The 2010 midterm elections have provided plenty of political theater, and one of the strangest scenes may be West Virginia Governor Joe Manchin firing a rifle at a “cap and trade bill.” An October 27 Boston Globe article explored how Gov. Manchin, a Democrat running for Senate, has positioned himself to the right of his party on many issues. The political logic behind his animus towards climate legislation can be summed up in one word: coal.

Gov. Manchin is a vocal – and, apparently, armed – supporter of the coal industry’s positions on climate change and mountaintop coal removal (MTR). As a Governor, however, he can only do so much, as key parameters of coal mining’s regulatory framework are set by the US government.

MSCI ESG Analyst Sam Block researches the coal industry, and as he explains below, federal regulation of coal mining can change drastically depending on which party is in power. If Republicans retake one or both houses of Congress, they could counter the EPA’s anti-MTR efforts under President Obama. Complicating the issue is that other Federal agencies, as well as the courts, also have a say in how the coal industry is regulated.

A recent Economist feature considered the role of business in managing the world’s water supply. Industrial production of goods – from soft drinks to microchips – consumes far more water than agriculture, and competes with other uses in arid climates worldwide.

Water is a human necessity, but is it a human right? If so, should access to water be guaranteed by governments? This question engages the United Nations, and governments in both poor and wealthy nations. There is growing evidence, though, that even without an “official” declaration of water’s special status, businesses will be compelled to help ensure access to water.

Have we already seen “Peak Oil Sands?”

This is the prospect raised by “Canada’s Oil Sands: Shrinking Window of Opportunity,” a new RiskMetrics ESG Analytics report. Produced for investor coalition Ceres, the study accounts for the present and future costs of extracting usable fuel from the oil sands of Alberta.

While this region is now the site of the world’s largest investment in unconventional oil, research shows that production costs, market shifts and political changes may swallow any future return on that investment.

This provocative conclusion raises serious questions for oil industry shareholders, as the firms they own have sunk $200 billion into oil sands development projects. What does ESG research uncover that the industry doesn’t know? Or rather, what costs are left out of its projections?

Tuesday evening, the Ceres coalition’s annual conference began in Boston. The group formed in 1989 in response to the Exxon Valdez’s grounding on March 24, 1989. The backdrop to its 2010 conference could not be more dramatic, more urgent.

As the Gulf of Mexico oil slick continues to spread, the New York Times and others are considering what it will mean for BP, which controls the oil rig that caused the disaster. Reporter Clifford Krauss wrote that, besides the monetary cost of cleanup, the cost of “long-term damage to BP’s reputation…is likely to be far higher.”

Mr. Krauss quotes BP head Tony Hayward asking his executives, “What the hell did we do to deserve this?” But BP’s historical record for employee safety suggests that while no one “deserves” such a tragedy, the firm may have earned its damaged reputation.

In an April 2009 profile of BP, RiskMetrics analyst Yulia Reuter summed up the direct costs of its health, safety and environmental practices:

Responsible Investor’s Hugh Wheelan has written a comprehensive survey of “the explosive talking point of this year’s corporate proxy season”: a shareholder resolution calling for BP to disclose the assumption behind its proposed $2.8 billion Sunrise development of Canadian oil sands. While 150 investors support the resolution, many big shareholders plan to vote against it at BP’s April 15 annual meeting.

Mr. Wheelan describes this fight as one that pits “environmental risks” against “potential company profit.” This is certainly true, but there is also evidence that BP’s expected profits are based on overly optimistic projections. By demanding more disclosure from BP and its Canadian partner, Husky Energy, shareholders are seeking to protect their investments, as well as the environment.

Earlier this month, Green Century Capital Management and As You Sow filed shareholder resolutions calling for utilities to disclose how they will address the risks associated with coal ash. Boston-based Green Century and As You Sow, an advocacy group, believe that the storage and reuse of coal ash could have broad consequences for both the environment and shareholders.

Coal ash made headlines in 2008, when a storage pond operated by the Tennessee Valley Authority (TVA) spilled 5.4 million cubic yards of the ash into nearby waterways. The EPA has indicated that the spill won’t be contained until 2013, and TVA estimated the resulting costs at $231 million through 2009.

In a press release announcing the shareholder resolution, Emily Stone of Green Century (a KLD Index client) said that the TVA spill shows that existing regulations don’t adequately mitigate ash’s environmental and financial risks. 

An interesting coalition of groups joined together for a side event at the Copenhagen climate change summit on Dec. 12. Gathered were the Worldwatch Institute, a respected think tank represented by its leader, Christopher Flavin; the United Nations Foundation, established by Ted Turner, and represented by its head, Tim Wirth, a former Senator and the main US negotiator for the Kyoto Climate Conference during the Clinton administration; and the American Clean Skies Foundation, which promotes natural gas as a clean alternative to coal, represented by its CEO, Gregory Staple.

Their three-hour conference was about a low-carbon energy source that could reduce US dependency on both imported oil and domestic coal: shale gas.

One of the lead speakers was Aubrey McClendon, CEO of Chesapeake Energy, a large natural gas producer. He stated that he was in Copenhagen to drive home the point that shale gas production was a game changer in "de-carbonizing" the US economy.

Mr. McClendon explained the potential of shale gas:

• New technologies, such as hydraulic fracturing ("fracking") and horizontal drilling, have made it feasible to extract vast "new" reserves of gas from underground formations of shale;
• Natural gas emits about 25 percent less CO2 than oil and 50 percent less than coal;
• Installed natural gas electricity capacity is already in place, and could meet current U.S. energy demands (unlike nuclear, wind, solar, or "clean" coal plants equipped with carbon capture and storage, or CCS);
• The steady output of gas plants can help balance the irregularity of solar and wind power; and
• Unconventional US gas would reduce the nation's dependency on foreign (OPEC) hydrocarbons.

While this message has been delivered consistently to investors by many of the US's independent gas players, the industry could do more to make its case to Congress and the public. The coal, electric utility, and railroad industries have employed top lobbyists to represent their interests, but the natural gas industry has been much less involved in the drafting of US climate change regulations.

Natural Gas Share of US Energy Use to Grow

Still, in its assessment of the American Clean Energy and Security Act of 2009 (also known as ACES, and the Waxman-Markey bill), the Energy Information Administration (EIA) projected that the share of natural gas in US electricity production could increase to 31 percent by 2020 from a 2007 level of 21 percent. EIA further projects a 39-percent contribution to the electricity supply from natural gas by 2030. This would lift the share of natural gas in the overall US energy supply to 26 percent in 2020, up 3 percentage points from 23 percent in 2007, and to 28 percent by 2030.

These projections, however, assume that the US will be unable to take advantage of overseas offsets for its domestic carbon output. EIA also assumes limited deployment of other low-carbon technologies, such as CCS and new nuclear plants.

Gas Industry Seeks Higher Profile

The US natural gas industry believes that ACES should have included greater explicit support for gas in the draft carbon regulation, and also taken a less lenient approach to coal, particularly in the allocation of emissions allowances. The gas industry's presence in Copenhagen is an attempt to raise its public-policy profile, as is the decision by 28 of the largest natural gas independents to form the "American Natural Gas Alliance," which is charged with promoting the benefits of natural gas to the public.

Big Oil Moving into Gas in a Big Way

In a sign of great expectations for the gas market, ExxonMobil recently announced a $41 billion, all-stock acquisition of XTO Energy, an offer price that represents a 25 percent premium above XTO's Dec. 11 closing share price. XTO has the largest proved natural gas reserves among the US independents, and Exxon's commitment to natural gas production in the U.S. not only will offset some of the carbon risks inherent in Exxon's portfolio, but it will also bolster the industry's ability to lobby Congress as it takes up climate change legislation in 2010.

The Impact of "Fracking"

While natural gas is set to play a more significant role in the US energy mix, increased domestic production will carry environmental costs. The industry will need to spend as much political capital on addressing these concerns as it will on improving the position of natural gas in carbon legislation. High on the list of these concerns are the environmental impacts of "fracking."

The Sustainable Investment Research Analyst Network (SIRAN) recently conducted a seminar on the implications of expanded fracking operations. In a follow-up to this article, Alan Petrillo will explore SIRAN's perspective on how the fracturing of shale formations could affect the environment, including the nation's water supply. The process of extracting the fossil fuel with the least impact on the atmosphere could have a big impact on the American landscape.

A new study of water companies' ESG disclosure finds that, with some exceptions, utilities in developing nations "disclose far more performance data" than their EU and US counterparts. The Interfaith Center on Corporate Responsibility (ICCR) reviewed water suppliers' reporting of environmental, social, and governance (ESG) metrics. "Liquid Assets: Responsible Investment in Water Services" also surveyed a representative sample of 12 major global water utilities, scoring them on 21 "key disclosure issues."

In the report's executive summary, ICCR notes that control of the global water supply is a sensitive topic, but also says that "it is not the purpose of this report to debate the merits of public versus private ownership." Instead, "Liquid Assets" explores how well utilities – whether investor- or government-owned – communicate with stakeholders. In calling for better disclosure of comparative ESG data, ICCR says:

"Creation of a 'data commons' is essential for protection of the water commons."

The Law is Not Enough

How do we know our water is safe? In most nations, the answer is that the law requires it to be. "Liquid Assets" argues that this is not enough. Chapter 5, "Benchmarking ESG Performance," explains that government regulators cannot always find hard data on service levels, water quality and costs – and neither can citizens or investors.

While utilities in New York City and New South Wales, Australia scored well on ICCR's tests, developed nations actually lag emerging markets in the overall quality of their water firms' ESG reporting. ICCR cites World Bank standards as a crucial factor in this disparity:

"Public and private water services utilities in most developing countries and emerging market nations disclose far more performance data via the World Bank's International Benchmarking Network on Water and Sanitation Utilities (IBNET) than do the utilities operating in OECD countries. … "The reports from the large utility companies surveyed indicate that their ESG disclosures are driven by regulatory, rather than corporate mandates."

Corporate Reporting May Not Describe Local Conditions

The Global Reporting Initiative (GRI) is a multi-stakeholder effort to improve sustainability reporting by corporations worldwide. GRI disseminates reporting guidelines to support the "transparent and reliable exchange of sustainability information," according to their website.

"Liquid Assets" explains why a firm's GRI-compliant reporting may not reveal the true state of its water-related holdings:

"The principal problem with use of the GRI by the water services sector is that the data are aggregated and reported globally, whereas water resources must be managed locally or regionally within a given watershed. Globally aggregated information about water supply, for example, is of little use to investors seeking how to understand how well a utility in a water-stressed area is managing supply risk."

The ICCR authors note that GRI guidelines call for reporting companies to disaggregate some data, but that none of the surveyed water utilities did so.

What Should Water Utilities Tell Us?

On behalf of investors, ICCR says that adequate disclosure would show that:

"Management systems are in place to capture data needed for protection of water supply, maintenance of infrastructure, and early identification of ESG risks; appropriate risk management policies exist and are being followed; and data are being used to monitor trends and progress in attaining benchmarks for continuous improvement. "This is critical information that should inform investment decisions by governments as well as private investors. It is a failing that must be cured."

Global water trends are forcing consumers, businesses, and industries to manage water resources more efficiently. In spite of this, the global economy still sustains wasteful practices, like the cultivation and export of water-intensive crops, including tomatoes and coffee, from regions that are critically short of drinking water.

Water's fundamental role in life complicates communities' efforts to keep it clean, accessible and affordable. Water is a core public good with no known substitute, and investors cannot trade or ship it as easily as many other commodities. Also, regional political and environmental factors affect industrial users of water, as consumers and businesses share limited supply and discharge capacity.

These factors have created an eco-efficiency imperative for corporations: learn to do more with less water. KLD environmental, social and governance (ESG) research to help investors support this important work follows two paths:

1) Evaluation of all companies' ESG performance to promote better internal (through efficient operations) and external (through effective community engagement) water management policies in every industry sector.

2) Sustainable water thematic research to identify particular companies whose products and services help consumers, businesses, and communities to conserve and manage water more efficiently.

ESG Evaluation

As part of our evaluation of a company's ESG performance, KLD identifies and considers water risks that have a direct impact on operations, reputation, and financial performance.

Current corporate best practices include measuring and publishing a water footprint, which is the total volume of fresh water that is used directly (to generate a product or service) and indirectly (as part of the producer's supply chain).

Other best practices include conducting assessments of sourcing of water, water vulnerability, water withdrawal, and water return, which is water that is released back into the environment after use. Researchers consider the quality and temperature of released water, and also evaluate corporate efforts to develop targets for conservation and wastewater recycling, and public disclosure on implementation.

More progressive efforts include making a credible commitment to achieving water neutrality, or returning a quantity and quality of water to the environment equal to that used in a company's operations.

Sustainable water thematic research

KLD's global thematic research on water focuses on companies that provide products or services to address the environmental challenges of water scarcity and water quality. Investments in sustainable water help support a multi-faceted, cross-industry, systemic approach to these issues.

No one company or community can reduce humanity's water footprint. KLD's comprehensive water research – evaluating the water policy performance of all companies, and also promoting the work of pure-play companies dedicated to efficient and effective water use – enables investors to support a global solution to a global crisis.

KLD Research Analyst Sharon Squillace manages KLD's thematic research program, which provides topical research for new index and research product development. Sharon is also part of the index selection committee for the Global Climate 100 Index, a specialty index comprised of 100 global companies with the greatest potential for mitigating the causes of climate change.