he fears that the government will misallocate this revenue.

AEP would prefer an allowance-based system that would distribute carbon credits, free of charge. More credits would be granted to companies that have greater current carbon emissions. As AEP is one of the nation's top emitters of carbon, allowances would sustain both AEP and the nation's coal-burning status quo.

Protecting the Status Quo, 2: AEP on Federal Emissions Standards

If new federal emissions standards supersede states' rules, AEP would seek exemptions that would effectively maintain the current regulatory patchwork.

Mr. Morris stated, "If the federal standard is 20% [of total energy use coming from renewable sources] by 2020, okay. But if West Virginia can't hit 20% because of its particular circumstances, then there shouldn't be any penalties. I don't want to see my customers pay a fee, really a tax, for something they can't do. … Paying a fee because we can't hit an unrealistic target is unfair to our customers."

AEP's position, then, is that federal regulation is acceptable if it still permits states to set their own standards. Mr. Morris's "particular circumstances" would seem to undermine national targets with piecemeal, state-by-state exemptions. Interstate utilities would still be able to pursue a kind of regulatory and legislative arbitrage, ensuring that states whose economies depend on coal mining and burning – like West Virginia – could deviate from federal rules without sanction.

It's Still Coal

AEP's public statements indicate that the company believes that human activity contributes to climate change and that GHG emissions must decline. Carbon capture and sequestration (CCS) and other clean coal technologies would protect AEP's investments – and AEP itself. But is what's good for AEP good for America?

Clean coal is still coal. Compare the CO2 emissions of a clean coal plant to those of a wind farm or solar array. We also must account for the coal plant's sulfur dioxide (SO2), nitrous oxide (NOx), particulate matter, and mercury emissions. Finally, consider the ecological impact of mountaintop coal removal, ash disposal and other ancillary costs of coal-powered utilities.

For an integrated utility like AEP – one whose entire business model has been built around generating and transmitting coal power – these are costs that governments, companies and citizens must share. Stakeholders outside the "coal states" cited by Mr. Morris, however, might prefer to direct scarce resources elsewhere.

To take only one dramatic example, General Electric claims that the entire energy demand of the U.S. could be satisfied by covering 7% of Arizona with solar panels. Also, there is great untapped potential in the "fifth fuel" – energy efficiency. A McKinsey study has shown that if the entire US used electricity as efficiently as California already does, 40% of US electricity demand could simply vanish.

These measures would be expensive, and their practical application would be a daunting task. But even AEP acknowledges that clean coal initiatives like FutureGen would also require massive federal investment.

Power: Electrical and Political

As citizens – and investors – consider the prospects for clean coal, they should keep in mind that the question is as political as it is technological. AEP concedes this. For example, here is a public statement on the potential for market-based carbon pricing:

"…Our stakeholders are divided on having a price ceiling, or "safety valve," in the [carbon pricing] legislation. The Environmental Defense Fund, for example, strongly opposes a safety valve and has urged us to abandon our support for that provision. Our customers, however, could be severely affected by escalating energy rates if carbon prices were entirely market-based, and would pay more for their energy, through no fault of their own, than customers of utilities that derive less of their power from coal." [emphasis added]

It follows from this position that if AEP's customers are not ultimately responsible for reducing carbon emissions, then neither is AEP. The cost of coal power, however, is not only borne by AEP's customers. Coal-burning utilities concede that their future depends on friendly federal regulation – and federal subsidy. In evaluating the prospects for these companies, investors should note that the industry's fate may be out of the coal states' hands.

Is the recently-passed economic stimulus bill a down payment on a greener economy, or does it reaffirm the carbon-centric status quo? The answer, as could be expected from a $787 billion omnibus bill, is "both."

The New York Times, BusinessWeek, and ProPublica have posted surveys of the stimulus, whose potential impact could be felt for generations to come. It could also take a generation to determine the bill's ultimate winners and losers, but some trends are apparent. The table below compares ProPublica's House, Senate and final numbers for initiatives that could have a significant environmental impact.

Positive signs include:

  • Support for battery and "smart grid" research and development.
  • A commitment to energy efficiency, both in the private sector and in government-owned facilities.
  • Increased funding for freight railroads, which move goods more efficiently than trucks.

Other commitments in the bill seem likely to ensure that carbon-heavy fossil fuels will retain their importance to the US economy. The final bill includes billions for fossil fuel energy research, which could include clean coal initiatives such as carbon capture and sequestration (CCS). While these programs could reduce the atmospheric impact of coal-burning, they also reinforce a long-term commitment to this "dirtiest" fossil fuel.

Also, funding for mass transit, clean water initiatives, and renewable energy research and loans all declined in the final compromise. For more details, please see the ProPublica site and Kate Sheppard in Grist.

Data Source: http://www.propublica.org/special/the-stimulus-deal

On February 11, a team from American Electric Power (AEP), including CEO Mike Morris, spoke to KLD analysts and clients. AEP is a utility company that runs the nation's largest electricity transmission system and owns 36,000 megawatts of generating capacity. It's also the largest user of coal in the Western Hemisphere. The company's executives visited KLD to explain how they're preparing for a future of sharply constrained carbon emissions.

This article will summarize AEP's policy positions as presented to KLD. Part Two will provide more detail on the technological, political and economic challenges facing coal-burning utilities, which power much of the US (and global) economy.

"Our window for timely action on climate change is fast closing, which makes it essential for investors to engage bellwether companies like AEP," said KLD Senior Analyst Andrew Brengle.

As part of its engagement efforts, AEP has committed to annual sustainability reporting and dialogue with stakeholders, including activist investors represented by Ceres. At the KLD forum, Mr. Morris presented an overview of his company's efforts to produce and/or purchase more renewable energy for its more than 5 million customers.

He also asserted the continued importance of coal as a source of electricity. Mr. Morris was candid about the political calculus behind AEP's position:

"We have 25 'coal states.' That's 50 Senators whose states depend on this economy."

The heart of AEP's response to a carbon-constrained future is "clean coal" technology. This is a controversial topic – pro and con recently dueled on the New York Times op-ed page – and AEP has bet its future on clean coal's potential.

AEP's Commitment to Coal

In response to a question from KLD Analyst Sharon Squillace, Mr. Morris described AEP's involvement with two clean coal R&D initiatives: carbon capture and sequestration (CCS) and integrated gasification combined-cycle (IGCC). CCS prevents carbon from being released into the atmosphere, while IGCC converts coal into a cleaner-burning gaseous hydrocarbon.

AEP was also a key participant in FutureGen, a government-sponsored pilot program that would combine IGCC and CCS at a single plant. FutureGen is currently in limbo, but AEP and others would like to see the project revived under the Obama stimulus plan.

Mr. Morris on CCS:

"[We're] demonstrating that carbon capture works. If CO2 emissions reduction is the law of the land, that's what we'll do. Nobody in our space is moving as aggressively on this issue. "Through the chilled ammonia process, we capture exhaust and re-segregate it into pure ammonia and pure CO2. Opening this September is a 20 megawatt plant with capture and storage capabilities. [In 2011 AEP will have a] 235 megawatt plant with CCS."

Mr. Morris said that AEP will incur a cost of $600 million for the first plant, with five additional plants planned at a cost of $200 million each. To keep this in perspective, he made clear that "We still have a massive investment in our existing facilities," he said. "We have $5 billion invested and we will not just walk away from that."

The as-yet-unbuilt FutureGen plant is designed to employ carbon capture and storage and also uses IGCC. Gasified coal burns more cleanly than solid coal, allowing for a smaller carbon capture system than is required for a conventional coal-burning plant.

Mike Morris explained AEP's position on FutureGen:

"Our Mike Mudd is president of the FutureGen alliance. We believe that the government made a massive mistake by pulling the plug. It's designed, bid out, shovel ready, ready to go. "The formula they used to use [to cancel FutureGen development] is no longer viable. Back then, $2 billion was a lot of money. In this stimulus package, they ought to build out the whole thing. It would mean 3,500 big time jobs. Put $2 billion towards something that really matters."

Carbon Credits: Auctions vs. Allowances

The KLD Blog has previously considered plans to account for carbon emissions, including the "cap and trade" concept that President Obama endorsed as a candidate and includes in his first budget. Mr. Morris told his KLD audience that "I'm not against a carbon cap," but he does have reservations about the auction of carbon credits. He would prefer the free distribution of allowances to utilities:

"Allowances should come after the cap [is defined and implemented], not before. The feds should come back to utilities with allowances to apply towards supplies of carbon. We believe that allowances should be distributed to those of us who need to put capital to work."

If carbon credits were to be auctioned, Mr. Morris does not believe the resulting revenue should be disbursed to ratepayers, as some have proposed in a "cap and dividend" program:

"An auction would be a massive revenue machine. The reallocation of that capital will look like a handout program, for better or for worse. If your goal is redistribution, that would do it….If funds were collected from auctions and sent out to customers, we will miss an opportunity to do the right thing."

Pat Tomaino, an analyst at F&C Management, asked, "Could there be a 'middle ground' between allocations and auctions?"

Mr. Morris replied:

"We need to target monies back to those forcing technology in the field. If we don't force new technology into the field, we're going to run out of energy. Our 'middle ground' is a sacrosanct funnel back to local distributors [such as AEP]."

"A states' rights issue"

In response to a question by Anita Green of the General Board of Pension and Health Benefits, Mr. Morris described AEP's position on the balance of regulatory power between states and the federal government. As an interstate company, AEP must work with many separate regulatory regimes, but the company is concerned that greater federal involvement could lead to other problems:

"We provide zero resistance to the idea of state by state renewable energy standards. …We argue strongly against the notion of penalties if standards aren't met. This is a states' rights issue. … Anything else is a cost to our customers without any benefit. "If the federal standard is 20% [of total energy use coming from renewable sources] by 2020, ok. But if West Virginia can't hit 20% because of its particular circumstances, then there shouldn't be any penalties. I don't want to see my customers pay a fee, really a tax, for something they can't do. … Paying a fee because we can't hit an unrealistic target is unfair to our customers."

AEP also supports greater federal investment in the long-distance electric grid. Increased transmission capacity could help distribute power from renewable-rich states to those with less potential for wind or solar generation.

Again using West Virginia as an example, Mr. Morris said, "I would accept higher standards for renewable use in West Virginia if I could sell them wind energy from Oklahoma."

AEP's Positions in Perspective

AEP's multibillion dollar cleaner energy initiatives show that the company takes sustainability seriously, as does its willingness to engage stakeholders such as Ceres, KLD and our clients. AEP's ongoing commitment to coal, however, is a bet on future technological and political developments that are by no means certain.

While CCS, IGCC, and other processes show promise, they have never been applied on the scale envisioned by AEP. Politically, the company is urging the US government to revamp the entire interstate regulatory structure, while also funding FutureGen and a massive expansion of the transmission network. AEP also resists the auction of carbon credits and the disbursal of fee revenue to consumers, rather than utilities.

Company CEO Mike Morris indicated his willingness to work with the Obama Administration, but his company's positions are at odds with many of the President's stated priorities. Still, the President's home of Illinois is one of the "coal states," and to judge by his recent address to Congress, the interests of coal producers and users will continue to shape US energy policy.

Can the US build a sustainable economy while remaining a coal-burning nation? AEP's policy positions and investments show that it believes we can. In Part Two, KLD Analyst Benjamin Blank will consider the implications – and risks – of this commitment to clean coal.

Sustainable Investing: The Art of Long-Term Performance, a collection of articles from 22 contributors including co-editors Cary Krosinsky and Nick Robins, was released in the fall of 2008. SI challenges investors to look beyond what contributor Steven Lydenberg calls "the fast-paced speculative nature of today's financial markets." Socially responsible investors (SRI) have been striving to meet this challenge for decades, and now current events have exposed the financial system's myopia as an urgent global crisis.

If it had been released last year, this book would have been a valuable primer on how some investors integrate environmental, social and governance (ESG) factors into their strategies. In the winter of 2009, however, Sustainable Investing now offers answers to questions the whole world is asking. Consider this diagnosis from a January 3 New York Times article by Michael Lewis and David Einhorn:

"Our financial catastrophe, like Bernard Madoff's pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today's financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that's the problem: there is no longer any serious pressure from outside the market." [Emphasis added]

Outside the Market, Inside the Real Economy

Mr. Krosinsky and Mr. Robins, their authors, and the SRI/sustainable investment sector worldwide could reply: We are the pressure from outside the market.

"Outside the market" is the real economy of workers, customers, communities and the natural environment. Sustainable investors balance the short-term demands of capital markets with the long-term needs of society itself.

Cary Krosinsky is vice president at Trucost PLC, and Nick Robins is head of the HSBC Climate Change Centre of Excellence. The editors and their contributors are industry insiders, but their view beyond quarterly returns, and beyond those Warren Buffett called "geeks bearing formulas" – reintroduces "outside" global concerns to finance. (For more about the editors, see the end of this article.)

What Share Prices Don't Tell Us

Defenders of the "efficiency" of modern capital markets might argue that the information embedded in a share price tells the outside world all it should know about a stock, or a company. In "The Emergence of Sustainable Investing," Nick Robins presents statistics that say otherwise.

In 1986, investors held a London Stock Exchange-listed share for an average of nine years. In 2006, the average stock was held for only eleven months. How much can a share price convey about a corporation's long-term value when stockholders, as Mr. Robins writes, "cannot wait between one annual report and another before trading"?

Another number offers a clue about who really benefits from the computerized churning of modern capital markets. In 1981, the US finance sector earned 14% of total corporate profits. In 2001, its share had grown to 39%. "A growing share of global output is taken by the finance sector and its employees," Mr. Robins notes.

SI contributor Steve Waygood, in his article "Civil Society and Capital Markets," acknowledges that markets "hold the scorecard, allocate and price capital, and provide risk coverage and price risks." Unfortunately, he argues, their "current structure undermines long-term sustainable development goals."

Sustainable Investing argues that the inequities generated by a myopic, ever-expanding finance sector are not only unfair – they're unsustainable. SI's contributors explain why, and they also outline a model for the integration of ESG factors into investment decisions.

How Sustainable Investors Help Prices Tell the Truth

When investors incorporate ESG factors into their analyses, they introduce new information into capital markets. Corporate environmental practices (such as energy consumption or carbon emissions), social policies (including employee benefits and customer relations) and governance (such as executive pay and responsiveness to shareholders) may be "outside the market" concerns, but they matter to governments, investors and ordinary citizens.

"SRI is a form of consumerism, which resonates with global common values that anywhere from 5 to 20 percent of every nation cares about," explains Tessa Tennant in "The Global Agenda." Such percentages may not add up to a political majority, but they do represent millions of people and billions of dollars of investment, labor and consumption.

Investment analysis cannot afford to ignore these global common values. Such ignorance distorts capital markets and may be a risk to the market system itself. To dramatize this risk, Nick Robins quotes Ernst Von Weizsacker: "The system of bureaucratic socialism can be said to have collapsed because it did not allow prices to tell the economic truth."

Prices in a capitalist system may also obscure the truth, if buyers or sellers neglect to measure and disclose relevant information. ESG factors represent relevant risks and opportunities for corporations, and quarterly statements and share prices may not account for these risks. For example, over the past three years, some US utilities with otherwise strong financials have been forced to cancel new coal-fired power plants. These setbacks – driven by political concern about carbon emissions, which is a key ESG metric – demonstrate the market risk of external societal forces.

Sustainable investors help equity markets tell the economic, political and ecological truth.

Sustainable Investing: Two Conflicts in Focus

SI is organized into four distinct sections. Parts I and II present the past and present of sustainable investing, and Part IV considers future trends. Part III is an intriguing look at asset classes beyond the publicly-traded equity markets. Each section could be the subject of its own review, but SI's treatment of two particular sources of tension is especially relevant to the current economic situation.

First, SI's authors, especially Cary Krosinsky and Julie Fox Gorte, distinguish between "socially responsible" and "sustainable" investing. Their work suggests that while both approaches rely on the sort of ESG research that KLD (and Trucost) provide, sustainable investors may use somewhat different methods than traditional SRI investors.

Second, SI considers the global forces that promote sustainable investing, and also the persistent obstacles to its broader mainstream acceptance. While public concern about issues like climate change has made sustainability a buzzword, Steve Lydenberg (among other contributors) finds reason to "wonder how real these changes are, how deep their roots."

SI complements high-level macroeconomic thinking with pragmatism. For example, contributors Valery Lucas-Leclin and Sarbjit Nahal, in "Sustainability Analysis," tackle the practical problem of creating price signals to incorporate ESG factors into mainstream quantitative analysis. Other contributors also consider integration's impact on real-world problems and processes.

Mr. Krosinsky and Mr. Robins conclude their book with a qualified endorsement of sustainable investing's – and the economy's – future.

On the Sustainable and the Socially Responsible

When mainstream academics and journalists consider ESG investing, they typically ask a variation on one simple question: "Will it hurt returns?" Some observers are certain that it will, while other studies have found that investment returns may even benefit from ESG integration. Cary Krosinsky – both in his GreenBiz blog and his contributions to SI – emphatically promotes sustainable investing as a "market-beating strategy."

In "Investors: A Force for Sustainability," Julie Fox Gorte argues that sustainable investing can outperform the market through "fidelity to long-term drivers of…superior sustainability." She writes:

"…Sustainable investing is defined positively by seeking to invest in companies whose practices and policies include sustainability goals, where classic SRI was often defined negatively by what industries or companies were excluded."

Long-time practitioners of SRI could argue that exclusions of cigarette manufacturers, for example, also serve the goal of sustainability. From this perspective, smoking's externalized costs to society, when considered over a longer time horizon, would outweigh any short-term financial returns.

In their introduction, the editors help explain why they believe that any tension between these perspectives is outweighed by their shared priorities:

"Sustainable investing…provides an agenda for action for purely financially motivated investors eager to mitigate risk and benefit from upside opportunities, as well as for civil society organizations [or individuals] aiming to achieve social and environmental progress."

Sustainable Investing's Growth Drivers

SI's authors are an impressively multinational group, and their breadth of perspective reinforces the sense of global momentum for ESG integration. They consider sustainable investing's growth drivers in depth:

Political and Regulatory Pressure – Abyd Karmali, in "Observations from the Carbon Emissions Markets," studies the European Union's carbon-credit trading scheme, and in "Carbon Exposure," Matthias Kopp and Bjorn Tore Urdal model the future impact of emissions reduction regulations on German utilities. Both analyses offer insight on how global business could respond to public impetus for a more sustainable economy.

New Asset Classes – In "Fixed Income and Microfinance," Ivo Knopfel and Gordon Hagart describe how institutional investors' increased appetite for bonds – combined with public pressure on investors like colleges and governments to invest sustainably – will shape the strategies of fixed-income managers worldwide. Other Part III articles consider sustainable property investing, "social businesses" and private equity investment. The private equity article, by Ritu Kumar, illustrates the potential for this sector with case studies of firms that already focus on clean tech, clean energy and emerging markets.

New Markets – China and India, as emerging economic superpowers, each merit articles in SI's section on future trends. Ray Cheung explains how the environmental impact of China's rapid growth has finally drawn a government response. He focuses on the huge potential that new Chinese regulations offer for clean tech suppliers and investors. India faces similar ESG problems – including not only labor and environmental concerns but also relationships with regimes that violate human rights, such as Burma and Sudan. As Dan Siddy describes in his piece on India, these issues may not have concerned investors in the past, but they will in the future:

"ESG problems related to Indian, Chinese, and other emerging-market companies are likely to become more frequent, more acute, more visible and more frequently associated with shareholder value destruction."

Obstacles to Sustainable Investing's Growth

Overall, SI makes the case that sustainable investing can, and should, redefine the practice of investment itself. As the editors write in their conclusion, "The challenge…is not to become like today's mainstream, but, rather, to replace it." But to the credit of the editors and their contributors, SI also describes the ongoing resistance to ESG integration.

Political and Regulatory Pressure – The same force that encourages better Chinese environmental practices – the power of an authoritarian government – is also a threat to the human rights that are of equal importance to traditional social investors. Ray Cheung explains:

"…[As] with everything in China, the buyer must beware. … Given the country's one-party political system, Chinese and international firms must be willing to make dubious compromises with authorities; for example, Google censored a local Chinese search engine, and Yahoo! turned over to police email records of a Chinese journalist, leading to his arrest."

This case may seem unique to China, but political considerations may inhibit sustainable investment in democracies, as well. Even regimes that support better environmental practices are subject to pressure from political blocs, such as fossil fuel producers, who support the status quo. As a result, the case for sustainable investing depends on political action from individuals and interest groups.

In "Civil Society and Capital Markets," Steve Waygood explains how non-government organizations (NGOs) play an important role in both mobilizing political pressure and helping companies implement divestiture campaigns and other initiatives. However, he writes, "To date, capital market campaigning has mainly targeted investors as a way of influencing corporations rather than attempting to change the structure of the capital market itself."

This may be changing. Government complicity in the current banking crisis – or, at least, the public perception of such complicity – has already motivated some sustainable investors to direct more effort towards regulatory reform.

Limited Thinking – Since sustainable/SRI investing first emerged, its skeptics have questioned its value. Nick Robins sums up the stock objection from adherents of "conventional financial theory":

"The assumption is that the introduction of non-financial factors will harm diversification and thereby incur penalties in terms of risk returns."

Mr. Robins explains that while not every ESG factor has an immediate impact on a company's bottom line, "investments selected on the basis of identifiable ESG factors…do tend to outperform." Each of SI's contributors presents evidence of the opportunities represented by ESG integration, or of the risks of neglecting these factors.

Still, conventional wisdom persists. Stephen Viederman confronts a still-strong redoubt of anti-SRI bias in "Fiduciary Duty." He cites the example of ExxonMobil, which acknowledges the reality of climate change but "refused to respond to a shareholder proxy resolution asking the company to 'adopt a policy on renewable energy research, development and sourcing.'"

How should investors – especially trustees who are bound by fiduciary obligations – respond to this recalcitrance? "Conventional financial theory" would suggest that a trustee who sold ExxonMobil stock because it wasn't prepared for climate change has violated his fiduciary duty. After all, the company's share price is steady and its record of dividends is strong.

Mr. Viederman proposes a contrary understanding of fiduciary duty. He asks:

"Although highly profitable now, are ExxonMobil's profits going to be sustainable, and is ExxonMobil in its pursuit of profit now limiting options for future generations?"

Until a critical mass of investors agrees with Mr. Viederman – that "advancing social, environmental, and financial benefits is the new fiduciary duty" – then their limited thinking will continue to limit the growth of sustainable investing.

Limited Resources – This obstacle to sustainable investing is rooted in a concept that its adherents are already familiar with: wealth, both human and natural, is finite. Most of SI's contributors convey at least some optimism about humanity's future, but Julie Fox Gorte concludes her piece by sizing up the task ahead of us.

"In order to stabilize the climate…emissions must be reduced 70 per cent below the levels of 1990 – a profoundly greater step than the 5 to 8 percent reductions called for [by]…the first Kyoto Protocol."

What tools can we use to accomplish this task? Ms. Gorte presents the conundrum of an extractive, industrial, corporate civilization choosing, perhaps, to stifle the source of its power. Hers is a sobering but necessary perspective:

"…For decades, the average profit margin in the US hovered around 8 percent. The simple arithmetic of this is that the amount corporations and investors have to spend on saving the planet is less than 10 per cent of what they spend to get that power, which is largely responsible for creating the problems in the first place. …We are accustomed to thinking…that our transformations…make things better for us. But we are at the threshold of a transformation that makes things profoundly worse, at least for the two or three generations whose faces we will see during our allotted spans."

Conclusion: The Sustainability Moment

In the face of such an awesome task, Sustainable Investing's editors and contributors offer no easy answers. Instead, they describe the steps that have been made towards a sustainable economy, propose further steps, and perhaps most importantly, they confront the objections of a still-skeptical world.

Mr. Krosinsky and Mr. Robins conclude by acknowledging that the recession has "put sustainability concerns on the back burner" for many leaders, citizens and investors. They describe this mentality as one that sees sustainable investing as a fad, as "merely a cyclical bull market phenomenon." Sustainable Investing is a thorough, much-needed refutation of this mistaken belief.

As the editors explain:

"This [belief that sustainability is a fad], however, is not just a misreading of history, but a strategic misinterpretation of the structural, secular nature of the sustainable investing phenomenon. ... Not only is the investor case [now] much better understood and embedded among the world's leading institutions, but sustainable investing strategies are increasingly seen as essential to the recovery itself."

As the UN proposes a "Green New Deal," and old economic assumptions fade throughout the world, this could be the moment when the mainstream becomes sustainable.

About the Editors:

Cary Krosinsky joined Trucost as Vice President in 2008 to help represent Trucost in North America. He was previously a member of CapitalBridge's Operations Committee, providing leadership on data and analytics. He maintained many of the largest banking and corporate relationships for the company in the US, Europe and Asia. He has also been a member of the 70 person Expert Group that led the creation of the United Nations Principles for Responsible Investment (PRI).

Nick Robins is head of the HSBC Climate Change Centre of Excellence. He has 20 years experience of promoting sustainability in business practice, financial markets and public policy. He joined HSBC in October 2007 from Henderson Global Investors, where he was Head of SRI Funds. During his time at Henderson, he helped to design and launch its pioneering "Industries for the Future" fund, and is a member of the UK Government's Sustainable Development Panel.

For a Greener Apple: As You Sow Seeks Better Sustainability Reporting

At BusinessGreen, Danny Bradbury reports that even as Apple launches new "green" products, the company is resisting shareholder requests for better sustainability reporting. Apple's board has asked its shareholders to vote against a resolution calling for the company to measure and disclose its environmental impact in a formal corporate social responsibility (CSR) report. The resolution is proposed by environmental advocacy group As You Sow, who also called on Apple to design its computers for end-of-use recycling in 2007. Mr. Bradbury writes:

"The [current] resolution would require the company to publish a CSR report detailing its approach to greenhouse gas emissions, toxics and recycling by July this year. The report would also require Apple to define 'sustainability,' and would include a company-wide review of policies contributing to sustainable operations. "As You Sow claimed in the resolution that there were strong commercial reasons for Apple to produce such a report, arguing that over 2,700 companies now produce formal CSR reports, including many direct competitors such as Dell, IBM and HP."

As You Sow's work is a reminder that even well-respected companies may not meet the reporting standards of the Global Reporting Initiative or other CSR guidelines. A 2008 SIRAN/KLD study found that while 86 of the largest 100 US companies addressed sustainability on their websites, only 49 produced complete sustainability reports for 2007.

While this represents considerable progress, it highlights a gap between US companies and their peers in Europe, where many governments require CSR reporting. As noted by Boston College Professor Sandra Waddock in her January 9 presentation to KLD, companies in France, Sweden and other nations must formally disclose their social and/or environmental performance.

Perhaps the incoming Obama Administration will follow the lead of Europe – and states like New Mexico – and incorporate sustainability disclosure into its "21st Century regulatory framework."

While new taxes are always a difficult sell, a carbon tax program that disbursed some income to utility customers could be politically palatable. Entrepreneur Peter Barnes proposed such a "cap and dividend" program to Congress in September, and the stalled economy has increased the appeal of any plan to send cash directly to struggling voters.

The cap and dividend concept combines a tax on carbon producers with tangible benefits for utility customers. The program would tax fuel producers if the carbon released from the use of their product exceeded a defined limit. If a coal mine's carbon output exceeded this limit–the "cap"–its taxes would go up. The producer would then pass along its increased costs to coal-burning utilities, encouraging those companies to develop alternatives. The customer rebate–the "dividend"–is a recognition that raising the price of fossil-fuel power would raise the retail price of all power, at least until new sources come on line. (The Carbon Tax Center provides a helpful FAQ on the concept.)

While this makes sense in theory, there are high hurdles for any program that could be blamed for raising the cost of energy–especially when memories of $4-per-gallon gas are still fresh.

For any carbon tax plan to succeed, the public must accept both climate change and the immediate costs of mitigating its impact. Surveys in the US and Europe reveal that this acceptance is incomplete. "There is a clear gap between what citizens are saying and what they are doing on climate change," EU Environment Commissioner Stavros Dimas told Reuters, in response to a 2008 poll of 30,000 people in 30 countries.

In the US, a 2008 ABC News poll found that a majority acknowledge that climate change is real. Unfortunately, our desire to do something about it collides with our attachment to the status quo, as detailed by the poll results:

"Majorities…support oil drilling in protected coastal and wilderness areas. … "64 percent now rate 'finding new energy sources' as more important than improving conservation–up 9 points since 2001. … "There's also an 8-point drop [from 2006 to 2007] in this poll, to 33 percent, in the number who think rising temperatures are caused mainly by things people do, rather than natural causes or both about equally."

The public's conflicting beliefs have real political consequences. If Congress or the President proposed a cap and dividend program, we could expect carbon producers to launch a PR campaign calling carbon taxes an unacceptable burden on a weak economy. The fight would mobilize voters and political leaders from oil- and coal-producing states and exacerbate tensions between producers and consumers. Tax rebates could be a popular cause, but politically, the threat of job losses is a powerful counter-argument.

Still, there is some cause for hope. Even as the public seems unwilling to fight climate change, we look to government for leadership–61 percent in the ABC poll said that our leaders can do more. If the President-elect's picks for energy and environmental leadership live up to their promise, there is the potential for a productive discussion of cap and dividend and other policy options. A little honesty–or at least honest debate–among those who pull the levers of power could help set the table for smart but difficult decisions.

To meet the climate challenge, we are going to have to confront some hard truths, including our own denial.

Archives
Browse our products and services for more information.
Browse our Resource Center for more information.