Greenhouse scheme spells uncertainty for share prices

Bosses of smokestack companies could soon find themselves paying heavily for the greenhouse gases their firms pump out. Until now fresh air has been free, but that is about to change, with repercussions for share prices.
But investors fail to understand this: they know little about the new European rules that will put a price on pollution – and, according to survey details released last week, many money managers are also in the dark.
So just how important is this for share prices? To answer this question, investors need to get to grips with the European Union Greenhouse Gas Emissions Trading Scheme, the central plank of the new rules. Then it becomes clear that the consequences are far from straightforward.
The scheme will deal in the permits that allow companies to release carbon dioxide. Once the scheme is launched next year, firms that reduce their emissions below their permitted allowance will be able to sell the surplus to other companies. Because of this, some businesses might see their share price improve. So which sectors and what types of company are likely to be the biggest losers, and how soon before prices start moving?
The scheme covers a number of industry areas, including power generators, cement makers, paper producers, refineries, oil & gas producers and iron & steel manufacturers. In the UK, it takes in 1,500 factories responsible for about half the country’s carbon dioxide emissions. Experts believe power generators will have an easy ride. They say these companies can pass on higher costs by pushing up electricity prices.
But time is running out for investors to protect themselves against any losses. The UK Government has already published draft details outlining the number of permits each area of industry, broken down to a company-by-company level, will receive.
The Carbon Trust was set up by the Government to help firms meet their climate obligations. Chief executive Tom Delay says: “The financial impact on these firms may not be felt for a year or so, but the knowledge about how that will come in will be available soon.”
So if markets, armed with this information, correctly anticipate the impact, it could be argued that firms are likely to see an effect on their share prices soon. Delay – whose company commissioned a survey of 100 investors and discovered that only 50% understood the scheme – believes utilities such as power generators will “do well” for the reasons mentioned above.
This view is shared by Insight Investment’s European Ethical fund manager Alex Illingworth: “Apparently, it is a done deal that the Government is prepared to let electricity prices go up.” Illingworth says Scottish & Southern Energy, which derives much of its electricity from gas, will do especially well. Companies more reliant on coal will trail.
But it is not just a firm’s ability to pass on the costs that counts. There is concern that some sections of industry will be treated unfairly by the Government. It has been claimed that they will be given fewer permits, and it certainly appeared that way when the draft allocations were announced.
Oil and gas producers look to be bearing the burden of the Government’s plans to cut carbon dioxide emissions. In the first phase of the eight-year scheme, running from 2005 to 2007, it is proposed that permits are sufficiently sparse to lead to a significant reduction in emissions from this area of industry.
Meanwhile, other areas, such as iron and steel producers, will be able to increase the amount of carbon dioxide they emit. While Government officials say the steel industry figures mask a cut at company level because overall production will rise over the period, there is scepticism among the experts. Illingworth notes that a key source of greenhouse gas emissions, the transport sector, is omitted from the scheme.
And Morley Fund Management’s Socially Responsible Investment Team analyst Luigi Minerva says the difference in the allocation figures is politically driven. He says ministers are prepared to put more pressure on power producers compared with the cement and glass industries because the latter are more vulnerable to foreign competition.
Illingworth says he takes a “finger in the wind” approach since it is unclear how much heavy polluters will have to pay for permits from cleaner firms. Despite this, Morley’s Minerva has looked at the possible impact on Scottish & Southern and says the scheme could boost the company’s share price by more than 10%.
But it is harder to make the same calculations for other UK power producers since, he says, they are internationally structured with plant in other EU countries, which have yet to indicate how quotas will be allocated.
It may be far from clear how the new scheme will impact on UK firms, but experts agree that the companies best able to pass on the extra costs, such as power generators, will be in a much better position. And, far from just looking at the negative impact on share prices, some companies may benefit from the changes.