The Environmental Protection Agency's lawsuit filed last week
against seven electric utilities for violating the Clean Air Act
illustrates the growing environmentally-related risks facing
investors and the importance of screening investments for
environmental performance. A recent study by Innovest Strategic
Value Advisors, a New York-based financial advisory firm, found
that utilities with above average environmental performance
outperformed those with below average performance by over 600 basis
points during the previous year.
The study confirms nearly 100 other studies which found a
positive correlation between environmental and stock market
performance, largely because environmental performance is an
excellent proxy for management quality, a key determinate of stock
returns. In high impact sectors, rising environmental restrictions
and consumer demands for more environmentally-responsible products,
services and corporate policies, make the environment one of the
most complex challenges facing management. If management can
effectively address this level of complexity, it is implied they
have the sophistication to succeed in other areas, and thereby earn
superior returns.
Innovest's study analyzed the growing environmental risks
facing investors, market opportunities created by these risks, and
the widely varying management responses to rising risks and
opportunities. In addition, the company's EcoValue'21(TM)
environmental rating methodology was used to assign ratings
intended to project stock market performance.
Under deregulation, responsibility for environmental costs is
being shifted from ratepayers to investors. As a result, investors
face potentially large write-offs if rising environmental
restrictions make some coal-fired power plants uneconomic.
Under the Clean Air Act of 1970, older "grandfathered"
coal-fired power plants are often allowed to emit over four times
as much as new coal plants. As a result, these older facilities
produce over 90% of the sector's emissions. The sector, in turn,
produces a significant portion of US emissions (67% of SO2 and 28%
of NOx). These contribute to the formation of acid rain, smog and
soot, which damage human health and the environment.
The CAA requires that grandfathered plants meet new plant
emission standards if they receive major renovations. The EPA
lawsuit contends coal-fired power plants, owned by American
Electric Power, Southern Company, Cinergy, First Energy, Illinois
Power, Southern Indiana Gas & Electric and Tampa Electric, were not
upgraded as required. The utilities plan to oppose the EPA lawsuit,
saying they extended the lives of their older plants through
routine maintenance, rather than major upgrades, and therefore did
not violate the CAA.
Regardless of the lawsuit outcome, utilities will face
increasing pressure to limit air emissions. This, in turn, raises
investor risk exposure. Given the large body of empirical evidence
showing that companies with better environmental performance
achieve superior stock market returns, more investors are realizing
that using an environmental screen, such as EcoValue'21, is a cost
effective means of minimizing risk exposure and maximizing stock
market returns.
Richard McCann
M.Cubed, Davis, California
(530) 757-6363