New Carbon Index asks interesting questions

by Mark Hoskin, 6th June 2011

The Environmental Investment Organisation (EIO), a not for profit organisation, has just launched a new index designed to improve the carbon intensity of the top 100 listed companies in the UK (ET UK 100) and the top 300 in Europe (ET Europe 300). The process is primarily designed to encourage public reporting on carbon emissions by listed companies and thereafter to reduce the carbon impact of their activities.

A company’s weighting in the index will depend on their market capitalisation reweighted by +/- 50% depending on their ranking in the ET Carbon Rankings. Thus in theory a company may have a 10% weighting by market capitalisation, but not report its emissions and end up with a 5% weighting in the overall index.

Each company is ranked firstly on their public reporting disclosures and thereafter on their carbon intensity, measured by the number of tonnes of carbon emitted per million dollars of revenue. The index has backdated data from 31^st March 2009 and in the ensuing 2 year period the EIO says there is little tracking error compared to the base indices (FTSE 100 and FTSEurofirst 300).

The EIO says that this has already had a positive impact on reporting through their engagement with companies in the index. Carnival Corporation was so disappointed with their ranking (100/100) that they immediately publicly disclosed information on carbon intensity and moved up to 72^nd, while Randgold Resources did the same, moving up to 70, also at that time from last place.

The EIO argue that by investing in a tracker and re-weighting by carbon intensity that this index will in the long term outperform its underlying index. This should be particularly interesting for institutional, charity and pension funds that want exposure to the broad market, but also to meet a corporate responsibility agenda.

Whilst the underlying rationale behind the index may prove correct in the long term, there are plenty of anomalies which may distort short term performance.  Carbon intensity is measured with reference to revenue denominated in US dollars. Currency movements will have a significant impact on revenue figures, while revenue as a measure also throws up interesting distortions. We find that Royal Dutch Shell which emits 76m tonnes of carbon per year has a lower carbon intensity (273.2 tonnes / $m) than BG Group PLC (464.58 tonnes/m$) despite the fact that BG Group PLC focuses on natural gas, a fuel with lower carbon intensity than oil. This seems to be a function of oil and natural gas prices. Equally when we look at Suez Environment SA, a business focused on waste and water management, their carbon intensity is 400.44 tonnes / $m. We might ask how a waste and water business can be ranked lower than an oil company? The answer would seem to be simply the value placed in the market for the end product.

In conclusion the EIO may be right, the new index will outperform, but the key driver in performance may not be carbon emissions but the reweighting in favour of high value end products such as oil. However, we should not belittle what the EIO are doing, because the methodology may also achieve the desired effect of reducing carbon emissions and intensity in publicly listed companies.  For investors the public information provided by the EIO is invaluable in looking at companies in each market sector. Their web site allows us to directly compare a company’s carbon levels absolutely and relatively very easily. This will both assist the investment industry in its assessment of a management team and enable management to evaluate the impact of its own working practices.  Thus I can now see that Sainsbury’s carbon intensity is half that of Tesco’s and Cairn Energy’s carbon intensity is over three times worse than Royal Dutch Shell – now that is interesting!

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