Cap and trade will hit US utilities hard

A report analysing the cost of a US federal cap-and-trade system to companies on the S&P 500 index warns that utilities could lose almost half their combined earnings if they had to pay for carbon emissions.

If the 34 utilities surveyed had to pay $28.24 (£17.50) for each tonne of greenhouse gas emitted, the costs could almost halve their combined earnings, according to the report, entitled Carbon Risks and Opportunities in the S&P 500 from Trucost, an environmental research group for investors.

The next most vulnerable economic sector to carbon emissions is basic resources, which could find a third of its earnings threatened. Food and beverage, chemicals and oil and gas are the other sectors at the most financial risk from a cap-and-trade system.

"High emitters which find it difficult to fully pass these liabilities on in higher prices could see profits fall, unless they profoundly change the goods they produce or how they produce them," says the report.

"Companies that are more carbon efficient than sector peers, with limited exposure to direct carbon costs or indirect costs passed on in input prices, stand to gain competitive advantage."

Significantly, the exposure to carbon risk varies widely in the utilities sector. PG &E Corporation, which has been innovating with clean energy programmes, would only face a two per cent earnings loss from cap and trade. American Electric Power would face carbon costs equal to 117 per cent of its revenue, the analysis warned.

In general, carbon costs would equal roughly one per cent of the revenue of the S&P 500 listed companies combined.

For more than four out of five companies, the majority of the burden comes from electricity purchases and emissions from direct suppliers, which the re port says could be passed on to these companies through higher prices.

The other potential problem for companies is the ability to report on their carbon emissions. Two thirds of companies don't publish adequate data on their emissions, which could leave them struggling in the face of mandatory reporting requirements.

"Standardised data on corporate emissions enables financial analysis of carbon exposure, which is essential for companies and investors to manage carbon risks and opportunities," warns the report.

However, similar warnings came from European utilities before the EU emissions trading system was introduced resulted in overall caps being significantly watered down. Companies have since made huge profits from selling surplus permits.

The Obama administration wants to put a cap-and-trade system in place for greenhouse gases, which would reduce emissions to 20 per cent below 2005 levels by 2020, and 83 per cent below 2005 levels by 2050.

The legislation, proposed by the House Energy and Commerce Committee, could be in place by 2012. The 2010 budget predicts $79bn in revenues from carbon credit auctions in the first year of such a scheme, rising to $646bn by 2019.

To reach Trucost's projected price, however, a carbon scheme would have to balance demand and supply. Empirical evidence shows lower carbon pricing thanks to oversupply. Credits auctioned by the Regional Greenhouse Gas Initiative (RGGI)'s only cleared at the $3 mark.