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The effects of climate change on corporate valuations: Part Two

Hydrocarbon Engineering,

Much uncertainty remains over the course of regulation and the pace of change for the other climate change related forces, such as technology, that will influence abatement levels. The value of companies is likely to change as these factors start to affect their performance. The immediate impact on cash flows (and therefore discounted valuations) might be limited, but it will eventually be significant for some industries.

As nations and companies start acting more aggressively to reduce carbon emissions, major shifts in the valuations of sectors and companies will start to become clearer and more predictable. Over the next 18 – 24 months, a number of regulatory and policy events, such as the December 2009 Copenhagen conference to replace the Kyoto treaty, will probably reduce the uncertainty and spark a rethinking of how carbon reduction efforts could affect valuations across a wide range of industries.

According to McKinsey, several steps can help companies and their executives as they start to position themselves to thrive in a low carbon economy:

Assess the impact of abatement efforts

A critical first step is reviewing a company’s exposure to regulatory measures (such as carbon pricing, new standards, taxes, and subsidies), new technology, and changes in consumer bahaviour. In the experience of McKinsey, the strategy mindset required for this analysis doesn’t come naturally to most executives. They will have to ask themselves, for example, how specific changes would affect a company’s competitive position if other companies adopted new business models or how a company can gain a competitive edge by moving more quickly.

Strengthen regulatory capabilities

Companies should ensure that they have a consistent strategy, informed by analysis, to participate in regulatory policy discussions and to engage with policy makes effectively and coherently across business units. The best companies will bring public and private stakeholders together to shape the regulatory environment – both policy principles and specific regulations – so that socially efficient solutions are also economically attractive.

Build capabilities to deal with uncertainty

The type of analysis McKinsey has conducted only scratches the surface of what is possible, the firm admits. Sophisticated scenario planning techniques can give managers an overall view of how the economy – and their markets, in particular – might evolve under different climate change outcomes. Many companies will succeed in managing the major transformations their sectors face only if they invest in generating more sophisticated forecasts and deeper insights into climate change related developments.

Adjust investment review processes

In accordance with the realities of climate change, decisions about new corporate investments should be geared toward carbon and energy efficient technologies that will remain competitive over investment lifecycles. As part of a portfolio of options, companies may find it necessary to make bets (in new technologies, for example) that are specifically related to climate change.

Develop new external links

Venture capital firms, universities, and scientists are logical starting points in efforts to build external networks that can help companies understand and manage the impact of climate change. In the hope of developing new solutions, some companies in the electric car segment, for instance, are creating consortia that include power companies in these respects.

So far, companies have had limited success in communicating their climate change – related activities, often because these moves from only a small part of a larger portfolio. In 2008, for example, the Spanish power generator Iberdrola spun off part of its renewables division –among other reasons, to access greater value. BP has looked for ways to realize the value of its alternative energy investments, proposing a partial flotation. However, very few public companies have succeeded in explaining the more deeply hidden efforts of climate change on their cash flows and competitive strategies.

Adapted from a report by Emma McAleavey.

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