A New Climate for Investors
Everybody talks about the weather, as the old saying goes, but these days there's a sense of urgency to do something about it. Mild temperatures in the Northern Hemisphere sent oil prices below $50 per barrel and coaxed Washington's cherry trees to bloom in January. On the West Coast, unseasonable freezes wiped out hundreds of millions of dollars' worth of citrus fruit in California. Historic storms hit Europe and the Rocky Mountains.
Environmentalists have long attributed weird weather to climate change caused by accumulating greenhouse gases such as carbon dioxide in the atmosphere. In recent years that view has become increasingly mainstream. It causes "extreme weather events in both directions," says Garvin Jabusch, director of sustainable investing at Sierra Club Mutual Funds. The question for him and other investors is how to profit from efforts to remedy the effect.
Industry Calls for Regulation
President Bush's Jan. 23 State of the Union address called climate change a "serious challenge" (see BusinessWeek.com, 1/24/07, "Salesman in Chief"). One day earlier a group of leaders from industrial giants such as General Electric (GE) and Alcoa (AA) called for greenhouse gas regulations; cars, power plants, and other industrial facilities are all major producers. Climate change is also on the agenda at January's World Economic Forum in Davos, Switzerland (see BusinessWeek.com, 1/23/07, "A Somber Mood at Warmer Davos").
Kevin Trenberth, head of climate analysis at the National Center for Atmospheric Research in Boulder, Colo., says that as a result of greenhouse gas emissions in coming years the southern and western U.S. and other regions of the world are like to encounter "more extremes of drought" and harsher storms and hurricanes, among other phenomena. Events that could be attributed to climate change could affect industries from energy to agriculture to insurance.
Even investors who reject climate change as environmentalist hysterics might want to keep in mind that more and more governments and businesses are operating on the assumption that it's a fact. Many investors will want to tinker with their portfolios to account for new policies that assume climate change is happening (see BusinessWeek, 1/29/07, "Beyond the Green Corporation").
"As citizens of the world we should be debating this subject, as investors we should be studying corporate and government behavior," says Citigroup (C) analyst Edward Kerschner. A report that he released Jan. 19 names more than 70 companies positioned to benefit from climate change in coming years.
Companies will likely profit from factors like regulations on greenhouse gas emissions and increasing reliance on alternative fuel. A thematic project, the report looks only at the companies and their potential market opportunities, not at how the stocks are priced. Investors should do their own due diligence.
Kerschner says he believes that some sort of climate change is happening and that regulations of carbon dioxide emissions, in some form, will be implemented. Among the most important is the recently enacted California law that will require automakers to sell lower-emission cars.
"There are a lot of wheels in motion here that don't begin and end at 1600 Pennsylvania Ave.," he says. This is especially true for multinationals, which also face pressures from abroad to conform to stricter emissions standards.
The Citigroup report divides stocks into those with physical, regulatory, and behavioral implications. In the first group are companies whose operations will benefit from the physical results of climate change.
They include oil companies like Chesapeake Energy (CHK), Southwestern Energy (SWN), and XTO Energy (XTO) that "have relatively 'efficient' operations and no exposure to the hurricane-prone Gulf of Mexico." Additionally, Kerschner sees insurers and reinsurers like ACE (ACE) and Arch Capital (ACGL) potentially gaining new business in the Gulf region. In agriculture, Monsanto (MON) could profit from selling drought-resistant crop seeds to farmers.
The companies subject to strong regulatory impact include major alternative fuel producers like Archer Daniels Midland (ADM) and Israeli geothermal energy producer Ormat Technologies (ORA). Similarly, automakers that offer cleaner-running vehicles such as Toyota Motor (TM) or Honda Motor (HMC) could be buys. Operators of nuclear power plants like Exelon (EXC) could benefit as well, since those facilities do not emit greenhouse gasses.
But greenhouse gases are only part of the story. "Climate-friendly is not necessarily green or environmentally friendly," Kerschner says. For example, nuclear plants produce nuclear waste. And ethanol derived from corn may be more politically than environmentally sound; it's appealing as a domestic and renewable fuel source, albeit one that requires huge investments of energy and chemicals to produce.
To be both "climate-friendly" and "green," is more difficult. Biofuel production in tropical areas threatens the habitats of endangered species. Giant wind turbines kill birds. Hydroelectric dams can cause massive environmental disruption. (Citigroup has a business relationship with many of the companies discussed in the report.)
Sierra Club Picks
Jabusch of Sierra Club Mutual Funds is concerned with resolving these disparities for the environmentally friendly portfolio. A basic premise of his investing thesis is the widely shared belief that sooner or later, probably during the next Presidential administration, the U.S. will institute a carbon dioxide cap and trading program.
A likely model is one in which emissions will be rationed. Outfits that exceed their allotment will have to buy credits from producers with emissions to spare. Now that companies are coming out in favor of regulation, he argues that they would prefer a national standard to a "quiltwork" where each state has its own policy. "I don't think these guys are doing this out of the greenness of their hearts," he adds.
As an investor, Jabusch likes companies that have already taken steps to mitigate their emissions. They include Starbucks (SBUX) and Whole Foods Market (WFMI).
Whole Foods buys wind-power credits to secure all of its electricity from renewable sources. "They're going to be selling credits to companies that didn't do anything to reduce their footprint," Jabusch says. Tech giant Hewlett-Packard (HPQ) could find itself in a similar position because of its well-established parts recycling program that reduces emissions from producing new parts.
In areas generally associated with green investing, Jabusch likes SunTech Power (STP), a profitable Chinese company, and Evergreen Solar (ESLR), a smaller, unprofitable outfit with strong technology and a growing client list. In ethanol, he prefers Pacific Ethanol (PEIX). (All the stocks recommended by Jabusch are in the Sierra Club portfolio.)
According to the National Weather Service, 2006 was the hottest year on record in the U.S. And some forecasters think 2007 could be warmer yet. While some voices are likely to continue playing down the trend, business and government are acting on it as never before. Investors may wish to take some steps of their own with a diversified basket of stocks positioned for the changing climate.