Green brakes

Governments do not meet their obligations when it comes to a greener world essentially because they are afraid of the ballot boxes with financially-strapped households balking at higher taxes aimed at cutting carbon emissions. So corporates do the leg work, egged on by consumers and stakeholders at large. This is not great news.

AlphaValue’s long held the view is that what is good for the planet is at a cost to shareholders. Before stakeholders paid attention to environmental matters (say pre 2015), a business would essentially not pay for the opportunity cost of tapping into natural and thus free resources. Now that these are identified as not infinite and become taxable, the economics of any business are ones of higher input costs, lower returns and higher risks.

As more assets are unavoidable so as to contain the environmental impact of any economic act, greening up a business is a simple case of falling ROCEs and rising Waccs. On the Wacc front, it amounts to saying that perceived risks are going through the roof with an expanding equity risk premium and a complete reshuffling of the sector betas’ pecking order.

Witness the case of the oil industry considered as a low beta one (no debt, phenomenal FCF). The current sector beta has been trending up to levels (0.96 from 0.85) last seen when the sector was regarded as unsafe (due to falling prices).  The blow dealt by Moody’s yesterday to the Oil industry by suggesting a downgrade of Exxon’s rating on environmental risks is a mighty warning shot for the oil industry obviously, but also for the corporate world at large.

In essence, Moody’s warns about a new layer of risks which is bound to change the cost of capital of many (and actually all) industries.

One of the most intriguing aspects of the greening up exercise is the discovery process imposed on corporates and the unforeseen complexity of the exercise as the datapoints are shifting so quickly and are all interlinked. Eating Brazilian-produced strawberries in Europe in winter does not make sense carbon-wise, but what about returning an empty airliner from Sao Paulo? The debate will be raging and ever more complex as the Brazilian farming context is entering into the equation, as well as a better understanding of the marginal cost of operating an airliner in carbon emission terms, etc.

The key point here is that there will be shifting truths in the environment equation. In Wacc terms, this is called a risk. Be ready as the environmental risk recognition is spreading like wildfire indeed.

There is only one sector that we can think of as a beneficiary of that risk: Reinsurance.

Posted in ESG