April 08, 2004
Social and Environmental Best Practice Linked to Financial Outperformance in Electric Sector
by William Baue
Innovest releases another sector report correlating progressive social, environmental, and
governance practices and policies with financial outperformance.
Once again, Innovest Strategic Value
Advisors, a global socially responsible investment (SRI) research firm, has produced a report
demonstrating the financial value of environmental, social, and corporate governance best practice.
The most recent report, released earlier this week, assesses 26 electric power producers in the
US. The electric power sector is particularly exposed to the risks of regulation and litigation,
as it emits approximately one third of the air pollution in the country.
As with almost
every other Innovest sector report, the half of this group of companies with better environmental,
social, and governance ratings generate better financial returns on average than the remaining half
of these companies that lag in these areas. Innovest applies both the EcoValue21 (EV21) rating,
which examines 60 aspects of environmental risk and opportunity, and the Intangible Value
Assessment (IVA), which analyzes 80 aspects of social and governance performance. Innovest's
ratings mimic bond ratings, ranging from AAA (best) to CCC (worst).
Both the EV21
and the IVA ratings find proactive companies outperforming laggards by over 900 basis points (or 9
percentage points) in average total shareholder return (stock price appreciation plus dividends)
over the 3-year period ending December 2003.
FPL Group (ticker: FPL) and Pinnacle West Capital (PNW) both earned
AAAs in the EV21 and IVA ratings.
On the other end of the spectrum, FirstEnergy (FE) ranked dead last
in both EV21 and IVA ratings, with a CCC grade in both. Allegheny Energy (AYE) also earned a CCC in both
Interestingly, FirstEnergy itself financially outperformed the North American
electric utility sector over the three-year period in question. In the aggregate, however, social
and environmental laggards financially underperformed the leaders.
Looking at electric
companies through the lens of nuclear power production and distribution, Allegheny would appear
more responsible than FPL and Pinnacle West. Allegheny commits only 3 percent of its operations to
nuclear, whereas FPL and Pinnacle West commit 28 and 34 percent, respectively. (FirstEnergy
commits 41 percent of its operations to nuclear.)
However, Innovest leaves screening
decisions up to its clients, and instead assesses the relative performance of companies in regards
to all their operations.
"In our model, we try to avoid any bias against any
particular issues, either fossil or nuclear," said Carla Tabossi, the senior analyst at Innovest
who authored the report. "We do not look at risk as an absolute metric in isolation but only in the
context of what makes economic sense over the long run."
"Specifically, we will look at
nuclear as a source of risk (for example, due to safety concerns, potential radiation, and waste
disposal constraints) and also opportunities (for example, climate change mitigation) with the only
goal of assessing how these issues currently and potentially can impact corporate profit," Ms.
Tabossi told SocialFunds.com.
Illustrating this approach is the revelation in
FirstEnergy's EV21 rating that the company "reports reduction of 6.7 million tons of CO2 annually,
mainly by increasing nuclear generation." Investors who prioritize emissions reduction of CO2, the
primary greenhouse gas associate with global warming, might regard this fact highly in their
investment decision, whereas anti-nuke investors might abhor the replacement of one environmental
liability with another.
However, a closer look at FirstEnergy's record on nuclear safety
might give even the former investor pause. In February 2002, the US Nuclear Regulatory Commission
(NRC) shut down FirstEnergy's Davis-Besse reactor
due to a hole in its pressure vessel, and ordered the inspection of the vessel heads in all US
pressurized water reactors. Less than a year earlier, the NRC fined the company $80,000 for
allegedly retaliating against workers that questioned safety at the Perry nuclear power plant.
Contrast this with FPL's record on nuclear safety: "the Company is committed to maintaining the
highest standard of nuclear safety in the design, operation, and maintenance of its nuclear power
plants," reads FPL's IVA rating. The company maintains "[r]elatively lower size of operations and
above [average] operating performance as reported by the World Association of Nuclear Operators;
Seabrook station is among the US' top performing facilities," reads FPL's EV21 rating.
whereas FirstEnergy commits 55 percent of its fuel mix to coal, FPL's 4 percent commitment to coal
is exceeded by its 7 percent commitment to wind and equaled by its commitment to other renewables.
"FPL Energy's industry-leading position in wind energy (1/3 of US installed capacity) will
likely provide for increasing corporate value as the market and regulators reward clean power
sources," states FPL's EV21 rating. "It also operates one of the world's largest solar plants in
California and conducts 7 PV [photovoltaic] pilot projects."