From the March 2009 issue of Investment Advisor • Subscribe!

March 1, 2009

The Green Advisor: Climate Change Opportunities

Investing with an eye on global warming and carbon emissions

On the January day that Al Gore testified before the Senate Foreign Relations Committee about the climate crisis, it snowed in Washington. That was apparently enough to convince some conservative (and apparently anti-science) bloggers that global warming isn't real. They are wrong. The fact of climate change presents a huge challenge for our global society, but it also offers us a tremendous opportunity to rethink how we use our resources, to realize that those resources are not infinite, and to emphasize sustainability.

Global warming can also help improve your clients' portfolios, which in this economic environment is no small thing. There are numerous "Investment Opportunities in the Climate Change Economy," which is the title of a new white paper put together by Chat Reynders, chairman and CEO of Reynders McVeigh Capital Management, in Boston, and Rick Duke, director of the Natural Resources Defense Council Center for Market Innovation. (You can download a copy of the paper here.)

The paper stresses that not only is there a tremendous potential investment upside, but that failure to address climate change could lead to global GDP losses of 1% to 5% with much higher losses at the local and regional levels. To get an idea of just what some of those investment opportunities are I spoke by telephone with Reynders and his partner Patrick McVeigh.

There are several ways for advisors to look at investing with a climate change lens, but according to these long-time SRI investors (see "Be Positive," in the July 2008 issue of Investment Advisor) one of the best places to start is by addressing energy efficiency. It's one of the easiest approaches and can produce the most immediate results.

"For a long time we've believed that efficiency matters and that if companies can do a good job in being progressive in how they manage their costs on the energy side, it's good for the company over the long term," says Reynders. "Companies that are aggressive in how they are managing their energy are going to end up being winners.

"Efficiency investments have made a lot of sense to us. For a long time we've been looking at things like transportation efficiencies and industrial efficiencies and investing in companies that focus on those areas."

Reynders thinks that the Obama Administration will institute policies on carbon emissions. The white paper he co-authored predicts that a combination of federal incentives for efficiency and renewable energy technologies and a cap and trade system to control carbon emissions will ultimately give low-carbon players a 10% to 50% cost advantage over their competitors.

Efficiency is really only one part of the climate change opportunity. "We've also been focused on the renewable side, understanding that there's an opportunity if it's true that the cost of energy is going to go up, decade by decade," Reynders continues. "We have been an investor in wind energy for some time. It's the most currently available alternative that has reasonable amounts of economic viability. It only gets better in a tougher carbon environment."

Complementing Reynders's thoughts, McVeigh adds that while the increasing cost of energy is an obvious reason to invest in alternatives, there's a misperception that renewable energy only does well when traditional energy prices are high.

"You can see, if you look at the growth of solar, the growth of wind and other renewables that the growth of the business has been very steady over the years, even when oil prices were relatively low," notes McVeigh. "The stock prices in the short term do tend to move with energy prices, but the underlying businesses don't seem to feel that much of an impact."

Many companies in the renewable sector had become overvalued, but as some investors have moved away in lockstep with the drop in oil prices, McVeigh sees an opportunity for new money to come in. "They've come back down to attractive levels and you'll continue to see growth in these areas," he says. "We anticipate strong growth and it may even accelerate with what's likely to come out of the stimulus package."

Speaking of the stimulus plan that as of press time was being debated in the Senate, Reynders thinks that many people have misunderstood the parts that relate to energy and infrastructure if they think that spending will be limited to the $8 billion mentioned so far. "I think people need to focus on the fact that the Obama plan is an initiation of a direction," he says. "Part of what the NRDC is talking about and others are talking about is the reality that's exerting itself in terms of the real cost that global warming will create, the real cost of these carbon emissions, and the need to cut these emissions.

"We're going to start with this plan and then there will likely be an entire regime that puts a premium on efficiency," Reynders continues. "If the government has to rationalize taxes in order to pay back some of this money that we're putting into the system, more than likely it's going to come from some sort of consumption tax. This is not simply a response to a stimulus package. This is looking out further over a changing landscape. What's very, very important to our investors is to understand that these efficiency plays will become growth plays in that changing landscape."

Fixing the Grid

There's a tremendous amount of work that needs to be done on infrastructure in this country. In politicians' rush to cut taxes over the past couple decades there are many areas that have not received the attention they need and deserve. That includes roads, bridges, schools, and as it relates to the topic at hand, the energy transmission grid.

"A lot of money will go into making the grid smarter," says McVeigh. "The average substation in this country is 42 years old. When they first were sold they were rated to be good for 40 years, so the average one is older than what the expected life was supposed to be. There are about 600,000 miles of power line in this country and since 2000 we've built 688 new miles. So it's a very old, inefficient system. We lose about 15% of our electricity in the transmission process."

One of the investments that Reynders McVeigh has made with an eye towards this infrastructure investment is ABB Ltd. (Ticker: ADR), the Swiss firm.

"Their business has been twofold," explains McVeigh. "They're the company that has supplied most of the products that built the grid in Europe and in the U.S. and is building the grid in the emerging economies of the world. They make everything to get electricity, once it's been generated, to the consumer--substations, power lines, etc."

ABB also makes products that can save much of the power lost in transmission as well as the equipment that makes it possible to connect renewable energy sources to the power grid. According to McVeigh, the company did about $600 million in sales last year to the wind power industry alone.

For advisors the key to helping clients make investments that will have an impact on the climate crisis means doing your homework and looking for investments that may not be pure plays. "What we're trying to say is that there's a large swath of investments on both the proactive clean energy side and on the efficiency side that deserve a great deal of attention," explains Reynders.

For Reynders McVeigh, that homework means looking at traditional energy companies that have added renewables to their stable of production vehicles, or companies like Wal-Mart which have seen how energy efficiency and waste reduction can have a dramatic effect on the bottom line.

"We think this is an ideal time on the efficiency front," concludes McVeigh. So don't say I didn't warn you.

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