A major change in Securities & Exchange Commission rules is about to drastically affect energy companies of all stripes.
In short, the change alters the way companies calculate one of the most important factors on which investors base purchase decisions: risk.
And I'm not talking about individual investors; I'm talking about market makers like institutional banks, hedge and mutual funds, and billion-dollar pension funds. They'll soon be looking at the market through a very different prism.
The change quietly took place in late January, when SEC commissioners mandated that companies disclose risk that climate change and the consequences of related legislation places on their assets and operations.
But before you can understand how this will impact your energy investments, you have to understand how it will alter the buying habits of some of the most influential financial institutions in the world...
Tisk, Tisk to Climate Risk
To see how this change will affect public markets, you needn't look any further than the response from managers of some of the biggest pension funds in the country who purchase billions worth of equities each year.
Nancy Kopp manages Maryland's $33 billion fund and called it a "big step forward."
Anne Stausbol, CEO of the $200 billion California Public Employee's Retirement System (CALPERS), said "Ensuring investors are getting timely, material information on climate-related impacts, including regulatory and physical impacts, is absolutely necessary."
She added, "Investors have a fundamental right to know which companies are well positioned for the future and which are not."
They are obviously looking to invest in companies with minimal climate risk. In other words, companies with high climate risk — high emissions, energy-intensive products, insurance companies — are less valuable to them.
That means they're less valuable to you.
Well-Positioned for the Future
Put yourself in the shoes of a billion-dollar fund manager for a moment, responsible for the wealth of large numbers of people.
Then consider the implications of this change, as described by the Wall Street Journal:
Insurance companies are among those affected by the SEC action. The agency said insurers may want to consider disclosing whether severe weather or changes in sea levels might increase the risk of claims in coastal regions.
The SEC also said companies should weigh disclosure on how pending rules or laws might affect the bottom line. For example, it noted, goods that produce significant greenhouse-gas emissions might see lower demand.
Now, imagine the investment decisions at hand. You have to decide which of two utility companies to invest in...
One has a large portfolio of coal plants with no significant plans to expand the use of clean energy. The other is still largely reliant on coal, but is deploying vast wind assets and has a robust efficiency plan for its customers.
This new rule will require that first company to report its future dependence on coal as a risk that could harm shareholder value.
Don't forget, the Environmental Protection Agency (EPA) is already preparing to regulate greenhouse gases and Congress is debating similar measures. Another new risk to report.
Which do you choose?
This new rule all but forces you to invest in the company with a better clean energy approach.
Such is the new energy investment reality. You have to be well-positioned for the carbon-constrained future to succeed.
The Risk/Reward Seesaw
While this change presents plenty of new risk, it should also make clear many possible rewards.
Take BusinessWeek's recent comparison of two utilities:
American Electric Power Co., the biggest U.S. producer of electricity from coal, released 148 million metric tons of carbon dioxide in 2008, according to data compiled by Bloomberg. Exelon Corp., the biggest U.S. nuclear-power producer, produced 9.7 million tons of greenhouse-gas emissions in the same year.
In some ways, it's not hard to see how market makers have been individually assessing this risk for years:
This just makes it official.
And by default, companies with less or no climate risk are becoming inherently more valuable. It's like a risk/reward seesaw.
As fund managers and banks try to reduce their exposure to companies with high climate risk, they'll conversely be trying to increase exposure to companies with little or no climate risk
It's not hard to imagine how this will play out...
Coal miners will be abandoned for wind turbine companies...
Ethanol companies could take the place of gas refiners...
That's why there's been a slew of new funds created to harness the upside of this seesaw, like the Guinness Atkinson Alternative Energy Fund (GAAEX) and the PowerShares WilderHill Progressive Energy Fund (NYSE: PUW), to name just two.
As you make energy investment decisions in the future, you'll want to keep this new risk paradigm in mind. Those with excessive exposure should send up an immediate red flag.
Call it like you see it,
P.S. One of the industries with the greatest exposure to this new risk is the auto industry. Their product is not only energy-intensive to make, it's also dependent on fossil fuels for all of its useful life. That's why big investors — Buffett included — are looking for alternative investments in the space.
One such investment — a tiny Chinese electric car maker — has already been touted by Buffett's go-to analyst as "one of the most interesting small companies in the world." This report reveals why that company is about to make early investors a fortune.