Are you carbon beta rated? Here's a look at the likely winners and losers in the carbon rationing age

Chief Executive, The, July-August, 2008 by Ronald Bailey

Probably the biggest risk faced by investors is fickle regulators. Agencies and Congress can change the rationing rules at any time. Consider the recent case of EcoSecurities in London, which aimed to create millions of carbon credits to sell in European markets by investing in projects that cut greenhouse gas emissions in developing countries. The United Nations climate change bureaucracy disallowed some of its projects, causing EcoSecurities' share price to crash by 50 percent last November.

The New York-based consultancy Innovest Strategic Value Advisors evaluates the performance of companies with regard to environmental, social and strategic governance issues and their impact on competitiveness, profitability and share price performance. To that end, Innovest has created a proprietary Carbon Beta rating that calculates the net carbon exposure of a firm, taking into consideration current and potential regulatory frameworks faced by companies as they operate around the globe. The Carbon Beta rating also estimates the carbon compliance cost of a company, as a percentage of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). EBITDA is a widely used measure of financial performance that is intended as a measure of the cash generated by the operations of a business. Just like bond ratings, an AAA from Innovest indicates that a company has lower net carbon risk for investors than its same-sector peers. According to Innovest president Hewson Baltzell, its analysts look at three different types of risk in a carbon rationed world: (1) direct risks, mainly through carbon caps, (2) indirect risks arising from increased costs of electricity and supplies and (3) market risks stemming from things like changes in consumer behavior, e.g., a shift to smaller, higher mileage automobiles.

As Carbon Trust CEO Delay noted, some sectors will be hit harder by carbon rationing than others, but there will also be winners and losers within sectors. Applying its Carbon Beta rating screen, Mario Lopez-Alcala, a senior analyst with Innovest, supplied a list of peer companies in various sectors, identifying some as carbon "leaders" and others as "laggards." Leaders are adopting strategies to hedge their carbon risks and to take advantage of profit opportunities from operations, products and services that carbon rationing might bring. (See box, page 32.) So what did Innovest find?

The advent of carbon rationing and permanently higher fuel prices is going to produce far-reaching changes in the way companies do business. In March, Energy and Air Quality Subcommittee member Rep. Mike Doyle told the Capitol Hill newspaper Roll Call, "You are either at the table or on the menu." Mixing his metaphors, Doyle added, "This train is leaving the station." CEOs must now figure out how to make sure that carbon rationing train doesn't run them over.

The beauty of the cap-and-trade carbon market scheme is that Capitol Hill denizens could say to voters that they had not increased taxes, just created a carbon market to save the climate.