Factoring carbon liability into your investments

Study finds 10% of Canadian companies account for 80% of carbon intensity

High tech companies like Google use massive amounts of power in their servers, but should they be excluded from low-carbon portfolios?

Just 10% of Canadian companies account for 80% of the carbon intensity on the Canadian stock market, a new white paper by Vancouver’s Genus Capital Management concludes.

The study also concludes that carbon intensity can be a liability for portfolios that contain stocks in carbon intensive sectors like oil, gas and coal.

“Our research shows that the greater carbon intensity that you have in your portfolio, that will have a negative effect on your return, as it has over the past seven years,” said Mike Thiessen, Genus’ manager of sustainable research.

According to Genus’ new report, The Effect of Carbon Emissions on Investment Returns, energy makes up 21% of the S&P/TSX Composite Index, whereas it accounted for only 6.6% of the S&P 500.

“Reducing exposure to the energy sector will mean losing exposure to approximately one-fifth of the Canadian index,” the Genus report states.

For wealth managers like Genus, which has a fossil-fuel free fund, coming up with investment strategies that filter out companies with high carbon emissions poses a challenge.

What about other companies that aren’t in fossil fuels but which nonetheless have large carbon footprints? Big banks, for example, or high-tech companies?

Filtering out companies for ethical investment portfolios based solely on their carbon footprint might not be such a wise decision for any wealth manager who is trying to maximize a return for clients.

What wealth manager, after all, would want to develop a portfolio that excluded high-tech companies like Amazon.com Inc. (Nasdaq:AMZN) or Google (NasdAQ:GOOGL).

Both companies have huge carbon footprints by virtue of their size and the amount of power they consume in their massive data farms. Google, for example, produced 2.5 million metric tonnes of CO2 in 2014. Amazon has steadfastly refused to disclose its carbon emissions data to the Carbon Disclosure Project.

Genus is now using a formula that does not filter out companies based on sheer carbon volume. Rather, it uses a formula for calculating carbon intensity: i.e. tonnes of carbon produced per $1 million in sales.

“As a result of this report, we’ve decided not to worry about carbon emissions as a sole metric and we’re only looking at carbon intensity,” Thiessen said. “A company like Apple or Google, they will have high emissions, but their actual carbon intensity is going to be very small.”

In doing its analysis, Genus concluded that 10% of Canadian companies account for 80% of the emissions on the Canadian stock market.

While Canadian oil sands producers like Suncor Energy Inc. (TAX:SU) are in that top 10%, they aren’t the most carbon intensive companies in Canada – utility companies like TransAlta Corp. (TSX:TA) and Capital Power Crop. (TSX:CPX) are.

“If you are looking at carbon intensity…really utilities that are burning fossil fuel, especially coal, are by far the most carbon intensive,” Thiessen said.

Those companies with the highest carbon intensity could become a liability for investors, Thiessen said.

Over a seven-year period, Genus found that carbon intensity had a “cumulative drag” of 9.2% on portfolio performance. Thiessen said several factors were likely at play.

“I think one of them could be utilities and the performance of utilities, especially coal utilities, over the past seven years…due to stranded assets and the risk of stranded assets in the future,” Thiessen said.

“I think it’s also representative of the cultural shift, where people are more worried about their own individual carbon emissions and what power they’re using, how their vehicle is powered. I think there’s a cultural shift there.”