The most common way to measure the climate risk exposure of a company is to understand the level of carbon output. In addition to portfolio-level carbon analyses, we disaggregate portfolios at the sector and stock-level to understand the specific contributions to carbon emissions.
In the MSCI World Index, the utility sector accounts for 47% of carbon intensity and 38% of total carbon emissions. Almost two-thirds of the carbon emissions and intensity come from the utilities, oil & gas, chemicals, construction and mining sectors.
An explicit goal of minimising carbon intensity in a portfolio will have significant implications for sector positioning, portfolio construction and potential alpha.
Fossil fuel reserves (reserves of thermal coal, oil and gas) can also represent carbon risk as “future” carbon emissions. With the rising pressure of decarbonisation and energy transition, companies that own untapped fossil fuel reserves may be exposed to stranded asset risk. Hence, examining the extent of fossil fuel reserves and mitigating the bet size of a company that is overly reliant on fossil fuels versus its peers or benchmark can be one way to manage the environmental footprint of a portfolio.
While a company’s carbon footprint is an important element in assessing climate risk, it needs to be reviewed in combination with the strategic initiatives the company is undertaking to manage any negative environmental impacts.
Case Study: Xcel
The company with the highest carbon intensity in a sample global portfolio is Xcel Energy, a regulated utility company with operations in Minnesota, Colorado, Texas and New Mexico.
While Xcel Energy ranks poorly today in carbon emissions, the company is in the process of dramatically reducing the amount of power that it generates using coal. Over the next three years, Xcel Energy is building over 3,500 megawatts (mw) of new wind generation, which has already been approved by state regulatory agencies.
The company is targeting an 80% reduction in carbon emissions by 2030 – greater than the reductions requested in the Paris Climate Accord and President Obama’s unsuccessful Clean Power Plan. Xcel Energy is also adding solar generation and battery storage to its system, and improving energy efficiency to offset future emissions.
Xcel is in the process of dramatically reducing the amount of power that it generates using coal.
Xcel Energy is choosing an environmentally responsible path, while targeting EPS growth of 5-6% per year and dividend growth of 5-7% per year. The company has a strong credit rating, good growth prospects, and, with the cost of renewable energy generation declining rapidly, can maintain customer bill inflation at reasonable levels while continuing the transition of its power generation portfolio. Coal generation accounted for 10% of Xcel’s regulated rate base in 2018 and is expected to decline to 5% by 2024.