The Carbon Trust establishes new measure of shareholder value at risk from climate change

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16 March 2006
Investors and corporates urged to understand and manage impacts.

Investors and companies need to understand better the shareholder value at risk from climate change, according to a new report issued today by the Carbon Trust. Entitled ‘Climate Change and Shareholder Value’, the groundbreaking report establishes, for the first time, a useable tool for the investment community and corporates to quantify shareholder value at risk from climate change.

It urges companies and investors to look at carbon impact in a way that has never been looked at before and highlights seven priority questions investors should ask companies, and that companies should ask themselves, to help understand and manage the impacts of climate change.

Produced in collaboration with strategy consultants Cairneagle Associates, the report shows that value at risk goes beyond simple carbon emissions exposure and, whilst climate change can appear initially a highly material risk, when properly managed the downside can be significantly reduced.

Companies and investors need to understand the areas of greatest materiality. For example raw materials, which involve significant carbon in their extraction or production, and services such as logistics and packaging can be key, and there is a significant shareholder value risk for sectors that may previously not have seen it or realised. In the food production sector, companies are exposed to emissions from packaging, raw materials and logistics, as well as the impact of climate change on production. Building materials companies are also exposed by the emissions associated with cement and other raw materials.

In order to understand fully the potential impact of climate change on a business, the Carbon Trust highlights seven priority questions that investors could ask companies, and that companies should ask themselves, in order to understand and manage risk, focusing on the areas of greatest materiality:

  1. What is the company’s full exposure to greenhouse gas emissions, including those linked to energy use, transport, logistics and supply chain?
  2. What is the company’s exposure to emissions regulation cost and how is this expected to develop?
  3. What other climate change impacts may affect the company?
  4. Are there supply side risks, either with electricity costs or other high carbon raw materials?
  5. Are there significant competitiveness implications and how well placed is the company versus its direct competitors?
  6. If the company needs to reduce emissions by 5%, 10% or 20%, how could this be achieved, and what would be the cost?
  7. Does climate change open up new market opportunities and, if so, how is the company positioned versus competitors in these new areas?

Emma Johnson, Head of Investor Engagement of the Carbon Trust, said:

“This report represents a major development in assessing the carbon impact on shareholder value. Investors and companies are beginning to realise that climate change has some significant risk implications, yet few are incorporating full risk assessment into their strategic thinking and, crucially, not all the information to quantify exposure to climate change is disclosed.

“In the future companies are likely to be affected by a tougher regulatory regime as well as potentially physical and weather-related impacts, so it is important that companies understand the implications and build them into their business-planning now. Investors must also ensure that climate change forms part of their ongoing dialogue with the companies they invest in. Part of this is a need to disclose everything needed to determine the shareholder value at risk. There will be large creation and distribution of shareholder value in the transition to a low carbon economy. There will be winners and losers, with the winners more likely to be those businesses that take time to understand and address this complex area.”

The Carbon Trust has established a four-step methodology to help businesses and investors understand where the company will be impacted most. It begins by assessing the company, its sector and its related value chain, before looking further along the chain to assess each company’s direct and indirect carbon emissions, quantifying total exposure from both direct and indirect carbon emissions. It then assesses how the financial exposure to carbon emissions can be reduced through regulatory and competitive market dynamics. Finally, it undertakes an assessment of broader climate change impacts affecting the organisation, which can be far more material in some cases.

To calculate the financial impact, the analysis quantifies the potential impact on profits using the shape of the business in 2004, but applying a potential 2013 emissions regulatory regime, the first year after the 2008-12 Kyoto commitment period. The report has tested the methodology on ten companies across different market sectors, five with high and five with lower carbon emissions.


 
 
Footnotes
 

Notes to editors
To receive a copy of the Carbon Trust report or to arrange interviews, please call the Carbon Trust press office on 020 7544 3100.

The Carbon Trust

  • The Carbon Trust works with UK business and the public sector to cut carbon emissions and develop commercial low carbon technologies. An independent company set up by Government to help the UK meet its climate change obligations, the Carbon Trust creates practical businessfocused solutions to carbon emission reduction on energy efficiency, carbon management, and
    investment.
  • The Carbon Trust's annual funding is in excess of £69m in grants from the Department for Environment, Food and Rural Affairs (Defra), the Scottish Executive, the Welsh Assembly Government and Invest NI.
  • For more information on the Carbon Trust visit www.thecarbontrust.co.uk

Seven priority questions to assess corporate risk from climate change

  1. What is the company’s full exposure to greenhouse gas emissions, including those linked to
    energy use, transport, logistics and supply chain?
    Does the company fully understand its exposure to greenhouse gas emissions, including those linked to energy use, transport and logistics, and its supply chain?
    Which emissions does it disclose?
    Which emissions are estimated solely for internal purposes?
    Which emissions are ignored, and how often is that decision (to overlook such emissions) reviewed?
    Are emissions benchmarked against competitors or industry standards, and – if so – how does the
    company compare?
  2. What is the company’s exposure to emissions regulation cost, and how is this expected to
    develop?
    How are the company’s emissions currently regulated, and what is the cost incurred?
    How is this expected to develop going forward, and what are the cost/planning implications?
    What regulatory and price scenarios are routinely run during business planning?
  3. What other climate change impacts may affect the company?
    Could demand patterns change as (a) consumer awareness of climate change increases, and (b)
    lower-carbon products become more competitive?
    Is the company exposed to extreme weather events?
    How do such risk factors feed into the planning process?
  4. Are there supply side risks, either with electricity costs or other high carbon raw materials?
    How exposed is the company to rising energy prices, and to what extent has this been hedged?
    Are other key bought-in goods (including packaging) linked to high greenhouse gas emissions, and what are the implications?
  5. Are there significant competitiveness implications, and how well placed is the company versus its direct competitors?
    How much of the incremental cost associated with climate change can be passed on to customers?
    Does the company face direct competition from non-EU producers, less exposed to emissions regulation?
    Does the company face competition from lower-carbon substitute products?
    What scenarios are analysed during business planning?
    What are their implications?
    Do competitors have different outsourcing strategies and does this impact positively or negatively their ability to react to carbon issues?
  6. What would be the cost of reducing carbon emissions by 5%, 10% or 20%, and does the company own any proprietary IP in this area?
    If the company needed to reduce emissions by 5%, 10% or 20%, how could this be achieved, and what would be the cost?
    Is the company itself involved in development in this area of process emissions efficiency?
    What is the estimated value of its IP, and what is its strategy for exploiting this?
  7. Does climate change open up new market opportunities, and how is the company positioned versus competitors in these new areas?
    Does climate change open up new market opportunities, that the company would be well placed to address?
    How is the company positioned versus competitors in these new areas?
    What are the revenue projections, and how much has been invested to date?

Value at Risk 4-Step Methodology

  1. Assess value chain and impacts
    Begin by assessing the company, its sector and related value chain. For some industries, such as automotive manufacture, even though the company’s own carbon emissions are relatively low, carbon emissions elsewhere in the value chain dominate. Is use or disposal of the company’s products particularly exposed to climate change? Do key raw materials or suppliers represent high
    sources of carbon emissions?
  2. Quantify carbon emissions – direct and indirect
    This needs to include both direct carbon emissions, and those indirect emissions linked to purchased electricity, bought in goods (including packaging) and distribution. These should be costed at an agreed carbon price – for this report and analysis we have used £20/tCO2 - for calculation of the company’s ‘emissions exposure’.
  3. How is financial exposure to carbon emissions minimised?

    Regulatory:
    How many emissions are allocated for free? This will be influenced by the perceived availability of cost-effective carbon reductions within that sector, and broader competitive and economic considerations.

    Competitive dynamics:
    What proportion of additional costs will be passed on by the supply chain?
    What proportion of additional costs will the company be able to pass through to its customers?
    What implications may this have for market share or revenue?
    How much of business is within the EU, versus elsewhere (where regulatory regimes may be less costly)?
  4. Other broader impacts

    Implications of broader carbon emission constraints
    Are there implications (positive or negative) of broader carbon emission constraints on demand for a company’s products?
    Will competitive positioning change – by company or sector? Is there a risk of low-carbon substitute products?
    Are there new business opportunities?

    Implications of physical impacts of climate change
    Do changing weather patterns (hotter, drier summers, warmer wetter winters, more extreme events) have any implications?

    Potential impact on customer needs and behaviours
    Will customers increasingly value ‘climate friendly’ products?
    Could brand values be affected (positively or negatively)?

In order to obtain a better indication of the likely impact on value, the methodology quantifies the impact on profits using the shape of the business in 2004, but applying the likely carbon management regime in 2013. This long term profit impact is used as a proxy for value at risk. The analysis focuses on carbon emissions, as carbon is the only greenhouse gas currently covered by the EU ETS. However, where relevant, non-CO2 greenhouse gases are also measured, and their materiality indicated.