The battle against global warming could be a boon to investors as new technologies and industries emerge, writes Annette Sampson.

It's easy to see climate change as a bad news story. Rising sea levels, a hotter and drier Australia, dying coral reefs, salinity in the Murray-Darling basin, even polar bears becoming endangered as their habitat is eroded by contracting sea ice. It doesn't give you much to smile about.

So, it's little surprise that much of the financial commentary has focused on the risks and costs of climate change. Higher energy prices, increased costs for goods and services, buildings falling into the sea and the negative effects on economic growth ... all have received substantial air time.

But, as with most big changes, climate change isn't that simple. There will indeed be costs to society as we try to ward off further environmental damage. But there will also be opportunities, especially for those who recognise the changes and plan ahead.

"Climate change is going to mean big changes to the economy but they may not be bad changes," says Michael Molitor, the chief executive of the CarbonShift consultancy and a senior adviser on climate management to PricewaterhouseCoopers.

"What we're doing now is putting a price on carbon to become carbon-fit and lean. It's like getting up early and exercising. There will be some discomfort but in the long term we'll be better off. It means creating more wealth, not less."

"There will be winners and losers," says VicSuper's chief executive, Bob Welsh. "There could be a period where profits are constrained but, on the other side of that, the investment opportunities will be enormous.

"To take the world from its dependency on fossil fuels will create the greatest investment opportunity we've ever seen. But we'll have to go through a period of adjustment first. That's why we need early action rather than later."

HOW WILL IT AFFECT THE ECONOMY?

There are too many variables for any real certainty but the consensus seems to be that the sooner we act, the more chance we have of avoiding economic disaster. In his draft report for the Garnaut Climate Change Review, Professor Ross Garnaut said unmitigated climate change could wipe about 4.8 per cent off Australia's GDP by 2100 and 7.8 per cent from real wages - and that's on the basis of middle-of-the-road climate-change outcomes.

The review's full economic modelling will be released shortly but Garnaut says the impact would be significantly reduced by global mitigation - and Australia needs to play its part.

"The first step is to take action as part of the developed world, with a view to bringing in developing countries - first of all China - on the earliest possible timetable," he told the National Press Club last month. Even if you are unsure about the science, he said, the risks of not acting now are high. "Delaying now will eliminate attractive lower-cost options," Garnaut wrote in the draft report.

AMP Capital Investors' head of investment strategy, Shane Oliver, says existing studies suggest putting a price on carbon pollution would cost about 3 per cent of GDP by 2050.

"In other words, it may take a couple of years to get to where we would have if climate change hadn't existed," he says. "But it's a relatively modest price to pay. Once the world starts adjusting to producing lower emissions, it will set off such a wave of technological innovation that [the economic cost] probably won't even be noticed."

If this sounds unlikely in the fear of the moment, Oliver points to other changes that doomsayers predicted would rock economies: reducing smog levels from industrial production, moving to lead-free fuel, phasing out CFCs to protect the ozone layer.

"History suggests technological adjustments and the economic blow-out won't be as negative as people make out," he says. "There will be a massive growth in new industries."

Industry Funds Management's chairman, Garry Weaven, says "It's absolute nonsense to say we can't afford to address climate change. It's patently obvious world economies can adapt to factoring in new costs; they've always had to do that. The price of oil went up about fivefold during the biggest boom market we've seen. It wasn't high oil prices that caused the end of the boom but stupid lending [practices]."

But inevitably there will be some pain along the way and a long list of winners and losers.

What's being done about it?

Australia's frontline response is the introduction of carbon trading - or, as the Government dubs it, a Carbon Pollution Reduction Scheme.

The idea is simple. We set a limit on how much carbon can be produced and major polluters must buy permits for the carbon they'll emit. These permits can be traded so that companies that become more efficient can sell permits they don't need, effectively putting a price on greenhouse pollution.

"The cost of carbon emissions at the moment is being indirectly paid by everyone," Welsh says.

"Putting a price on carbon will increase the costs of energy and therefore goods and services but it will be paid for directly."

Goldman Sachs JBWere's head of research, Andrew Gray, says last month's Government green paper set the broad framework for a carbon trading system in Australia. But it did not set a cap on the level of emissions to be allowed. This won't be known until it releases its white paper in December.

Austock Securities' team leader for agribusiness and chemicals, Paul Jensz, says: "The most important thing is the 2020 target for emissions. That's what will drive the carbon price. If it's a tough target, the carbon price will be higher but if it's too lax, there's a risk that a tougher target will be introduced later on and all the plans put in place by companies will have to change.

"We need a reasonable target and, once we have that, for the Government to work towards a level global playing field by about 2020."

In a research note, Gray said the consensus was that carbon would eventually trade at $30-$40 a tonne. But because the scheme is likely to be phased in, the initial price is likely to be lower.

The Government also proposed compensation for emissions-intensive export industries and possibly non-export industries with large emissions that don't have economically viable abatement opportunities - such as coal-fired power stations. The Garnaut review also recommended revenue raised from permits be allocated to low- and middle-income earners to help offset higher prices and for development of new technologies.

Impact of Carbon Trading

The green paper estimated a one-off 0.9 per cent increase in inflation if a $20-a-tonne carbon price was imposed. Only about 1000 companies (the biggest polluters) are likely to be included in the trading scheme but charging for carbon will increase basic costs such as energy, which will filter down through most goods and services.

Weaven says almost every company will be affected and while the obvious winners are renewable energy companies and the obvious losers big polluters, factors such as company management also will come into play.

"Some of the companies with the biggest carbon footprints have the most to gain," he says. "If they can do better than their competitors, they will have an advantage."

Last year VicSuper commissioned a report on carbon emissions of Australian companies, The VicSuper Carbon Count, which found companies in the S&P/ASX200 directly emitted 133 million tonnes of carbon dioxide equivalents, or about 0.5 per cent of global emissions. Just four sectors - metals and mining, oil and gas, airlines, and construction materials - contributed 74 per cent of emissions. And four companies, BHP Billiton, Rio Tinto, Bluescope Steel and Qantas, accounted for nearly half the emissions.

Gray's research identifies 19 stocks that have high emissions relative to their earnings: Bluescope Steel, Onesteel, Alumina, Qantas, Orica, Boral, Paperlinx, Origin Energy, Newcrest Mining, Contact Energy (NZ), Caltex, BHP, Leighton, Rio, AGL, Fletcher Building, Amcor, Wesfarmers and Woolworths.

But he says this doesn't necessarily mean they'll be most affected by the scheme. Other variables such as compensation and their ability to pass on carbon costs through higher prices will have an effect.

Jensz says: "It's hard to be definitive from what we've seen so far but I can't see [carbon trading] being especially negative, particularly if companies are pro-active. If it's not handled well, it will be more harmful but a lot of the larger companies, and those more exposed to greenhouse gas-emissions, are reasonably well prepared.

"People are looking at companies and trying to ensure they have a good pricing position and management nimble enough to adapt to change. You can't just dismiss dirty industries. Inside dirty industries there are smart dirty companies and ones that are not as adaptable."

Weaven believes carbon trading will lead to better reporting of companies' environmental risks and management.

"The day the Government crystallises some of its plans for a trading system, people will work out that some companies will have additional costs and others will [have an advantage]. Businesses will start reporting to potential investors, especially where they have taken steps to do the right thing."

Michael Walsh, the executive director of Ethical Investor, says carbon trading is bringing a new commodity to global markets. "[When we have a scheme that connects with the global market] carbon will be a valuable commodity," he says.

"It will be like the oil price in the way it can have a significant impact on markets, companies and, ultimately, people's hip pockets and consumer sentiment."

How will it affect investments?

Welsh says climate change will affect investment returns, though there's not a lot of evidence of that yet.

"Super funds understand it is probably the most significant long-term risk to their members' wealth generation but at the same time there's still an element of short-termism," he says.

Initiatives such as the Investor Group on Climate Change (which focuses on the impact of climate change on investments) are driving the trend to take account of climate change risks in company valuations.

From July 1, companies are required to report on their greenhouse emissions and Gray says Australia also has the most signatories to the UN Principles for Responsible Investment, which incorporate social, governance and environment issues into funds management.

Ultimately, Jensz says, the growing focus on sustainability has to be good for investors.

He says carbon trading is like the battering-ram at the front, changing attitudes to a whole range of issues including waste management, energy efficiency and social responsibility.

Customarily such issues have been the province of ethical and sustainable investment funds but they are becoming more mainstream.

"At the moment, carbon pollution is normal," Oliver says. "But as it gets brought into the economic system, it will become a factor in investment decisions and an important thing for analysts to look at."

Molitor says there are already signs climate change is affecting the value of investments.

"The whole world is moving towards putting a premium on carbon. Look at the huge premium Rio paid when it bought Alcan. It paid much more than Alcan's highest traded price and all the analysts wondered what they'd been smoking," he says.

"But Alcan is one of the lowest-emission producers of aluminium and large bulk buyers increasingly need to buy low-carbon aluminium." Molitor says large buyers, such as car companies, are under increasing pressure from institutional investors to lower their carbon footprint and will be prepared to pay more for lower-emission products.

Molitor says governments are also playing a role. He says France is talking about import restrictions on carbon-intensive products and the US has said it may do this if it develops emission trading.

"The institutions are getting involved but they're not saying it's important to be green," he says. "They're saying climate change is a material commercial risk and they have to take measures to mitigate that risk."

Gray says climate change will become an investment theme which is broadly negative for fossil fuels and energy-intensive industries and positive for renewable energy, low-energy industries and companies that can manage their emissions. He says the immediate questions for investors are the impact of the carbon price and what opportunities exist to profit from the structural changes. That may mean diversifying internationally to find investment opportunities, particularly in areas such as renewable energy, where local companies are often smaller and many of the technologies unproven.

At the moment opportunities for retail investors to invest in renewables and other clean technology are limited. But Molitor says funds are already appearing in the wholesale market and will be offered to retail investors.

Weaven says: "There will be all sorts of people running around offering you-beaut investments. In many cases people should be extremely wary because [there will be many] trying to cash in on sentiment and buzzwords. It's not that long ago we had the IT bubble, where we had some good companies but most have never been heard of since."

Walsh says technologies that can reduce emissions will also be a growth area.

Jensz says: "If Australia can get into the position of being a champion for cleaner technologies and have service and technology companies pushing sustainability and making it achievable, then we can export that expertise. It gets very exciting. If we can improve our energy efficiency here, we may be able to export it to countries such as China and India."

Jensz says renewable energy is the obvious opportunity but there are also opportunities in areas such as waste management and companies becoming more energy-efficient.

Weaven says gas, forestry, water management and horticulture will present opportunities and even infrastructure should get a boost. "A lot of money will need to be spent on infrastructure to meet the climate change challenges."

But the proposition is not as simple as selling dirty companies to invest in cleaner ones.

"You have to put [the losers] into the context of a world that is energy-constrained and energy-resource scarce," Weaven says. "[Carbon trading] is just telling them, 'Don't make out like bandits."'

* The author owns shares in BHP, Telstra, Transurban, Fosters, Qantas, Alumina, Paperlinx and Woolworths.

The footprint of your fund

Next month the 237,000 members of VicSuper will receive a report from the public-offer super fund that tells them the level of carbon emissions associated with each dollar they have invested.

"If you have a $50,000 account balance, we will be able to report how many kilograms [of carbon dioxide are] associated with that investment," says chief executive Bob Welsh.

"If members are concerned about climate change, they can do things like change the type of light bulbs they use but what about their super fund? We're telling them what we think the emissions are and will try to reduce them. In five years, if we work with the companies we invest in, we'd like to be able to go back to members and report lower emissions but the same type of investment returns."

For the report, VicSuper had commissioned British company Trucost, to look at the published data on the companies the fund invests in here and overseas and to identify their levels of carbon emissions as at June. Where no data was available, modelling has been used to arrive at an estimate. This data was then broken down into how much carbon dioxide was associated with each dollar invested.

"We're not saying that we won't invest in a cement company or BHP or Rio," Welsh says. "But we will try to work with them to see what can be done to reduce emission levels."

Institutions take the lead

The Carbon Disclosure Project is an initiative to better inform investors on the risks of climate change.

Involving more than 385 major institutional investors globally and more than 30 Australian and New Zealand funds managing more than $1 trillion, the project is now gearing up for its third report in Australia.

VicSuper's Bob Welsh - the chairman of the survey backer, the Investor Group on Climate Change - says the largest 200 Australian companies and 50 New Zealand companies are sent a questionnaire covering issues such as the companies' level of emissions and what they see as risks and opportunities.

"Responses range from companies that absolutely understand the issues - they've measured their emissions, know what they can do to avoid, reduce or offset carbon use and are real leaders - to those that don't respond, either because they still don't accept climate change is a risk or they're still trying to understand their position," he says.

Last year about 60 per cent of Australian and New Zealand companies responded.

Goldman Sachs JBWere researcher Andrew Gray says this year's report, which his group also supports, is due for release next month and has bettered that response.

From the report, Goldman Sachs JBWere produces a Climate Disclosure Leadership Index of companies "that have most adequately demonstrated that they understand and have put in place strategies to manage the risks and opportunities of climate change." Last year 25 made this index (see below).

Gray says the responses "show how integrated climate change is to the business. The companies in the index are the ones who can communicate to investors what they're doing in regard to climate change. They're potentially a low-risk group.

"The information isn't audited but there's generally a high correlation between the companies that are able to talk about the issues in a considered way and those that are genuinely doing something."

For information on the project, including the 2007 report, see http://www.cdproject.net.

Goldman Sachs JBWere climate disclosure leadership index: AGL, ANZ, BHP Billiton, Boral, Goodman Fielder, Insurance Australia Group, Investa Property Group, Mirvac, National Australia Bank, Origin Energy, Rio Tinto, Telstra, The Warehouse Group, Transurban, Westpac, AMP, Coca-Cola Amatil, Cochlear, DB RREEF Trust, Foster's, Lend Lease, Perpetual, Santos, Telecom NZ, Woodside Petroleum.