If the U.S. regulates carbon emissions, would your portfolio take a hit?

A discussion with Dan Bakal, director of electric-power programs for Ceres.

For years, investment experts have warned about the financial risks industries face if the United States regulates greenhouse gases. Now, they're getting specific – focusing on which companies face the most risk under what legislation. Ceres, a Boston-based network of investors, environmental organizations, and other groups, has published an in-depth report on how electric utilities might fare under two carbon-regulation bills. The Senate began debating one of them on Monday. The Monitor's Laurent Belsie talked recently with Dan Bakal, the group's director of electric-power programs, about the findings. Here is an edited transcript of their conversation: Would carbon regulation wallop the electric-power industry?

Mr. Bakal: It certainly will have a significant impact. And I would say both positive and negative. So it will wallop maybe some companies. But it doesn't necessarily wallop the industry overall.

What's the negative impact?

A lot of it depends on what happens in Congress.... At a basic level, the companies that emit the most CO2 will be certainly impacted as you put a cost on CO2 emissions, which is what any regulation is going to do. That does have an impact on the biggest emitters. And those tend to be the biggest coal-fired generators, meaning they use coal to produce electricity.

Let's talk about the impact on the investor. Depending on the legislation, the impact varies hugely.

That's true. We are not doing analysis on what the impact on any company is. We show what their emissions are and allocations they might get under various scenarios. And then we expect analysts ... to be doing the more rigorous financial analysis about what the impact is on specific companies.

But your report makes pretty clear that some companies are far more efficient than others in generating electricity without too much CO2.

What really impacts the rates are the fuels that are being used to generate electricity. Coal is the most CO2-intensive. Natural gas has about half the CO2 intensity of coal. Oil has more than natural gas. Nuclear is very low on CO2 emissions. And of course, renewable energy, like wind and solar, [is] essentially carbon-free. So that's the primary factor in determining a company's CO2 emissions.

If investors were looking at specific utilities, they would look at how much of their energy comes from coal?

That's a key factor. Then again, the markets they operate in are pretty key – whether or not they're in states that are regulated or deregulated. Approximately half of the country is still regulated.... Those are rough numbers. There are a lot of factors that go into this.

Two bills in the Senate – the Lieberman-Warner Climate Security Act and the Low Carbon Economy Act – contain specifics about how industries would be able to get allowances to emit CO2.

They both have portions that they want to auction. So a portion of the allowances will be auctioned and those will have to be purchased by power companies and other entities. A portion of them will be given to companies for free. And then another portion can be given to local electric-utility companies to be used for consumer benefit. At least that's under the Lieberman-Warner Climate Security Act. That's the one that's getting the most attention and will be coming to a floor debate [this week].

Those free allowances amount to a big chunk of change. Your report says that under one scenario, about $6.2 billion a year for the 10 largest investor-owned utilities.

Yes, although it's actually quite complicated because it depends on what markets they operate in. So for companies that operate in regulated markets, those allowance values may not translate into profits for them.

That's what stands out from the report: The impact on investors depends hugely on the details of what's enacted.

There are many ways to slice this up. What we do show is that if you allocate some of the allowances to the local utility companies and enable them to use those allowances ... to help their customers reduce their bills and even invest in energy efficiency, that's an effective way to address some of the rate impacts they might be seeing.

Because consumers will be affected, too?

Absolutely. And what we try to do is give a really concrete example. So we look in Indiana. The majority of the electricity comes from coal. And under the Lieberman-Warner bill what it does show is that if it's implemented properly, whatever rate increases might impact customers due to the added costs of CO2 [regulation], they can be offset by a combination of rebates and energy efficiency programs. So that the average Indiana customer, who spends approximately $82 a month on electricity, may see a slight increase in rates but that can be offset by a combination of rebates and incentives.

Is carbon regulation inevitable?

I would argue it's inevitable because the science of climate change is so compelling right now. There's so much consensus around it. And the amount of action that we really need to take – or the amount of greenhouse-gas reductions we really need out to 2050 – are so significant that they're not going to happen following any business-as-usual approach.

What other industries may be affected?

The legislation in Congress is really economywide. It is not just the power sector. So any other high-emitting industry – from oil and gas to heavy manufacturing to the coal industry, mining, and so on – face impacts because of their emissions or their contribution to the problem. Then there are industries that face impacts because of the climatic changes we're already experiencing and likely to experience. So agriculture is facing climatic impacts. Of course, the insurance industry is dealing with implications of severe weather events of all kinds. And real estate [faces] sea-level rise and other issues.

Are there any winners in this?

Every place where we see risk, we also see opportunity. So for a lot of industries, they have to get their heads around the risk and then see how it becomes a competitive advantage for them.... On top of that, there are clean-tech or clean-energy companies. It's a burgeoning growth area where companies of all different kinds – whether it's the wind-power generators or the solar technology companies or even the emerging ones like tidal power and enhanced geothermal, but also all the energy-efficiency technologies that get us to use energy more wisely. That whole space is growing rapidly to the point where $150 billion was invested in global clean-energy companies last year.

So what should an ethical investor do?

You look carefully at the most carbon-intensive industries and try to avoid some of the real risk areas. And then you look on the upside.

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