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Are You Carbon Beta Rated?

Consumers and the aviation industry will take it on the chin while environmental groups and rent-seeking companies that form a classic Baptist and Bootleggers coalition stand to gain big time.

American business executives are increasingly resigned to the fact that carbon controls are coming. Some 17 bills for cap-and-trade schemes to limit greenhouse gas emissions from fossil fuel energy sources are floating through the halls of Congress. Both Republican and Democratic Party presidential candidates favor limits on greenhouse gas emissions. Limiting carbon dioxide will have far-reaching effects on every business in America, ranging from energy production, transportation, food and beverages to retail. Right now, Congressional committees are meeting to pick which industries and companies will be winners and which losers in the great carbon rationing brawl. Executives who know this are likely to be winners; those who are oblivious or think it doesn’t concern them are going to be losers.

The idea behind cap-and-trade schemes is to progressively lower carbon dioxide and other greenhouse gas emissions cost-effectively throughout the economy. Why? In order to prevent greenhouse gases-like carbon dioxide emitted from burning fossil fuels-from accumulating in the atmosphere where they tend to heat up the planet. Under a cap-and-trade scheme, the government sets limits on how much in greenhouse gases companies may emit. Emitters must have allowances for every ton of greenhouse gas (chiefly carbon dioxide) they emit. Some companies will find it easier and cheaper to cut their own emissions, leaving them with excess allowances that they can sell to other emitters who cannot cut as easily or as cheaply.

Carbon rationing will hike the price of fossil fuel energy, which will push companies and consumers to conserve energy and seek energy supplies that do not emit greenhouse gases. Advocates of carbon rationing argue that higher prices for fossil fuels will encourage inventors and innovative companies to develop new low-carbon and no-carbon energy supplies, such as wind, solar, biomass and nuclear power. This energy can be sold without having to be offset with government-issued emissions allowances.

The leading cap-and-trade bill in Congress is the Lieberman-Warner America’s Climate Security Act, introduced by Sen. Joe Lieberman (I-Conn.) and Sen. John Warner (RVa.) last fall. The Climate Security Act aims to cut U.S. greenhouse gas emissions 70 percent by 2050, below what was emitted in 2005. The cap applies to U.S. electric power, transportation, manufacturing and natural gas sources that account for 87 percent of U.S. greenhouse emissions. The cap starts at 4 percent below the 2005 emission level in 2012 and then falls every year at a constant gradual rate. By 2020, emissions will be 20 percent below 2005 levels, reaching 70 percent by 2050.

In order to achieve this goal, the Environmental Protection Agency (EPA) will issue 5.7 billion emission allowances, each one equivalent to 1 metric ton of carbon dioxide. The number of these allowances will decline by 106 million each year (1.8 percent annually) ratcheting down the cap to 1.7 billion allowances in 2050. Initially, in 2012, 77.5 percent of the allowances will be given away free to emitters and states, while 22.5 percent will be auctioned by the federal government. The number of allowances given away free declines until 70.5 percent of them is auctioned off in 2031.

This cap-and-trade scheme allows companies and anyone else to trade, save and borrow emission allowances. If a regulated company emits less than the allowances it holds, it may sell those allowances to other companies emitting more than the allowance they hold. In addition, companies can generate new allowances by investing in projects that cut emissions in businesses, forestry projects and farms that are not covered by the Act.

The EPA estimates that emission allowances would cost $22 to $35 per ton in 2015 and $28 to $46 in 2030. Using those estimates, that means the total value of the permits would be $125 billion to $200 billion in 2015 and $100 billion to $177 billion in 2030. The total value of permits in 2030 will be lower, despite the fact that the prices are higher, because only 3.8 billion emission allowances will be issued that year. But are these estimates realistic?

A real-world example suggests caution. In 2005, the European Union created its Emissions Trading Scheme (ETS) that covers about 45 percent of the continent’s greenhouse gas emissions. Compared to the ambitious goals set by the Climate Security Act, the ETS cap is a relatively modest 8 percent cut in emissions below what was emitted in 1990. The ETS has had its ups and downs-the price of carbon dioxide allowances collapsed to near zero in 2006 when it was discovered that European governments had handed out far more free emissions permits than there were actual emissions. No scarcity, no price. However, EU governments promised to tighten up, and the ETS market recovered. Recently allowances were selling for nearly $40 per ton. What has been achieved so far? In 2007, EU emissions were up by 1.1 percent. So the simple truth is that nobody knows what the actual prices of emissions allowances will be. (See sidebar, p. 31.) 

Baptists and Bootleggers

With hundreds of billions of dollars at stake, it is no wonder that corporate lobbyists are now circling Capitol Hill anxiously trying to protect their clients’ bottom lines. At the beginning of 2007, a group of large corporations joined by a number of prominent environmentalist groups created the U.S. Climate Action Partnership (USCAP). Corporate members include General Electric, Duke Energy, Pacific Gas & Electric, Caterpillar, Alcoa, Ford, Exelon and AIG, along with environmentalist organizations such as Environmental Defense and Natural Resources Defense Council. USCAP is a classic “Baptist and Bootlegger” coalition.

The idea of a Baptist and Bootlegger coalition is that both Baptists and bootleggers support blue laws forbidding the sale of liquor, according to Clemson University economist Bruce Yandle. The Baptists favor blue laws because they are against sin and the bootleggers because they create a profitable black market for them. In this case, the righteous environmentalists denounce emitting carbon as a climate sin while wily corporate bootleggers think they can grow rich trading scarce carbon indulgences, a.k.a. emissions allowances.

So hand-in-hand, the USCAP Baptist and bootleggers trooped up to Capitol Hill in February 2007 calling on lawmakers to enact “a robust cap-and- trade program.” Such a program would aim “to slow, stop and reverse the growth of greenhouse gas (GHG) emissions over the shortest period of time reasonably achievable.” And it looks like the coalition of climate prophets and profiteers are going to get their wish, perhaps even before the 2008 presidential elections.

Why? Because even without the danger of possible future disruptive climate change, the Democratic-led Congress is inclined to grant the coalition’s prayers and petitions. Congress is strapped for cash to pay for many of the goodies that presidential candidates and Congress have promised voters. Goodies like universal health insurance, a fix for the alternative minimum tax, the farm bill, an increase in student loans and help for householders facing foreclosure.

According to an April 2008 Congressional Budget Office analysis, creating a cap-and-trade carbon market could raise a trillion dollars in revenue over the next 10 years for Congress to shower on favored projects. Some of the permits to emit greenhouse gases, chiefly carbon dioxide from coal, oil and natural gas, would be auctioned off and the money tossed into the general revenue fund. The beauty of the 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.

But not all of the emission allowances would be auctioned off-a lot of them would be given away for free to deserving parties. The USCAP partners made it clear to Congress that “a significant portion of allowances should be initially distributed free to capped entities and to economic sectors particularly disadvantaged by the secondary price effects of a cap.”

Industries that would feel the brunt of a carbon dioxide emissions cap most heavily argue that their shareholders need to be compensated for the loss in value that such limits impose. An April 25, 2008, Congressional Budget Office analysis noted that a cap that cut carbon emissions by 23 percent would tank stock values by 54 percent in the coal sector, 20 percent for oil and natural gas firms, and about 4 percent for electric and natural gas utilities. 

Allowance Allocation

Putting a price on carbon dioxide emissions boosts the cost of coal, oil and natural gas to consumers who will demand less, meaning that coal, oil and gas companies will sell less and make less money. Executives and shareholders of fossil fuel companies and energy intensive manufacturers ask, why should they bear the bulk of the burden of addressing climate change? A Congressional Budget Office analysis found that allocating 9 percent of allowances free to affected companies would be enough to compensate for most shareholder losses. Another study by the Washington, D.C.-based think tank, Resources for the Future, found that allocating 6 percent free to the electric power generators would be enough to fully compensate their shareholders.

The Climate Security Act initially allocates more than 30 percent of emissions allowances free to fossil fuel-fired electricity generation facilities and energy intensive manufacturers such as iron, steel, pulp, paper, cement and chemical industries.

Giving away free emissions allowances is like giving away money. This is what the ETS is doing. In March 2008, the consultancy Point Carbon issued a report noting that handing out free emissions permits will provide European electricity generators more than $100 billion in windfall profits between now and 2012. Generators pass along the price of the carbon permits to their customers because they see those permits as an opportunity cost. That makes sense, because as the Point Carbon report notes: “The carbon dioxide price is an opportunity cost because in deciding to generate, a power producer will use up both its fuel and the CO2 allowances required to offset the emissions from that generation.”

In February 2008, an analysis of the allocation of free permits under the Climate Security Act by environmentalist group Friends of the Earth claimed, “All-in-all, between 2012 and 2050, 102 billion pollution permits, worth $2.3 trillion, would be given away.” Even if the FOE report exaggerates, which is likely, the point about the huge amount of money at stake still stands. So it is no surprise that groups like USCAP are lobbying Congress for as big a share of free allowances as possible. And from the point of view of senators and representatives, free allowances are the sweeteners needed to entice corporate America to go along with carbon rationing (and incidentally supply them with campaign contributions). And there’s more. USCAP argues that “those companies that take early action should be given appropriate credit or otherwise be rewarded for their early reductions in greenhouse gas emissions.” On Feb. 15, 2007, Chad Holliday, CEO of chemicals giant DuPont and USCAP member, testified before the Senate Environment and Public Works Committee, “Since 1991, we’ve reduced our greenhouse gas emissions by 72 percent globally and avoided $3 billion of energy costs. We made these changes because they earned solid returns for our shareholders and they helped the environment.” Saving money and boosting profits is what it’s all about, so hooray for DuPont. But that’s not enough for Holliday.

DuPont’s cuts are equal to 420 million tons of avoided greenhouse gas emissions. The Climate Security Act sets aside 5 percent of emissions allowances in 2012, declining by1 percent per year until 2016 to reward companies that reduced their greenhouse gas emissions since 1994. Let’s say those permits are worth $25 per ton. That would mean that Dupont would receive allowances worth more than $1 billion. That’s a tidy reward for a company that was just doing what it’s supposed to be doing, e.g., “earning solid returns for our shareholders.” 

Winners and Losers

“There will be a large creation and redistribution of shareholder value in the transition to a low carbon economy – there will be winners and losers at sector level, and within sectors at company level,” declared Tom Delay, Chief Executive of the Carbon Trust. The Carbon Trust is an independent company set up in the U.K. government to aid companies in making the transition to a low-carbon economy.

From their CEOs’ points of view, U.S. Climate Action Partnership companies are just trying to protect their shareholders’ interests. But USCAP companies are also engaging in a bit of “rent-seeking.” Economists define “rent-seeking” as the economically unproductive practice of individuals, firms and industries investing significant resources in lobbying government authorities to boost their profits by obtaining benefits such tax breaks, subsidies and countervailing tariffs. While shareholders may gain, consumers and taxpayers are big losers from rent-seeking.

Let’s look at what some of the USCAP may have to gain when Congress imposes cap-and-trade carbon rationing. BP Oil plans to invest $8 billion in various renewable energy technology projects, which will become more valuable as fossil fuels are made more expensive. Ford Motor Company is installing its new six-speed, automatic transmissions that cut fuel consumption by 4 to 6 percent in its down-market automobiles. In addition, automakers like the provision that earmarks $40 billion over the next couple of decades for them and their suppliers to help them build more climate-friendly vehicles. Smelting aluminum requires a lot of electricity, so Alcoa is worried about foreign competitors with access to cheaper power. Alcoa wants Congress to include trade sanctions on imports from countries without their own mandatory carbon emission caps. Energy production companies like NRG, Duke Power and Pacific Gas & Electric want to make sure they get free emissions allowances when the cap is imposed. On the other hand Exelon, as America’s largest nuclear power generator, doesn’t want free allowances, but stands to benefit enormously as the price of electricity generated using fossil fuels rises.

A new study, Climate Changes Your Business, by the international business consultancy KPMG, identifies various business sectors that are at greatest risk as a result of climate change. They include aviation, transport, financial companies, tourism, and oil and gas. Transport, which emits about 13 percent of greenhouse gases, is at high regulatory risk. Policy makers want to discourage high-emitting transportation, such as road and air transport, in favor of lower emitting forms such as rail and public transport. The main danger is higher fuel prices. 

Winners and Losers



Carbon Beta


Carbon Beta

Integrated oil and gas

 BP Oil


 Exxon Mobil





 U.S. Steel


 Electricity Utilities

Florida Power & Light


 American Electric Power








 Air France-KLM


 American Air


Construction & Equipment



 Joy Global


 Metals & Mining



 Peabody Energy


 Cement & Materials

 LaFarge SA


 Vulcan Materials


 Real Estate

 Simon Property


 Equity Residential


In the Line of Fire

Aviation as a subset of transport is particularly at risk. The KPMG study cites estimates that “the risk from climate change to aviation accounts for 50 percent of the sector’s market value.” Again the danger here is higher fuel prices and less business travel. The tourist industry is at risk not only because higher energy prices will reduce leisure travel but also because of ecological shifts. Scenic mountain glaciers will melt, coral reefs may bleach, forests decline and so forth. Carbon rationing whacks coal, oil and gas companies directly. As noted above, under a 23 percent carbon emissions cut, coal shares would take a 54 percent hit, oil and gas 20 percent and utilities 4 percent.

On the flip side, there would certainly be some corporate winners under carbon rationing. As energy prices rise, producers of solar, wind and perhaps biomass energy generation equipment and generators would cash in. In addition, electricity generators whose portfolios are heavily weighted toward coal generation will have to raise their prices to pay for any excess emissions allowances. Meanwhile, companies that produce electricity using nuclear power will benefit, since they will be able to raise their prices yet not pay for any emissions allowances.

Two-thirds of the electricity generated in the U.S. is used by commercial and residential buildings. As residential and commercial energy prices rise, consumers and facilities managers will seek to conserve energy. Companies that sell building products that conserve energy, such as insulation, energy efficient windows, more efficient heating and cooling systems, and more efficient lighting will benefit. The U.S. Green Building Council has created the Leadership in Energy and Environmental Design (LEED) certification program, which sets a benchmark for the design, construction and operation of high-performance green buildings. LEED homes use 15 to 20 percent less energy than does a house built to code. Many in the financial sector are eagerly anticipating rich new carbon markets in which to trade. But the advent of carbon rationing means that institutional investors also face substantial risks to the value of their portfolios. The nonprofit Carbon Disclosure Project (CDP) represents some 385 institutional investors including Merrill Lynch, Goldman Sachs, Morgan Stanley, AIG Investments, Barclays and HSBC that manage $57 trillion in assets.

The CDP issues reports annually aggregating information from a climate change questionnaire that it sends out to the world’s 3,000 largest publicly listed companies. Its annual reports evaluate each company’s exposure to carbon taxation and regulation, changes in the climate system, technological innovations and shifts in consumer attitude and demand. The idea is that investors should take how companies plan to deal with these issues into account when making investment decisions.

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 Economics of Emissions


Technological assumptions about how easy it will be to develop new sources of low-carbon energy and store carbon dioxide emitted by coal-fired plants drive the estimates on the price of emission permits. The American Council for Capital Formation (ACCF) and the National Association of Manufacturers (NAM) ran an econometric model using less rosy technological and economic assumptions than used by the EPA.

In March, the ACCF/NAM study found that under the declining emissions cap set by the Climate Security Act, the price of carbon dioxide emissions permits would rise to between $55 and $64 per ton in 2020 and between $227 and $271 per ton in 2030. That implies that the total value of 4.4 billion permits in 2020 would be $242 billion to $280 billion, rising steeply to between $860 billion to just over $1 trillion in 2030.

The ACCF/NAM analysis projects that this would push prices to residential consumers of natural gas up by 26 percent to 36 percent by 2020 and 108 percent to 146 percent by 2030. Residential electricity prices would rise by 28 percent to 33 percent by 2020, and by 101 percent to 129 percent by 2030.

U.S. GDP would be reduced by as much as $210 billion (2007 dollars) in 2020 and $669 billion in 2030, with concomitant job losses reaching as high as 1.8 million in 2020 and 4 million in 2030. Interestingly, the ACCF/NAM estimates fit in the mid-range of EPA calculations, suggesting that enactment of the Climate Security Act capand- trade scheme would result in an annual reduction in GDP ranging from $238 billion to $983 billion in 2030. The ACCF/NAM study finds that higher energy costs, lower economic activity and fewer jobs would reduce average household incomes by as much as $2,900 in 2020 and $6,700 in 2030. The EPA s

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