Climate Change and Shareholder Value

7/30/2019 Climate Change and Shareholder Value

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Climate Change and

Shareholder Value


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Table of Contents


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INVESTEC ASSET MANAGEMENT: CLIMATE CHANGE AND SHAREHOLDER VALUE

Preace

Preface

The issue o climate change is one that we ignoreat our own peril. There may still be disputes aboutexactly how much were contributing to the warmingo the earths atmosphere and how much is naturallyoccurring, but what we can be scientiically certaino is that our continued use o ossil uels is pushing usto a point o no return. And unless we ree ourselvesrom a dependence on these ossil uels and chart a newcourse on energy in this country, we are condemninguture generations to global catastrophe.President Barack Obama

In 2008 Investec Asset Management signed the Principles or ResponsibleInvestment (PRI). We signed the code later than some o the other assetmanagers in both South Arica and the United Ki ngdom, as we wantedto ensure that we could ully abide by the commitments that we weremaking. The irst principle o the PRI which relates to the commitmentto incorporate environmental, social and governance (ESG) issues intoinvestment analysis and decision-making processes is possibly themost challenging. Methodologies that are used to do this are i n thei remergent stages, and are oten diicult to apply given the high levelso uncertainty and long time rames. Investec Asset Management sees

value in pulling together these new methodologies and subjecting themto the scrutiny o its analysts and portolio managers. We do this to betterunderstand the impact that ESG issues may have on the investmentdecisions we make on behal o our clients.

With this in mind, we commissioned a study to assess the investmentimplications o climate change in key sectors in South Arica. Al thoughInvestec Asset Management is a global manager, it originates and has asigniicant presence in South Arica. Many o these issues discussed inthis study apply globally, but our i ntention was to speciically ocus onkey sectors in the South Arican market, which our clients are exposedto. In addition, there has been limited attention given to the e ects oclimate change on South Arica equities.

The study was under take n by I nci te Sus tai nab il it y, a reputable Sou thAr ica -ba sed consul tancy that has bee n doin g t he research or theCarbon Disclosure Project in South Arica, and Irbaris, a UK-basedstrategy consultancy, which was instrumental i n orming the methodologyor assessing the impact o climate change on shareholder value in aground-breaking project or the UK-based Carbon Trust. This studypresented the link between climate change eects and mitigation-relatedrisk to inancial perormance. The study included a process o discussionand debate within the Investec Asset Management investment teamand moves beyond simply providing a report or internal and externaldistribution.

Top S outh A r ican cli mate c hange exper ts were b rought in to Inve stec

Asset Manage ment to di scuss the antic ipate d physica l and policy impactso climate change. Studies using the methodology were then conductedon ten dierent sectors. Each study was presented and discussed ona one-on-one basis with the relevant Investec Asset Management analyst.Comments rom these analysts were incorporated into the sector reports,which were then sent back to the analysts or urther review andcomment. In addition, the methodology was tested with an Investec AssetManagement industrial analyst applying it to an additional sector (Oil& Gas). This report presents an outcome o these indings.

The ma in object ive o this study was to assis t in embedding an ana lyt icalapproach to the eects o climate change within the research team,thereby ensuring that we have the tools to incorporate some o these

ESG actors (even as they change) into our research processes andinvestment recommendations. Investec Asset Management sees thisapproach as adding considerable value to our investment process, aswell as to meeting our stewardship responsibility over our clients assets.

Another important objective o this s tudy is to contribu te to, and encourage,an inormed discussion within the South Arican business and inancialcommunity on the investment implications o climate change. With this inmind we look orward to engaging with our clients, investee managementand other key stakeholders on this critical issue.

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ExecutiveSummary


Climate change is as much an economic and social issue as it is anenvironmental issue. I climate change goes unchecked, it is anticipatedthat the world will become increasingly unstable, political and territorialconlict will grow, the economy will become more volatile and socialwell-being will decline, urther increasing tensions in already unequalsocieties. Globally, governments, multi-lateral agencies, business and civilsociety bodies are beginning to appreciate this threat, and are developingresponse measures aimed at mitigating and adapting to an increase inanthropogenic emissions.

Understanding the investment case or climate change is undamental tothe duciary responsibility that we, as investors, have or our clients. Thisreport assesses the principal risks and opportunities that climate change

presents or ten critical sectors in the South Arican economy, and itpresents a general methodology aimed at assisting investors to evaluatethe value associated with climate change, and with environmental, socialand governance (ESG) issues more broadly.

Climate change: Understanding the investment case

Climate change is a signiicant investment issue. The science tells us thatthe climate is changing and that, i unmitigated, the economic and societalimplications will be proound. The policy and regulatory environment is alsochanging; whatever ones view on the nature and timing o the physicaleects o climate change, it is evident that rom a policy perspective weare moving towards a carbon-constrained uture that presents signiicantpotential risks and opportunities or business. The marketplace is similarly

changing, with stakeholders across all sectors shiting their expectationso business on this issue: investor groups across the world are demandinggreater transparency on ESG perormance, customers are beginning toinclude climate change actors in their purchasing activities, and manycivil society bodies are engaging governments and businesses on climatechange actions.

These changes in the climate, and in the e orts o soci ety to curb thesechanges, will have a proound eect on equity markets, both in termso the overall perception o risk, as well as in the evolving character othe investment opportunities that will ensue. I governments do not actin a timely manner, these long-term uncertainties are likely to becomeaccentuated. Given that equity markets discount the possibility o utureevents, the presence o widespread and systemic uncertainties will result

in higher discounts being applied to these uture earnings. As uncertaintyrises, the likelihood o sell-os and total loss situations could rise. By

contrast, i there is concerted and co-ordinated action by governments toenact long-term policies to mitigate emissions and reduce the impacts oclimate change, many o these long-term uncertainties will diminish andsigniicant new investment opportunities will emerge, enabling companiesto embrace new technologies and business models.

Managing our clients assets under such conditions o uncertainty isexceptionally diicult; ulilling our mandate to provide them with thenecessary long-term perormance will become increasingly challenging.As responsib le inve stor s, it is essent ial that we seek to devel op aninormed understanding o these potential implications so that we canprepare to minimise risks and enhance long-term nancial benets. Withthis mind, Investec Asset Management initiated a high-level study and

undertook an associated process o engaging with our analysts in orderto urther enhance our understanding o the investment implications oclimate change. This report presents the outcomes o this study and theprocess o the engagement. The report introduces a general methodologyor assessing the value-at-risk associated with climate change, and appliesthis in the context o eleven critical sectors in the South Arican economy.In doing so, the study has sought to develop and test a conceptualmodel that could be used by our analysts more broadly or assessingthe investment implications o ESG risks and opportunities within ourinvestment decisions.

Identiying the impacts o climate change

The physical impacts o climate change

Many businesses will eel the eects o higher average temperaturesand changing weather conditions, as conirmed rom trends highlightedor example by the major global re-insurers. The anticipated increase inextreme weather events, coupled wi th the likely changes in the distributiono rainall and water resources, could have signiicant implications acrossall sectors, including in particular those in the agricultural, ood retail andmining sectors, as well as companies providing insurance and inancialservices to these sectors.

Declining water availability and increasingly erratic rainall will haveobvious implications or agricultural production, with increases in theprice volatility o agricultural products having a negative impact on theconsumer and consumer-acing sectors such as ood products andood retail. Branded ood companies will either have to diversiy their

source o inputs, apply hedging strategies or invest in supply chain andproduct innovation. Inevitably this will mean increases in their costs that

Executive Summary

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ExecutiveSummary


they may not be able to pass on to customers, particularly in marketswhere there are close substitutes, limited brand equity and the presenceo price controls. Some ood producers, such as sugar companies,could gain signiicantly rom the growth o bio-uels/co-generation, whileothers may experience substantial improvements in margins as theybeneit rom global price volatility. Potential water scarcity due to climatechange and poor resource management is expected to pose potentialexpansion constraints in the mining sector, where plans to expand inwater-constrained areas are likely to result in conlict wi th communities,as well as impacting on sensitive ecosystems. This will either result inprojects being put on hold, or in expensive cap ex on inter-catchmentwater transer, i it is viable.

South Arica is predicted to ace speciic regional impacts, such asdecreased winter precipitation, and increased temperatures2. Otherpotentially signicant impacts o climate change within the country include:negative impacts on human health, dispersion o alien invasive species,and an increasing vulnerability o commercial orestry due to waterrestrictions, wildres and changed distribution o pests3. In addition, mucho South Arica has low and variable rainall, with prolonged droughts acommon occurrence and a signicant proportion o surace water resourcesalready ully allocated. Exacerbating these potential environmental changesis South Aricas speciic demographics and socio-economic situation.The popul ation is parti cularl y vulnerable to the impac t o cl imate changewith a large proportion having low resilience to climatic changes. Extremeclimatic events are likely to exacerbate existing socioeconomic challenges,inequalities and vulnerabilities.

The policy impac ts o clima te change

The South A ri can Government has al ready committed to reducing itsemissions and has set a target o a 34% deviation below a business-as-usual growth trajectory by 2020 and a 42% deviation by 2025, conditionalon the provision o inancial resources, the transer o technology andcapacity building support by developed countries. These targets as well asstatements in the Governments recent National Climate Change ResponseGreen Paperand the National Treasurys Discussion Paper on ReducingGreenhouse Gas Emissions: The Carbon Tax Option suggest that SouthArica is adopti ng something o a leadership position amongst developingnations ahead o the country hosting the UNFCCCs COP-17 negotiationsin Durban in November/December 2011. Indeed, South Arica, as a BRICS

country, part o the Arica Group, and par t o the G77, is uniquely pl acedamongst Arican countries to exert infuence internationally.

The count rys posi tion wi ll be more clearl y a rti cula ted in the ClimateChange White Paper, and in the resulting policy and legislative measuresto be introduced rom 2012. While the impact o these policy measures willbe elt across the economy, certain companies and sectors stand to be armore aected than others, both positively and negatively. Opportunities willemerge to invest in companies that embrace new technologies, becomemore resource eicient or develop business models to take advantage onew constraints. Those companies that do not adapt will encounter higherlevels o taxation, diminishing competitiveness, lower returns on capitaland may ace higher costs o capital.

Understanding the impact o climate change on value

Various studies in terna tiona lly have examine d sharehol der risk rom

climate change and have concluded that it is signiicant4. The impact oncompanies can be broadly classiied into two broad areas: those relatingto reducing greenhouse gas emissions (mitigation), and those relatingto the need to deal with the physical changes resulting rom a changingclimate (adaptation).

Assessing the preci se impact o climate change mitigati on and adaptation onthe value o a business throughout its value chain is challenging, and subjectto high levels o uncertainty. This report provides a structured ramework which includes elements o qualitative assessment to understand theseimpacts and proposes a methodology that links to, and extends, typicalinvestment analysis. Eective application o the methodology requires ablend o skills and knowledge covering industry expertise, nancial analysisand an understanding o the science and policy relating to climate change.

Assessing the risk to shareholde r value: A methodology

The our key steps in the methodology invol ve:

1. Accurately dei ning the organisations value chain.

2. Developing a set o raming questions to identiy the climateissues that potentially aect the organisations value drivers.

3. Assessing the impact o these issues on the drivers o theorganisations inancial perormance (including cash low aswell as the income statement and on the balance sheet).

4. Linking this to the existing inancial models used by analysts,investors and others in the inancial community.

2 IPCC (2007) Regional Climate

Projections, Fourth Assessment

Report, Working Group 1, chapter 11

http://www.ipcc.ch/pd/assessment-

report/ar4/wg1/ar4-wg1-chapter11.pd

3 Department or Environmental A-

airs (2011), South Aric as Second

National Communication on Climate

Change: Key Findings, Presentation

to climate change workshop on 1

April 2011,

http://www.environment.gov.za/HotIs-

sues/2011/cop17_stakeholderwork-

shop/keyclimatechange_communica-

tiondings.pd

4 For example, Mercer (2011),

Carbon Trust (2008), Carbon Trust

(2006), Carbon Trust (2005),

Ceres (2009) and Ceres (2002)

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Our study applied this methodology to 11 sectors, selected on the basiso their relevance to the South Arican economy and the sector weightingo the JSE Top 100. The report contains a summary o the analysis oeach sector, which includes an overview o the potential mitigation andadaptation eects on that sector, an assessment o the risk to shareholdervalue or key companies within the sector and an initial view o potentialcompany outperormance on climate issues. The intent o these sectorreviews is not to provide denitive quantitative assessments, but rather toillustrate the power o the ramework methodology in highlighting issuesthat could aect the perormance o the sectors and companies in thatsector and reviews themselves are based entirely on readily accessible,publicly available inormation. An overview o some o the key indings othe sector analysis is provided in Table 1.

Allow ing or clima te change in the investment process

As thi s study demonstrates, understanding the r isks and oppor tuniti esrelating to climate change in the investment decision-making processis becoming increasingly important. Although many o the risks andopportunities are not easily quantiiable particularly in the absenceo certainty regarding a carbon pri ce the issues have the potentialto signiicantly aect corporate earnings, impacting on the need orsome companies to retain earnings to meet new capital expenditurecommitments, raise urther equity or increase their debt levels.

Improved understanding o the investment implications o climate changeprovides a new angle or analyst interaction with management. This willnot only enhance analysts understanding o the company, but may also

encourage the company management teams to develop a more incisiveunderstanding o the risks and oppor tunities that climate change presents.As a l ong-term investor, this i nteraction is undamenta l to ensuring that ourclients assets are protected, and that our portolio strategy is appropriate.

In general, companies that actor climate change issues into their long-term decision making altering their business models and implementingmeasures to reduce their exposure to increased emissions, waste, energyand water costs will be more resilient and will typically present a betterlonger-term investment proposition. The act that climate mitigationmeasures generally require capital expenditure in the short-term andoten do not oer investors immediate returns, may act as a disincentiveor management and undermine short-term shareholder support. Thispresents a challenge or the investment industry, which has comparativelyshort-term perormance requirements, determined in many cases byclients whose investment objectives should be undamentally long-term.

As a steward o our clients assets, Investec Asset Management is committedto playing an educative role in this respect through communicating suchrisks and opportunities to our clients.

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Table 1: Investment implications o climate change across sectors Source: Irbaris & Incite Sustainabilit y (2011)

Sector Key indings

Basic Resources:

General Mining,Gold Mining, and

Platinum andPrecious Metals

Generally suer negative exposure to mitigation and adaptation risks, particularlyrelating to water availability and cost, reliance on carbon-intensive energy supply,and extreme weather events.

While impact on multinationals may be re latively limited through hedging strategies anddiversication, individual mines and smaller companies could be signicantly exposed.

Longer-term changes in the relative operating attractiveness o dierent locationswill drive dierential perormance.

Role o gold as a hedge is unlikely to disappear, although some demand driverscould change.

South Arican platinum miners should be long-term beneciaries i water/adaptationissues are managed.

Clean technologies should drive demand increase with competing sourcesrom Russia potentially more adversely aected by the changing climate.

Oil & Gas:

Oil and GasProducers

Potentially signiicant negative eect due to possible punitive regulatoryand policy measures, including e.g. a carbon tax.

Signicant nancial implications associated with identiying alternative eedstock,processes and/or mitigation technologies (such as carbon capture and storage).

Possible upside associated with using existing technological capacity or innovationand operating large acilities, to invest in new low-carbon energy technologies.

Industrials:Constructionand Materials

Potential negative impact o policy measures on raw material, process anddistribution costs, as well as increased costs rom extreme-weather eventscausing disruptions to construction projects.

Business opportunities associated with anticipated increase in demandor construction activities and building materials arising rom inrastructuremaintenance needs, and investment in new green inrastructure projects.

Consumer Goods:

Food ProducersPrimary producers directly impacted by erratic weather patterns, resulting in increasing

or decreasing (depending on location and ood product) crop ailures and yields.A key impac t wi ll be grea ter v olati lit y in ood pric es, w hich is ge ner ally bad

or the sector.

Consumer

Services:

Food Retail

Impacts likely to be mainly negative, although marginal, at least over the short-to medium-term due largely to the sectors ability to pass on costs to consumers,the inelastic demand or basic ood products, and the low likelihood o benecialbrand dierentiation amongst a price-sensitive consumer base.

As ch oice edit ors or c onsu mers , re tail ers are key i nter medi ari es or l oweremissions in the supply chain.

On the whole, the sector is likely to be deensive, as widely spread procurementinrastructure will enable large chain stores to attain sourcing advantages oversmaller more locally based competitors.

Telecommuncations:

Mobile

Telec ommu nica tion s

Negative impact on telecom operations outweighed by the potential ornew opportunities associated with the transition to a green economy.

Alth ough it wi ll be impor tant to redu ce di rect emis sion s (as soci ated e .g. wi th hig hcontinuous energy use in data-centres) and ensure asset resilience (base stationsin remote locations), the real value will be in helping other sectors reduce emissions

and accelerate deve lopment through smart systems.

Financials:Banks

Volati lity, inl ation and l ow le vels o ec onom ic g rowth that may r esul t ro mclimate change are bad or the banking sector as a whole; i adaptationis severe, the sector will be aected by bad debts, low levels o depositsand possibly deaults by other banks.

Overall, however, the impact o mitigation measures may be positive, as itpresents some signiicant opportunities or the sector in product innovation,structured inance and inrastructure inance.

Financials:Insurance

Industry should be at the cutting edge in addressing climate risks and opportunities.

Long-term insurance sector is dependent on the market, the state o the economyand lapse rates; climate shocks will have a negative impact on stock exchanges,and carbon taxes will aect company protability.

Lie assurers need to invest or long term and should be catalyst or changesin the sectors in which they invest.

Non-lie insurance increasingly exposed to adverse consequences o extreme weather.

Limited investment upside and substantial downside risk.

Financials:Real Estate

Sector generally will experience higher costs, some o which may not be actoredinto rental agreements, resulting in lower yields and an associated decline in theNet Asset Value o portolios.

Increased costs associated with electricity usage caps, higher maintenanceand insurance costs, and potential stranded assets, rom extreme weatherevents; responsive companies will have reputational, tax and cost beneits.

Tenant push may b e more impor tant or prop erty c ompanies . Obligated by th eir ownpressures to reduce energy consumption and environmental impact, key anchortenants will increasingly seek premises in greener buildings and buildings wherethey can share responsibility through owner-tenant covenants. This will result in thedowngrading o properties where eciency measures have not been implemented,

as a result o vacancies, low escalations or unavourable rollover conditions.

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1. Introduction:Business, investors& climate change


I believe global warming is the most importantinvestment issue or the oreseeable uture.Jeremy Grantham UK investor 5

Investec Asset Management recognises that environmental, social andcorporate governance (ESG) issues can have a signiicant bearing onthe perormance o investment portolios. We believe that giving dueconsideration to ESG issues is undamental to ulilling our iduciary dutyas an investor, which is why Investec Asset Management has been, andcontinues to be, a strong supporter o the Principles o ResponsibleInvestment (PRI)6. In ulilling our iduciary responsibilities, Investec AssetManagement believes it is essential to have an inormed understanding othe potential investment implications o climate change. With this objective

in mind, this report assesses some o the principal risks and opportunitiesthat climate change presents or ten critical sectors in the South Aricaneconomy, and it p resents a general methodology aimed at assistinginvestors to evaluate the impact o climate change on shareholder value.

1.1. Why climate change is a business and investor issue

From an investment perspective, Investec Asset Management believesthat there are three principal reasons as to why climate change is or should be an issue on boardroom and investor agendas:

1.The science tells us that climate change is happening and that i unmitigated,its implications are proound; rom a purely risk management perspectiveit is good business practice to adopt cost-eective business measures

that err on the side o caution, particularly given the potential scale o thephysical impacts o climate change.

2.The policy environment is changing. Whatever ones view on the natureand timing o the physical eects o climate change, it is evident that thepolicy environment is changing and will continue to do so, nationally andinternationally. Businesses will need to prepare or a carbon-constraineduture. Depending on the sector, and the extent o its exposure throughoutits value chain, the implications o these policy measures and associatedlegislation and regulation, can be proound. Smart businesses are thosethat are anticipating the shit, and realising the important potentialbusiness opportunities that this creates.

3.The marketpl ace is changing, with stakeholders across all sectors

shiting their expectations o business on this issue. Investor groupsacross the world are demanding greater transparency on ESG

perormance, customers are beginning to include climate change actorsin their purchasing activities, and many civil society bodies are engaginggovernments and businesses on cl imate change.

Managing emissions will pose a number o challenges or businesses,as illustrated in Figure 1 below.

Figure 1: Impacts o mitigation on business

Source: Irbaris & Inci te Sustainabili ty (May 2011) Presentation to Investec

1.2. Impacts o climate change

Investec Asset Management believes that the physical impacts o climatechange, coupled with the changing regulatory and market context, willpresent potentially proound threats and opportunities or global andSouth Arican business and investors, with varying impacts on the inancialperormance. The impact on investment returns and shareholder valuewill dier between and within sectors depending on sector dynamicsand the preparedness and inancial strength o companies. While the ulleects o some o the potential changes in climate may be some yearsaway, it is nevertheless essential that investors are provided now with an

understanding that will develop over time so that they can start to minimisetheir risks and potentially secure long-term inancial beneits.

1. Introduction: Business, investors and climate change

Possible threats and opportunities Potential impacts

Regulation o site emissions Margins

Emissions regulations in key markets Investment returns

Oset and carbon market developments Operational perormance

Renewables and cleantech Competitive position

Customer and consumer expectations Market demand

Investor expectations New business opportunities

Other stakeholder concerns Reputation

Disclosure requirements

Legal and litigation threats

5 Jeremy Grantham in his July 2010

newsletter http://www.gmo.

com/websitecontent/JGLetter_

SummerEssays_2Q10.pd

6 The United Nations-backed

Principles or Responsible

Investment Initiative (PRI) is a

network o international investors

working together to put the

six Principles or Responsible

Investment into practice. These

principles, devised by the

investment community, provide

a voluntary ramework by which

all investors can incorporate ESG

issues into their decision-making

and ownership practices.

http://www.unpri.org/principles/

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1. Introduction:Business, investors& climate change


While there are uncertainties regarding the exact nature, extent and timingo the physical, policy and market impacts o climate change, these are notsuicient cause or inaction. Uncertainty is inevitable i n a global systemthat is as complex and interconnected as the Ear ths climate. As investors,we are used to dealing with such uncertaint y in global markets and totaking decisions in this context. We believe that investors and corporatemanagers should include an assessment o climate change risks withintheir risk management processes; understanding these risks and theirmateriality is likely to prove essential to developing resilient investmentstrategies that protect and grow client wealth.

Across all sectors, the prici ng o carbon (through ta xation, regulation and/or trading), the introduction o emissions reduction regulations, and the

impact o changing technology and consumer preerences, are drivinga need to explore and adopt new business practices and models. Whilethe precise eects o climate change (particularly at a local level) remainuncertain, it is nevertheless increasingly certain that businesses will needto adapt to the physical changes in the climate that will aect not onlytemperatures, but also as importantly such issues as the availability owater, the distribution o disease vectors, and the incidence and severityo extreme weather events. As a major exporting economy that has a highdependence on ossil uels, South Arica may also be signiicantly aectedby changing regulation and consumer attitudes in other parts o the globe.

The vari ous extreme weather events that occur red whi le t his report wasbeing prepared, provide a sobering indication o the potential costs shouldsome o the broadly agreed climate scenarios be realised.

In July and August 2010, re, drought and record-breaking temperaturesin Russia, loods in Pakistan, and severe weather in parts o the USand Latin America contributed to wheat prices hitting a 22-month highas Russia imposed an export ban on its wheat. Food prices continuedto rise or the ollowing eight months. In February 2011 the Food PriceIndex7 hit a record high o 237 points, ollowing signiicant crop ailurescaused by bad weather. In Brazil, unseasonal weather patterns delayedthe oloading o sugar at its ports, prompting one market analyst tosuggest that weather-related issues will result in this years worst-perorming commodity to rise more than gold.8

The ex treme winter weather in Europe i n December 2010 resulted insigniicant disruptions in transport and logistics, and contributed to

reduced consumer spending in the retail sector.9 In August 2011 theUnited States hit its yearly record or billion-dollar weather disasters,

with the cumulative tab rom loods, tornadoes and heat waves hitting

$35 billion beore hurricane season even began.10 The impact o extreme

weather is more signiicant in developing countries: the Horn o Arica

is suering rom amine caused by the worst drought to aect the area

or 60 years, high ood and uel prices and government ailure to inance

agriculture and irrigation schemes.

In January 2011, loods in Australia caused billions o dollars worth o

damage to inrastructure, disrupting supply lines, leaving mines and

agricultural land under water, and impacting global supplies o coking

coal, wheat and sugar, while presenting new business opportunities orthe construction sector.

While one should be cautious beore attributing extreme weather events

to climate change, they provide a useul indication o the vulnerability o

key elements o the economy to changing weather patterns, especially with

changing demographics. The physical eects o climate change, and the

risks and opportunities associated with adaptation, are only one aspect

o the potential corporate vulnerability to a changing climate. For many

companies and sectors, the implications o the anticipated policy measures

and market shit associated with the transition to a low carbon economy

are likely to have a more immediate impact on their inancial perormance.

The publication by the South A rican Trea sury i n De cember 2010 o adiscussion document on carbon tax (Box 12) gives an indication o the

potential scale o these eects.

Alt hough this repor t i s ocused on t he impact o c lim ate chan ge o n

shareholder value, it is important to be aware o the context or these

impacts. The so-called perect storm o the converging shortages o

water, ood, minerals and energy is made worse by the demands o a

rapidly growing population. Some have argued that these changes are

happening so ast that we are entering a new paradigm11. We believe

it is vital that investors are aware o the risks and opportunities that this

changing world brings, as in this resource-constrained world, the impacts

o climate change will be even more signiicant. Successul companieswill be resilient ones that can adapt to these changing trends and shocks.

7 The UN FAOs ood price index isa measure o the monthly change

in a basket o ood commodities

wheat, corn, rice, oilseeds, dairy

products, sugar and meats. The

previous peak o 213.5 was in June

2008 and resulted in a series o

ood riots. UN Food and Agricultural

Organisation (January 2011) - http://

www.ao.org/worldoodsituation/

ws-home/oodpricesindex/en/

8 Quoted in Bloomberg (2 August

2010) Sugar rallying as ships clog

Brazil ports, India rains diminish

http://www.bloomberg.com/

news/2010-08-02/sugar-rallying-as-

ships-clog-brazil-ports-while-india-monsoon-disappoints.html

9 See e.g. report that clothing

retailer Next lost nearly 22 million

in prots due to snow; http://

www.t.com/cms/s/0/a081368-

18a0-11e0-b7ee-00144eab49a.

html?tcamp=rss#axzz1A9s2jhX3

10 Reuters (17 August 2011) US

sees growing losses rom extreme

weather, http://uk.reuters.com/

article/2011/08/17/usa-weather-cost-

idUKN1E77G0MK20110817

11 Jeremy Grantham (2011) GMO

Quarterly Newsletter July 2011

Resource Limitations 2, http://www.

gmo.com/websitecontent/JGLetter_

ResourceLimitations2_2Q11.pd

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2. Understandingthe impact

o value

2.1. Climate change and business value

Various studies12 have examined the impact o climate change on shareholdervalue and concluded that it is signiicant. It is clear that South Aricanbusinesses will also be aected, even i the risks are dierent in nature ormagnitude. The impact on value or businesses rom climate change canbe broadly broken up into the r isks and opportunities relating to measuresto reduce greenhouse gas (GHG) emissions (mitigation) and to measuresneeded to deal with the physical changes resulting rom a changing climate(adaptation):

Mitigation risks and opportunities include higher costs (arising romthe cost o GHG emissions), new regulatory requirements, mandateddisclosure o potential risks, emergence o new technologies, business

models and competitors, changes in relative competitiveness, theneed or new capabilities and processes, as well as erosion o thecompetitive beneits o existing capabilities.

Adaptation r isks and oppor tun ities inc lude the disruptions to supplychains and to operations, the eects o water shortage and/or looding,changing (agricultural) seasons, the need or additional inrastructure,as well as shits in demand or products and/or services associatedwith changing weather patterns.

Figure 2: Impacts o climate change on society and business

Source: Irbaris & Inci te Sustainabilit y (May 2011) Presentation to Investec

Misconceptions about climate change

While climate change may not be the most signiicant driver o short-term company perormance or investment value, unless the issues areunderstood and careully monitored, companies and investors will ailto spot and to manage the longer-term risks and opportunities until toolate. It is thereore essential that the investment community develops itsunderstanding o the risks and opportunities rom GHG mitigation andclimate change adaptation as well as the appropriate tools to assessand manage the potential impact on investment perormance. A deeperunderstanding o climate change will enable investors to act as catalystsor change and to protect their interests by raising awareness in, anddemanding action by, the companies in which they invest.

Despite the number o studies analysing the e ects o climate changeon business proitability, and on investment value, there are still a numbero investors or whom climate change remains disputed or is deemedirrelevant. As Table 2 shows, many o the common viewpoints sharedby this group are misconceptions and are open to challenge.

Table 2: Common misconceptions about climate change impacts

2. Understanding the impact on value

12 See, or example, Merce r (2011),

Carbon Trust (2009), Ce res (2010).

AFFECTS

Common misconceptions Reality

Climate change is

all very long term

Climate is already changing and urtherchange is inevitable

Dramatic change will occur by 2050in absence o mitigation eorts

We will adapt gradually anyway,there will be no shocks

Actu al c han ges is l ikely to be

location speciicEven i climate changes gradually, human

response may not be gradual

Its all too uncertain

to model

Clear trends are apparent; especiallyon regulatory aspects

Scenarios can be used to exploreeects under uncertainty

We dont have regulation in South

Ari ca; we dont need to worr y

Companies will be aected bycustomers needs and behaviours

Regulations that aect suppliersand customers will also aectSouth Arican companies

The sector I analyse isnt

very emissions intensive

Adapt atio n wil l a ect many com pani esirrespective o their emissions

Even i businesses with limiteddirect emissions can be aected byregulations elsewhere, especially intheir customers markets

AFFECTS AFFECTS

BusinessRaw materials

Asse t main tenan ceProduct demand

Disruption to supply

RemediationAsse t valu esCost variability

SocietyHuman healthInrastructureFood security

Housing needs

Migration patternsEmployment

Personal securityAsse t val ues

AFFECTS AFFECTS

Changing

environmentTemper atureWater

SeasonalitySoil ertilitySea levels

Extreme weatherErosionSpecies

distribution

DRIVERS

10


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2. Understandingthe impact

o value

Impacts o climate change on inancial perormance

Mitigation and adaptation will aect all aspects o the nancial perormanceo a company. As shown in Table 3, income statements may be aectedby many aspects o GHG abatement, including increases in the cost oraw materials and inputs due to the cost o carbon and supply chaindisruptions, changing customer expectations, increased insurance costs,and the potential or stranded assets13, which could require signiicantassociated write-downs.

Table 3: Potential eects o mitigation and adaptation on company income statements

Company balance sheets and assets (see Table 4) are also likely to b eaected, particularly ixed assets that are exposed to the risk o changingregulations and market needs, as well as to the physical eects o climatechange. Companies may need to divest rom unattractive businesses aswell as invest in GHG abatement technologies or other businesses. Theycould also ace the possibility o having to relocate away rom vulnerablesites, as well as investing in new suppliers to reduce emissions rom thesupply chain.

Table 4: Potential eects o mitigation and adaptation on company balance sheets

Ultimately, a key driver o value is the markets perception o a company andits ability to manage the risks and opportunities. Given the uncertainties,strategic fexibility and eective stakeholder and reputation management arelikely to be eatures o companies that successully address the challengeso climate change. Those companies that have clear decision-makingand governance structures or dealing with the rapidly changing risks andopportunities and increasing market volatility are likely to deliver greaterlong-term value than their less responsive competitors.

Income

statement

Examples o possible eects

Mitigation eects Adaptation

RevenueChanging customer needs

New market opportunities

(In)ability to pass on new costs

Changing customer needs

New market opportunities

(In)ability to pass on new costs

Cost o

goods sold

Cost o carbon/energy

Embedded carbon costs

Reductions in energy use

Changes in availability/sourcelocation/price o inputraw materials

Supply chain disruption

Labour health costs

Operating

expenses

Cost o carbon/energy

Reporting/compliance costsR&D costs

Insurances and riskmanagement costs

R&D costs

Depreciation and

amortisation

Costs o additional investments

Write-down o damaged assets Costs o additional investments

Write-down o damaged assets

Taxes

Indirect/direct taxes on carbon

(e.g. uel duty)Tax in cen tive s (c arbo n ta xes)

New taxes to und

inrastructure adaptation

Balance sheet

items

Examples o possible eects

Mitigation eects Adaptation

Fixed assets

Investment in abatementtechnologies

Disinvestment romunattractive businesses

Asse ts s tran ded d ue tochanging market needsor regulations

Investment in new locationsand/or risk management(e.g. lood deences)

Investment in new suppliers

Asse ts s tran ded d ue t ochanging market needsor physical disruption

Current assets

Need to carryincreased inventory

Current liabilities

Changing relationshipswith suppliers

Changing relationshipswith suppliers

Other liabilities

Compensation claims/uninsured losses

Compensation claims/uninsured losses

13 Stranded assets reer to assets

whose perormance has been

so adversely aected that they

are structurally uneconomic

or so unable to perorm

operationally that their economic

value cannot be recovered rom

uture activities and they are

thus economically stranded.

11


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3. Assessingthe impact o

shareholder value

3. Assessing the impact on shareholder value from climate change: A methodology

Assessing the i mpact o the physic al and pol icy implications o climatechange on the value o a business is challenging, but is not impossible.The methodol ogy used in thi s repor t is a structured ramework to explorethe issues and to ensure that important points are not easily overlooked.Critically, the ramework output is designed to link directly to the kind oinancial models typically used by the investment analyst community.

Figure 3: Framework to analyse GHG mitigation and climate adaptation impacts on value


As F igure 3 shows, the methodology is a st ructured process that linksto, and extends, typical investment analysis. Successul application othe ramework requires a blend o skills and knowledge covering industryexpertise, inancial analysis, and an understanding o the science andpolicy relating to climate change.

The activities associated with each o these steps are reviewed below.

1. Deining the value chain

The e ects o c limate change o n a bus iness a re typ ica lly dis tri butedthroughout the value chain. Indeed, in many cases, the direct eect oeither climate related regulations or the local eects o the changingclimate on a companys core operating assets may well not be the principalsource o the impact on value. In many cases the major consequences

or value may occur either upstream in the companys supply chain(or example due to the eects o climate change on water availability

impacting on raw material costs) or downstream o the company due tochanges in market needs (associated, or example, with the growth inclean technologies and markets) or changes in customer speciications(such as those imposed by certain retailers on their suppliers).

Any evaluation o the risk and oppor tunities on sha reholde r value createdby climate change needs to capture the complexity o the issues acrossthe business system. The irst stage o the methodology is to deine therelevant value chain.

Figure 4 provides an illustrative example o this or a generic business, aswell as indicating some o the issues that may need to be considered. Thecritical issue is to ensure that the value chain is deined broadly enoughto capture the material drivers o value. Typical issues that need to be

captured include the impact on raw material availability, costs and theconsequences o changes in customer needs, and regulation aectingcustomers that could aect demand.

Figure 4: Potential climate change issues across a generic business system


Determine

appropriate broadvalue chain to

consider

Trade-of f betwe en

accuracy and

complexity

Potentially

different for

different business

streams within

same company

Define the key

questions thatthe analysis

needs to address

Climate adaptation

vs. carbon

mitigation

Risks vs.

opportunities

Where feasible,

develop a broadestimate of the

impact on value

Scenarios and

sensitivities

Critical issues

Aim is to ens ure

that findings areincorporated into

reusable tools and

ongoing models

Analy st mode ls

Capacity buildings

Link to ongoing

models

Assess the

impact

Develop the

key questions

Define the

value chain

Supply chainTypical activities within amanufacturing company

Distributionsystem

Raw

materials

B

ought-ingoods

In-bo

unddistribution

Manufacture

Salesandmarketing

Management

andoverheads

Distribution

Pointofsale

Consumption

Disposal

Additional potential is sues

Embedded carbon

Changes in overall

availability

Changes in

(geographic) sourcing

Disruption risks

Changes in costs

Typical ocus o

company analyses

Additi onal po tenti al is sues

Addit iona l ca rbon cre ated

Need changes

Margin pressure /

cost pass-through

12


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shareholder value

2. Developing the key questions

The deini tion o the value chain sets the scope o the ana lysi s. Deve lopingthe key questions will assist in developing an understanding o the issuesand how these issues aect the drivers o value in the business. Identiyingkey questions that collectively address the risks and opportunities arisingrom both climate mitigation and adaption along the entire value chain isthereore critical. These questions might be used to guide analysis o dataor they might actually be asked o company management, relevant expertsor key stakeholders. Figure 5 provides examples o some o the questionsthat typically need to be addressed across sectors. A detailed set osuggested questions across sectors is provided in Box 1 (Chapter 4).

Figure 5: Example questions addressed at the sector level

3. Assessing the impact

Due to the inherent uncertainties associated with changing governmentpolicy and a changing climate, an exact quantiication o the inancialconsequences can be diicult and speculative. Although standardapproaches to analysing investment risk rely on quantitative analysis,much o the risk relating to climate change requires additional qualitative,orward-looking consideration. Given the unclear policy environmentand uncertainty relating to the economic implications o climate change,investors will need to take a new approach to risk assessment andincorporate this qualitative assessment o risk.

While ull consideration o the technical and practical challenges o assessingand quantiying the eects is beyond the scope o this document, the

ollowing gives an indication o some o the associated issues. The cost o carbon.

Calculating the impact o the cost o carbon is straightorward assumingdata on the companys carbon ootprint is readily available. The actualchange in proitability and value resulting rom a cost or carboncritically depends, however, on the ability o the company to resist costincreases rom its suppliers and to pass on its own increases in coststo its customers. This will depend on the market power o the companyand the availability o substitute suppliers or its needs and the degreeo competition or its customers.

The eects o other GHG emissions regulations.

Asse ssin g the po tenti al impact o other GHG emis sions and s imi lar

regulations related to climate change that aect customers or otherparts o the value chain (such as embedded carbon standards or carbonlabelling) can be much more dicult, especially as the greatest eect othe regulations may be on the relative demand or companies products.Similarly, trying to quantiy the scale o new opportunities can also beproblematic.

The impact o adaptation.

In some cases, the eects o adaptation (either through increased costsor investments, or through disruption) may be the most important.Typically, such costs are the most dicul t to quanti y in par t becausethey are not the result o planned market interventions and in partbecause the actual eects o climate change are both localised anduncertain. It may be possible to estimate the impact on agricultural

productivity or losses due to storm damage or water shortage/foodingand develop some indication o the eects.

Risks Opportunities

Carbonmitigation

How will changes in the costo carbon across the businesssystem impact the business?

How much o the cost can bepassed through to consumerswithout impacting demand?

What investment or processchanges will be required toreduce emissions o carbon?

Will supply or demand beaected directly by carbonmanagement eorts?

What can managementdo to reduce (the cost)o carbon emissions?

What new business opportunitiescould carbon managementcreate or the business?

How can the business gaincompetitive advantagethrough better managemento its carbon emissions?

Climateadaptation

How might climate changeadversely impact the costso the business?

How might climate changeincrease the risk o businessdisruption?

What impact could climatechange have on demand orthe product (either directlyor indirectly)?

What actions can managementtake now to mitigate the impacto climate change?

What new business opportunitieswill changes in climate create?

How can the business beneitrelative to competitors?

Shareholder value Ability to out-perorm

13


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shareholder value

Figure 6 shows a simple template that can help to identiy climate changemitigation and adaptation eects within the business system o thecompany analysed, ocusing on speciic aspects such as: inrastructureand other assets; operational activities; overheads and management;inancing; and supplier and customer needs.

Figure 6: Example template to identiy climate change mitigation and adaptation eects


The template can also ca pture the c oncl usio ns rom any anal yses ,the indings rom any discussions and any hypotheses about the likely

eects. Clearly, not every cell in the template will be relevant or all sectorsor companies.

4. Linking to existing (inancial) models

The inal chal lenge i s to link th e assess ment o t he e ects o c lim atechange to the various inancial models used by analysts, investors andothers in the inancial community. Importantly, as Figure 7 shows, it ispossible to link the dierent outputs rom the ramework to the drivers ocash low value, both on the income statement and on the balance sheet.

Figure 7: Establishing the links to value Example or Platinum


In the example above, the impact on the sector was assessed qualitatively.Where an impact is very negative or negative, urther analysis can be

carried out to quantiy the potential impact and it can be developed assensitivities or scenarios or existing analyst models.

Ra

w

materials

Boug

ht-ingoods

In-bound

distribution

M

anufacture

Salesan

dmarketing

M

anagement

andoverheads

Distribution

Pointofsale

C

onsumption

Disposal

Infrastructure

and other

assets

Adapt ation

Mitigation

Operational

activitiesAdapt ation

Mitigation

Overheads &

management

Adapt ation

Mitigation

Financing Adapt ation

Mitigation

Supplier and

customer

needs

Adapt ation

Mitigation

Value

Revenues Costs Assets / liabilities Cost o capital

P&L Balance Sheet

VolumeCost o goods

soldAsset s Debt

Demand due toadoption o ueltechnologyDecline in use oautocatalystsSupply disruption

Access to waterDisruption inlabour costs dueto adaptationCost o carbonin uel/energyand other boughtmaterials

Extreme weatherevents and/orlooding

No clear trend

Price Selling, generaland admin.

Liabilities Equity

Price likely toincrease dueto increase indemandAbility to passon cost o CO

2

Labour costsIncreasing energycosts or coolingmine

Remediation /decommissioningcosts

No clear trend

Very pos itive Positive Neutral Negative Very nega tive

14


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4. Sector analysiso South Arican

companies

4.1. Scope of this study

Context

This study has l ooked broadly at s ome o t he potenti al impacts onshareholder value due to climate change. There are a number o issuesthat will determine the extent o these impacts, but which are beyond thescope o this repor t to explore; however, they should be acknowledged:

Future scenarios:The exact impacts o cl imate change on business inthe uture are currently uncertain and cannot be precisely predicted.They w ill depend to some ex tent on what m itigat ion actions are takennow and what uture technological and uture economic developmentsoccur. These di erent uture possibilities can be explored by examiningdierent climate change scenarios (such as those in the IPCC SpecialReport Emissions Scenarios14 or the IEA Scenarios15).

South Arica-specic issues: South Arica aces specic socio-economicissues that are likely to exacerbate the impacts o climate change onbusiness and on the country more generally. South Arican companiesare reliant on carbon-intensive coal-powered electricity and will be hit byany mitigation policies both within South Arica and also in export markets16.

South Arica-speciic climate change: Southern Arica is seen to beespecially vulnerable to the impacts o climate change. There is a highrelative dependency on agriculture and natural resources or income,exports, employment and ood, and there is poor inrastructure in mucho the region. The potential damage to inrastructure could urtherconstrain the regions economic development and also undermine

its general adaptive capacity. South Arica contains a number obiodiversity hotspots and is already a water-stressed country withalmost all o its water resources currently utilised. S peciic climatechange impacts that are expected to occur in South Arica include:alteration in the quality and productivity o natural resources andincreased water stress due to changing rainall patterns and increasedtemperatures (See Annex 1 or more details).

Purpose

This study was not intended to provide denitive assessments o the impactso climate change on shareholder value, but rather to illustrate the powero the ramework methodology and to highlight issues that could aect theperormance o the sectors. The study should contribute to, and encourage,

an inormed discussion within the South Arican business and inancialcommunity on the investment implications o climate change.

In this regard, the main objective o this study was to be a learning process through which an analytical approach to the impacts o climate changecould be embedded within the research team. This ensures that we havethe tools to incorporate some o the ESG actors associated with climatechange (even as they change) into our research processes and i nvestmentrecommendations. Investors have usually taken a bottom up, opportunisticapproach, investing when opportunities arise; yet this is changing. Investorsare starting to build in potentially signiicant large-scale systemic risks intothe decision-making process. At Investec Asset Management, we see thisapproach as adding considerable value to our investment process, as wellas to meeting our stewardship responsibilit y over our clients assets.

Applying the methodology

This study appli ed the metho dology outl ined in Sect ion 3 above to tendierent sectors in South Arica and one company (Sasol). These ndingsare not the work o in-depth studies and are based entirely on readilyaccessible, publicly available inormation, such as company websites,investor inormation and company reports, and published reports. Thestudy examines the possible impact on the ollowing sectors:

Basic Resources: General Mining

Basic resources: Gold Mining

Basic Resources: Platinum and Precious Metals

Oil & Gas: Oil and Gas Producers (Internal analysis)

Industrials: Construction and Materials

Consumer Goods: Food Producers

Consumer Services: Food Retailers and Wholesalers

Telecommunications: Mobile Telecommunications

Financials: Banks

Financials: Insurance

Financials: Real Estate

These sectors were chosen as they represent e leven o the larges t sec torson the JSE Top 100. Mining (under Basic Resources) was split into threesub-sectors: diversiied metals (covering a wide range o commodity andspecialist metals), gold and platinum (both precious metals that have verydierent market dynamics). These sectors were analysed to illustrate thepotential eects on South Arican business and to demonstrate how the

ramework can be applied i n practice to deliver insight or investors andcorporate managers.

14 Intergovernmental Panel on ClimateChange (2000) Special Report on

Emissions Scenarios, Available at:

http://www.ipcc.ch/ipccreports/

sres/emission/index.php?idp=0

15 International Energy Agency

(2008), Energy Technology

Perspectives, Available at:

http://www.iea.org/techno/etp/

ETP_2008_Exec_Sum_English.pd

16 For example, according to the

International Centre or Trade and

Sustainable Development (ICTSD)

(2011), Developing Countries

Trade Vuln erabil ities to EU Cli mate

Policies, Issue No.19, South Arica

would be hardest hit by an EUcarbon border tax

15

4.12. Financ ials: Real Estate


4.2. Basic Resources:

General Mining


Gold Mining


Platinum and

Precious Metals

4.5. Oil & Gas:

Oil and Gas Producers

4.6. Industrials:

Construction and Materials

4.7. Consumer Goods:

Food Producers

4.8. Consumer Services:

Food Retailers

and Wholesalers

4.9. Telecommunications:

Mobile Telecommunications

4.10. Financials: Banks

4.11. Financials: Insurance


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companies

Annmarie

Each sector analysis includes:

Context: a brie introduction to the sector, and an explanationo its value chain.

Potential mitigation eects: an overview o the principal eectsassociated with climate change policy.

Potential adaptation eects: an overview o the implicationso the physical eects o climate change.

Link to value: an assessment o the possible climate changeimpacts on the income statement and balance sheet.

Company outperormance: a review o the potential orcompetitive dierentiation between companies.

Without oering an exhaustive analysis o the dynamics determiningreturns in each sector, the study ocuses on identiying the key sectortrends where climate change consequences are deemed to be mostsigniicant. This analysis is intended to contribute to a more inormeddiscussion on the potential implications o climate change in terms oshareholder value.

16




General Mining


Gold Mining


Platinum and

Precious Metals

4.5. Oil & Gas:


4.6. Industrials:



Food Producers


Food Retailers

and Wholesalers






17/69



companies

Box 1: Questions or analysts

The ollowing questions are broadlyrelevant or all sectors and will helpanalysts, und managers and othersinterested in the impact o carbonmitigation and climate adaptationon a companys business andnancial perormance. Thesequestions can be used to guideexternal research and to directengagement with companies in

order to reach a deeper level ounderstanding o and greatercondence in the measuresthat a company is taking.

Assessment

What are the key risks andopportunities that the companyhas identied arising rom globalGHG mitigation eorts?

What is the potent ial positi veand negative impact of GHG

mitigation efforts on futurefinancial performance?

Has the company assessedthe potential impact o climateadaptation on the uture oits business?

What issues has it cons idered?

Over what time frame and with

wha t a ssumpt ions (s cen ari o)for the changes in the climate?

What is the potent ial magnitude

of the different impacts?

How realistic and comprehensiveare the assessments?

Do the assessments cover allfunctions and geographies inthe business (including the

impact on customers and onthe supply chain) and consider

the impact on revenue andmarket competitiveness as

well as on costs?

What understanding andassessments does the companyhave on the potential impact on itsvalue to its investors and what stepsis it taking to protect or enhancevalue in the changing environment?

Management

What incentives (or dis-incentives)exist to support management actionon climate change?

Who has day-to-day responsibilityor addressing climate changeissues, particularly on the needor adaptation?

What au thorit y do they haveand what scope of actionscan they take or guide?

What act ions have theysuccessfully implemented?

Are the potent ial impacts o bothGHG mitigation and climate changeadaptation ully considered andrelected in the business strategyand investment decisions?

What ev idence is the reto support this?

What has changed as aresult of factoring climatechange into decisions?

How will the company maintainor enhance its competitivenessas a result o its strategy on climatechange (e.g. through lowercosts, more desirable products,enhanced brand /reputation, etc.)?

How will the company outperform

its competitors on critical resourceefficiencies such as energy, GHGemissions and water use?

What new commerc ial opportuniti esor investments in clean technologyhas the company considered?

Which does it plan to p ursueand why?

Engagement

Is the companys stated positionon climate change consistent withthe long-term best interests o itsinvestors and other stakeholders?

How well is the company engagingconstructively with the ull rangeo stakeholders who can aect orwill be aected by the companysresponse to climate change (e.g.government, local authorities andcommunities, customers, suppliersand NGOs)?

What steps is the company takingto manage or enhance its reputationon climate change and relatedissues, in particular with respectto business critical stakeholders

(e.g. brand, licensing or planningauthorities, etc)?

Disclosure

How well does the companydisclosure provide a clear andcomplete picture o the businessrisks and opportunities?

Is the pattern of disclosuredesigned to score thecompany highly on disclosureor demonstrate leadership

on the underlying issues?

What met rics and ta rgets have

been set? What evidence is therethat achieving these targets willdeliver substantial benefits inaddressing risks and opportunitiesrather than the targets having been

set to make them easy to scorehighly against?

What additional inormation wouldsigniicantly enhance understandingo the business risks, opportunitiesand responses to carbon andclimate change?

17




General Mining


Gold Mining


Platinum and

Precious Metals

4.5. Oil & Gas:


4.6. Industrials:



Food Producers


Food Retailers

and Wholesalers






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companies

4.2 Basic Resources: General Mining

Context

The listed m ining se ctor in South Ar ica incl udes two global d iver si iedmining companies: Anglo American and BHP Billiton. These account ora high weighting in the JSE All Share Index (ALSI) with global operationsacross a wide range o commodity groupings. There are also severalsmaller, less diversiied companies whose operations are ocused ona ew commodities (such as coal, manganese and chrome) and aregeographically more concentrated in South Arica and neighbouringSADC countries. The dynamics aecting the larger diversied companiesand the smaller ones are dierent.

Larger companies holding portolios that span base metals, preciousmetals and energy, are geared to shits in global commodity demand;

these are closely correlated with shits in global economic growth thathas been uelled over the past decade by increasing demand rom China.These po rt oli os shi t rom time to t ime through corporate acti on andexpansion capex, refecting the companys view o growth trends and theassociated gains in speciic commodity prices. Smaller producers tendto be ocused on a speciic commodity and a limited number o miningoperations. They are, however, more geared to price increases in theirspecic commodity and more disposed towards high takeover premiumsduring periods o industry consolidation.

Given the long-term nature o the mine investments, companies abilitiesto change the underlying perormance o their mine portoli os are limited.Over the short term, valuations relect the level o commodity prices andrelative cost positions. In the long term, access to economically recoverable

reserves is critical to value in an increasingly resource-constrained world.The lead times between ini tiation and rece iving any returns are lengthy. Thecommodity cycle thus plays a critical role in terms o project planning, theinitiation o new capacity and the abilit y o mining companies to servicetheir debt or provide adequate returns to their shareholders. The policy andphysical impacts o climate change on the commodity cycle could have asigniicant eect on value.

Some o the varied eects o GHG mitigation and adaptation on thevalue chain o the diversiied mining sector are summarised in Figure 8.

Figure 8: Carbon and climate change eects across the value chain o diversiied metal mining

Potential mitigation eects

In South Arica, GHG mitigation eorts are likely to raise costs or the

industry. Proitability and the attractiveness o uture investment will beaected by such costs i higher prices cannot be realised. Higher pricesarising rom carbon or adaptation costs or some metals may lead to anincrease in the use o substitutes (such as titanium instead o vanadiumin steel-alloying elements). Additionally, the export demand or somematerial could all due to border taxes or impor t restrictions erected asa result o environmental policies in target markets. Mitigation eortsin the industry itsel could, however, reduce the costs o carbon and oenergy. New technologies and processes such as improved ventilationand cooling systems could become available and the industry may bedriven to investment in renewable or alternative energy, including hybridsystems that combine dierent types o renewable technologies in order toenhance energy security. Investments in technological upgrades and asset

restructuring, such as rebuilding urnaces to control ume emissions, may beneeded to avoid rising environmental compliance costs in the longer-term.

Carbonmitigation

Reduced

operational

costs due

to new

technologies/

processesavailable

(e.g. paste-

thickening)

Rising energy

costs (partly)

due to carbon

Improved

eiciency

through

energy-efcient

technologies(e.g. super-

critical boilers

or coal plants,

FBC1 tech-

nologies)

Border taxes in

target markets

Increased

demand romrenewable

energy and

green buildings

(e.g. platinum,

concrete)

Climateadaptation

Rising

resource

costs due

to increasedcompetitionor scarce

resources

(e.g. water)

Disruptions

to supply

chains

and risingmaintenancecosts due

to extreme

weat her

Higher cooling

loads in

mines due

to increasedtemperatures

Damaged

inrastructure/

loss o

productiondue to extreme

weathe r events

New maritime

transportation

routes in polar

regions dueto permarost

melting give

access to

new markets

Higher decom-

missioning

costs due

to changing

environmentalconditions

Rising labour

costs as

environmentalchanges ad-

verse ly i mpac t

labour orce

ConsumptionRefiningSmeltingMiningBought-in

goods

Raw

materials

18



General Mining


Gold Mining


Platinum and

Precious Metals

4.5. Oil & Gas:


4.6. Industrials:



Food Producers


Food Retailers

and Wholesalers







19/69



companies

Potential adaptation eects

Should an extreme weather event, such as fooding, leadto a one-week production disruption at Exxaros open castmines, the estimated impact (based on around 30 000 tpacoal produced, and using Decembers coal price) would bea loss o US$40m.Exxaro CDP 2010 South Arica

Climate change adaptation is likely to aect the mining industry in SouthAri ca to a gre ater exten t than cl imate change mi tigat ion. IPCC studi es17indicate that the eects o climate change in Sub Saharan A rica are

likely to be signiicant par ticularly due to the rising temperatures anddecreasing water availability and prompt action is required to prepare orthe uture changes. Furthermore, changing rainall patterns in South Aricacould result in fooding in some areas o the country (particularly in low lyingareas)18 potentially disrupting mine operations or even causing mine closure.This could result i n substanti al losses or the aected mining company andalso have repercussions on metal prices aecting important world deposits,as in the case o Camecos Cigar Lake uranium mine in Canada.19

Overall, climate change adaptation could lead to increased operationalcosts due to changes in the nature and requency o asset maintenanceand monitoring. Capital expenditures could also rise i n order to cope withwater scarcity (e.g. desalination plants) or temperature rise (e.g. coolingsystems). The diversied nature and international ootprint o major mining

companies means they are less exposed to any one speciic climatechange related physical eect, but they are also likely to be required to dealwith greater complexity when anticipating and dealing with adaptation andmitigation risks in multiple locations compared with regional producers.

A key balance sheet r isk is the uture decommissioning li abilit ies that couldarise as a result o changing environmental conditions. Decommissioningliabilities represent a signicant part o a companys long-term nancial riskbecause most o the cash low associated with decommissioning occursat the end o a mining projects lie20. Companies are thereore at risk ounderestimating decommissioning costs, especially i they ail to recognisethe potential eects o climate change on the extent and nature o thedecommissioning process. Insurance costs could also increase should

businesses wish to protect themselves rom business disruption andrelated losses.

Figure 9: Manganese production and reserves in South Arica

17 IPCC, 2007: Climate Change Working

Group II: Impacts, Adaptation and

Vulnerab ility

18 Ibid19 In 2006 Cigars Lake underground

uranium mine, which is believed to

be the biggest undeveloped high-

grade uranium deposit in the world,

experienced severe fooding, with

repercussions or the companys stock

price as well as uranium market prices.

A remedi ation progr amme ha s been

running since then and works were

delayed due to continuous fooding.

(http://www.world-nuclear-news.org/

ENF-Cameco_tackles_Cigar_Lake_

fooding_again-2610094.html )20 Acclimatise, 2010 Building Business

Resilience to Inevitable Climate Change.

Carbon Disclosure Project Report,

Global Mining21 2030 Water Resources Group (2011)

Charting Our Water Future

Box 2: The impact o climate adaptation on the manganese industry

The manganes e sec tor as a w hole may be parti cularly ae cted by th eimpact o water scarcity. The demand or manganese is expected to growdue to an increasing use o steel globally. South Arica, which currentlyaccounts or only a small amount o global manganese production, holdsnearly 80% o global reserves (Figure 9). The impact o climate change onthe manganese industry in South Arica could hinder uture expansion andas a result aect the global manganese market, which will be increasinglyreliant on South Ari cas reserves.

Figure 10 shows that the majority o South Aricas mines are locatedin the Northern Cape Province, which is predicted to suer moderatewater scarcity by 203021. These mines are likely to be exposed to rising

temperatures, which can lead to higher water consumption or cooling.Addit ional ly, the indust ry could ace ri sks due to water competi tion w ithlocal stakeholders, such as water levies or increased obligation to investin local water inrastructure.

South

Africa

Rest of

the world

South

Africa

Rest of

the world

100%

80%

60%

40%

20%

0%

Globa l Mn Product ion, 2008 G loba l Mn Reserves

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companies

The link to value

Figure 11 provides an overview o climate change impacts on the incomestatement and balance sheet o a company. The balance sheet eects arelikely to be negative overall, because o additional investment requirementsand the adaptation (water) r isks to some assets. However, the actual risksand opportunities will depend on the asset location and climate changestrategy o each company.

Figure 11: Diversiied mining company value and climate change impacts at a glance


22 Farol, S & Perret, S. (2002) Inter-

sectoral competition or water

allocation in rural South Arica:

Analy sing a case study through a

standard environmental economics

approach, Proceedings o the

XXXI X Cone rence o the Italia n

Society o Agricultural Economics

(SIDEA), Florence, 12-14 September

23 southarica.ino (2008, May 28)

Limpopo gets R7.4bn water

project. Retrieved rom: http://www.

southarica.ino/business/economy/

inrastructure/oliants-280508.html

Value

Revenues Costs Assets / liabilities Cost o capital

VolumeCost o goods

soldAsse ts Debt

Demand romrenewable energyapplications andgreen building

Potential newsources rom

more accessiblepolar regions

Blocked expansionin water-scarceareas

Increased costs orenergy and carbon

Improved energyeiciency due toalternative energyinvestment

Facilities upgradeor relocation orwater scarcityand looding

Earlier depreciationo assets due

to physical CCexposure

Reputationalimpact

No clear trend

PriceSelling, general

and adminLiabilities Equity

Price likely toincrease dueto increase indemand

Ability to passon cost o CO

2

Labour costs

Supply chaindisruption andrising maintenancecosts due toextreme weather

Climate changeinsurance coverage

Remediation /decommissioningcosts

No clear trend

Very pos itive Positive Neutral Negative Very nega tive

Box 3: Increasing investments in water inrastructure in South Arica

The midd le O liants region ( Limpopo) represents a good i llus tration othe potential water issues between the mining industry and the localpopulation. Mines in the region compete or scarce water resources withrural armers who use water to irrigate crops. The area is currently waterscarce and this situation is orecast to worsen by 2030, as shown inFigure 10. Currently, miners and armers have water rights that allowaccess to water or business use and these rights are not currentlyexchangeable between the parties. Mines have however investigated thepossibility o buying water rights rom armers as they plan to expandactivities in the region. Research22 has suggested that, were a ree waterrights market to be implemented, mining companies higher ability to payor water rights would result in decreasing agricultural production and

thereore urther rural poverty. Aware o such ethical challenges, Sou thArican mines are i ncreasing investments in water in rastructure; in 2008,23 mines agreed with the government to j ointly invest R7.4bn in a waterinrastructure project in Limpopo that includes a new loodwater dam tosupply local users and mines23.

Figure 10: Water gap and main industries in South Arica

Source: Irbaris & Incite Sustainabilit y (May 2011) Presentation to Investec

Limpopo

Crocodile Westand Marico

LowerVaal

LowerOrange

UpperOrange

MiddleVaal

Upper Vaal

Thuke la

Oliants

Inkom

OliantsDoorn

Fish-Tsitsika ma

Mzimvubu-Keiskamma

Mvoti toUmzimkulu

GouritzBerg

Breede

Luvulvhu-Letaba

Size o gap:

Surplus over projected needs

Moderate (0%-20%)

Severe (20%-50%)

Power

Mining

Manuacturing

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Misha

Company outperormance

Carbon regulations and the impact o the changing climate will aect minelocations and the dierent range o metals in dierent ways. The costso carbon, whether directly incurred by energy use in mine productionor indirectly incurred elsewhere in the value chain, could be suicientlysigniicant to change the cost curve or the industry with consequentimplications or relative proitability either between companies orbetween dierent geographic regions. Furthermore, adaptation risks orcosts or some locations could signiicantly aect the competitivenessor even viability o a particular site.

Companies will be able to reduce some o the impact o mitigation coststhrough improvements in energy eiciency and through investment inrenewables. While some perormance improvements will come romoperational changes, most will necessitate (additional) investment. Earlyassessment o the likely risks around adaptation and eective planningcould reduce the actual costs o adaptation signiicantly or individualcompanies, although the costs will be driven primarily by asset locationsand coniguration. Taking proper account o adaptation risks in planningnew acilities could deliver signiicant competitive and economic beneits.

At t he port oli o l evel, majo r co mpan ies may be su i cien tly divers ii edthat the overall impact appears small. That does not, however, precludethe need or eective management o the issues at each site. Thosecompanies that are dependent on a particular commodity or geographicregion (even i rom several speciic sites) may be much more exposedto the collective risks and their options or managing the risks may be

equally limited.

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4.3 Basic Resources: Gold Mining

ContextWhile South Arican gold mining remains a major bourse or global gold stocks,it is no longer the dominant source o the metal. Unlike most other major goldproducers, gold production in South Arica comes predominantly rom deep mines,as a result o which it aces dierent economics and risks. For investors, goldmining is a play on the gold market, which itsel is an unusual market. Traditionally,gold has been used as a store o value and a hedge against insecurity. As a result,there are signicant stocks o gold already in existence (mostly in jewellery, withapproximately 19% in c entral bank vaults24) and global m ine production annuallycontributes only an incremental 1% increase in these stocks.

Industrial consumption o gold (other than or jewellery) is small, although it isgrowing. For investors, gold mine valuations primarily refect the gold prices, relativecost posit

Climate Change and Shareholder Value

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