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Greening IOU Equities

Low-carbon strategies are yielding rewards for shareholders.

Fortnightly Magazine - March 2008

purchase high-cost power at market prices, due to poor hydro conditions.

Similarly, the review of companies with nuclear assets is consistent with the view of companies with high relative amounts of non-carbon generating capacity, as the average TSRs for these companies are substantially higher than the remaining portfolio of companies. Specifically, for the utilities where nuclear assets comprises over 20 percent of their installed capacity, the average one-year TSR is 29 percent, compared to 11 percent for the remaining companies in the portfolio; the results from this analysis are consistent with results from reviewing average three-year TSRs, as the three-year TSRs for these nuclear-intensive companies is 99 percent, compared to 59 percent for the remaining companies in the portfolio.

Conversely, companies with the highest relative carbon exposure (annual tons of CO 2 emitted per total installed MW) are substantially lower than the remaining portfolio of companies. Specifically, for the fourteen utilities with over 4,000 annual tons CO 2 emitted per installed MW, the average one-year TSR is 6 percent, compared to 17 percent for the remaining companies in the portfolio. Also, this trend is consistent when reviewing average three-year TSRs, although to a lesser extent; for the companies described above with high carbon exposure, the average three-year TSR is 54 percent, compared to 69 percent for the remaining companies in the portfolio. In effect, the market may be pricing into these stocks the uncertainty of potential carbon regimes.

Breaking With History

TSR results in 2007 for the 77 company utility portfolio revealed that the strategic distinctions of past years’ winners and losers ( e.g., back to basics, traditionalists, etc.) have all but disappeared. And most of the post-Enron recovery stories of past years’ winners are now ancient history.

Further, 2007 revealed that the companies with the largest amounts of non-carbon generation capacity and the highest relative percentages of nuclear capacity were high performers in terms of both 1-year and 3-year TSR. This is explained by the significantly higher margin opportunities afforded to nuclear generation in competitive wholesale markets—a dynamic that will only increase when a market mechanism for carbon control is introduced.

Companies with the highest relative carbon exposure tended to be low performers in terms of one-year and three-year TSRs. One possible explanation is the uncertainty surrounding any future carbon regime; depending on carbon allocation (or taxation) mechanisms and the relative position of their generating units in the resource stack, these companies could turn out to be winners or losers. We could, in fact, be seeing the beginning of the market discounting shares of these companies with the most uncertainty regarding future earnings due to carbon exposure.

In the end, companies with CO 2-emitting generation resources (and their investors) will need to consider future scenarios related to potential market mechanisms for carbon control, and initiate strategic actions that will result in “no-regrets” outcomes. Many companies are well positioned based on past years’ bets ( e.g., the acquisition of nuclear assets by Entergy and Exelon). Others are now diversifying their generation portfolios to include more non- carbon-emitting generation