Investing to Reduce Returns - Of CO2 

By Heidi Soumerai, CFA
From the Summer 2013 Edition of Values


On May 9, 2013, the National Oceanic and Atmospheric Administration reported an ominous milestone from an observatory in Hawaii. Atmospheric levels of carbon dioxide (CO2) had reached 400 parts per million (ppm), nearly 22 ppm above average levels one decade ago and well above the 350 ppm that scientists believe we must return to in order to avoid severe consequences of climate change. The signal is not ambiguous; a rapid increase in CO2, attributed largely to the burning of fossil fuels, is an existential threat to the natural environment and global public health. 

The Intergovernmental Panel on Climate Change (IPCC), the world’s leading scientific authority on climate change, estimates that a 50 percent reduction in greenhouse gas (ghg) emissions globally is needed by 2050 (relative to 1990 levels) to stabilize global temperatures, entailing a U.S. target reduction of 80 percent. The dismal pace of progress has ignited the passion of students and others in a growing movement to divest from fossil fuel companies, inspired by Bill McKibben’s “Do the Math Tour.” McKibben argues that 80 percent of oil, gas, and coal reserves must never be burned.

Walden shares our clients’ deep concern regarding climate change and recognizes the urgent need for effective actions to mitigate and adapt to the growing risks. To achieve the global emissions reduction required to avoid catastrophic climate change, we believe that priority number one is to develop, enact, and enforce strong public policies that place a price on carbon, through mechanisms such as a cap-and-trade system or carbon tax. At the same time, companies and consumers must take immediate steps to reduce their dependence on fossil fuels. Additional government leadership to promote energy efficiency and renewable energy development is also critical.

Investors are an important and strategic voice to build momentum for sustained progress. Since U.S. and global economic growth remain inextricably linked to fossil fuel use during the transition to a more carbon-constrained environment, Walden pursues a multi-pronged approach that integrates climate change risk in investment decision-making, corporate engagement, and public policy advocacy.

Company Selection
All companies rely on carbon-based fuel sources to varying degrees. Hence, Walden favors investment in companies with products and processes promoting energy efficiency and natural resource conservation; strong and transparent greenhouse gas reduction policies, goals, programs, and results; and supportive and consistent public policy positions. Exemplary companies include members of BICEP (Business for Innovative Climate & Energy Policy) – EMC, Intel, Nike, and United Natural Foods, among others – an organization that was created to promote “broad, bi-partisan consensus among policy-makers to reduce U.S. greenhouse gas emissions 80 percent below 1990 levels by 2050.”

Walden’s investment approach results in portfolios with favorable carbon footprints relative to comparable benchmarks. Utilizing carbon intensity data provided by Trucost, a leading independent provider of corporate environmental metrics, our analysis of a representative Walden client portfolio of larger capitalization stocks shows the portfolio to be approximately 30 percent more carbon efficient than the S&P 500.

Our approach to investment in the energy sector leads Walden to exclude coal companies from client portfolios. Coal is the most carbon-intensive fossil fuel, according to International Energy Agency estimates, representing 45 percent of total energy-related CO2 emissions in 2011. We also seek to minimize exposure to bituminous sands (also known as oil sands or tar sands) – an unconventional oil source with relatively high carbon intensity. Conversely, we emphasize natural gas because it is a lower-carbon fossil fuel that, in combination with resource conservation and energy-efficiency measures, can play an important role in the transition to cleaner fuel technologies.

Walden favors energy companies with public policy positions that call for a price on carbon. ConocoPhillips is a case in point. In 2007, the oil company became the first in the U.S to make a public statement supporting regulation of ghg emissions. CEO James Mulva stated, “Voluntary programs are not going to meet the challenge of climate change… The longer we wait – two or five years or more from now – it won’t be mitigation, it will be adaptation.” In 2010, Mulva testified before Congress for “the passage of a comprehensive federal law establishing a clear and transparent price for carbon.”

More proactively, Walden looks for opportunities to invest in companies with innovative, solutions-oriented technologies such as energy efficiency, carbon sequestration or renewable energy development. Independent oil and gas company Denbury Resources specializes in carbon dioxide-enhanced oil recovery of older, depleted oil fields. The company recently began using man-made, or anthropogenic, CO2 from a hydrogen production facility in Texas to demonstrate that it can safely and permanently capture and store in secure geological formations the industrial CO2 emissions that would otherwise be released in the atmosphere. Emerson Electric provides a broad range of efficient process management and climate technologies such as energy-conserving heat pumps for businesses and residences. Polypore International is a leading manufacturer of lithium-ion battery separators used in hybrid vehicles and, more recently, electric vehicles. Power Integrations makes energy-saving integrated circuits used in power conversion in appliances, computer equipment and electronics, enabling manufacturers to meet energy-efficiency standards. The company estimates its technology accounts for a 97 percent reduction in standby energy waste.

Impact Through Engagement
Shareholder engagement is a core component of Walden’s investment philosophy and a key mechanism to achieve positive outcomes. Through company dialogues and shareholder resolutions, often in collaboration with other investors, informed professionals, affected constituencies, or nongovernmental organizations, Walden encourages company policies and actions that reduce ghg emissions to levels indicated as necessary by the IPCC. We believe that effective shareholder engagement can help build the critical mass needed to advance sound public policy.

Our engagement on climate change across the universe of client portfolio companies encourages an array of outcomes: effective and transparent ghg reduction policies and programs, increased energy efficiency, resource conservation, renewable energy development and use, and climate and water risk assessments. Because short-sighted corporate managements have stymied progress on public policy, Walden has also engaged with numerous companies, including energy firms, to strengthen political spending and lobbying transparency. These initiatives have resulted in tangible progress. Moreover, Walden’s shareholder engagement has encouraged many companies in a variety of industries to disclose publicly their climate change mitigation and adaptation policies and practices through the Carbon Disclosure Project (CDP), the largest global repository of corporate information on climate change.

As an example, earlier this year Walden withdrew a resolution at medical devices company Stryker asking it to adopt and disclose quantitative goals for reducing total ghg emissions. Stryker committed to gather three years of historical ghg emissions data to serve as a baseline from which it will establish and disclose formal, quantitative reduction goals before year-end. Additionally, Stryker committed to respond to CDP, which brings a new level of accountability on its management of climate risk.

Walden also pursues shareholder initiatives that aim to minimize the environmental impacts of the energy sector. Examples include advocating for best practices in hydraulic fracturing (i.e., shale gas exploration and production), robust and transparent environmental impact assessments of any investment in oil sands development, and strong policies and procedures regarding drilling in environmentally sensitive areas.

Walden joined other concerned investors in convincing Apache to increase public reporting of climate change data, policies, and practices. We have met with CEO Steven Farris several times as part of an investor coalition to discuss and encourage best practices in hydraulic fracturing (i.e., chemicals use and disclosure, water management and recycling, community and land impact assessments). Similarly, engagement with ConocoPhillips has been productive, particularly with respect to moderating impacts of exploration and development on indigenous populations. Our May 2013 resolution on lobbying disclosure at the energy company received 26 percent support, sending a strong signal to management that shareholders believe corporate activity in the political sphere should be consistent with internal policies on climate change and other matters.

Public Policy Advocacy
The importance of effective legislation and regulation as a means to tackle climate change is paramount. Walden participates in public policy advocacy at the state, federal, and international levels to press for a substantial and coordinated response to climate change and more sustainable energy production. Recent examples include:
 
  • Support for the Obama administration’s proposal to dramatically increase fuel efficiency standards for vehicles to an average of 54.5 miles per gallon by 2025, estimated to reduce greenhouse gases by 50 percent and fuel consumption by 40 percent.
  • Support for the U.S. Environmental Protection Agency's (EPA) proposed Carbon Pollution Standard for New Power Plants as a means to help spur innovation and investment in low and no-carbon technologies as well as in new energy infrastructure and energy efficiency.
  • As part of the Investor Network on Climate Risk, advocated for an extension of the Production Tax Credit for wind energy. The credit was extended in the final hours of the 112th U.S. Congress.
  • Signatory of a letter to the Canadian government and the provincial government of Alberta, commending their implementation plan for a robust and transparent monitoring system for oil sands development while also encouraging the establishment of independent oversight. 
  • Initiatives challenging corporate public policy and lobbying activities, directly or indirectly through trade groups or think tanks such as the Heartland Institute and the American Legislative Exchange Council, that undermine the development of legislative and regulatory policies addressing climate change (e.g., lobbying against renewable energy regulations at the state level). Numerous companies have cut ties with such groups. 

Unfortunately, current efforts in the United States to mitigate and adapt to climate change are grossly inadequate relative to the IPCC targets. A serious response to the climate crisis will require collective and concerted action by policy-makers, companies, nongovernmental organizations, and the public. We believe that Walden’s multi-faceted approach to integrate climate risk in the investment process through company selection, shareholder engagement, and public policy advocacy helps amplify a constructive investor voice.

Fossil Fuel–Free Portfolios
For Walden clients who decide to exclude investment in fossil fuel companies altogether, we have decades of experience implementing separately managed portfolios without direct exposure to coal, natural gas, and oil companies. By allocating funds from the energy sector to other companies with positive correlation to rising energy prices, we have been able to reduce the portfolio impact of not owning energy companies.