FRATER ASSET MANAGEMENT

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GLOBAL CLIMATE CHANGE Risks for South African
InvestorsFebruary 2005
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CONTENT

• The South African financial sector
• Climate impacts and market vulnerability-
  global and SA context
• International investor initiatives
• Climate change as a portfolio risk
• The role of the financial sector

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• Every truth passes through three stages before it
  is recognised. In the first it is ridiculed, in
  the second it is opposed, in the third it is
  regarded as self-evident" Arthur Schopenhauer

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CLIMATE CHANGE IN SOUTH AFRICA

• Other socio-economic priorities
• No emissions reduction obligations
• Low levels of communication
• Government response strategy released, but not
  strong on action
• Low media coverage relative to international

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THE SA FINANCIAL SECTOR ON CLIMATE CHANGE

• If there is pressure from government to meet
  emission targets, industry would respond. CEO of
  an asset management division of a large SA
  financial services company
• Some commentary from the domestic insurance
  industry

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FUND MANAGERS AND NON-FINANCIAL ISSUES

• Fiduciaries have a responsibility to their
  beneficiaries
• What is the time horizon of the investor?
• Examples of impacts on shareholder value
• Leak of the Draft Mining Charter
• Undisclosed asbestosis liabilities at Gencor
• Non financial refers to those issues not
  traditionally reflected in the financial
  statements

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OPTIONS AND COSTS .

Options
Range of options
Total Costs
Costs
Latency
Awareness
Activism
Regulation/litigation
Time / Impacts
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CLIMATE CHANGE VULNERABILITY GLOBAL AND SOUTH
AFRICAN CONTEXT
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THE CLIMATE CHANGE IMPACTS FOR SOUTH AFRICA

• We no longer have a normal climate.
• Prof B Hewitson, UCT, Weekend Argus, 15
  /01/2005
• Increasing aridity and change in weather
  characteristics

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GLOBAL WARMING

• Climate change hits the headlines January 2005
• Severe impacts anticipated should average
  temperatures rise above 2oC from pre-industrial
• At current rates of emission release, a 2oC
  increase will be reached within 10 years Source
  International Climate Change Taskforce, 2005.
  Widely reported by international media 25 January
  2005
• Impacts are linked
• Warming changes in weather characteristics,
  changes in water availability, loss of ecosystem
  productivity, loss of agricultural land and
  reduction in crop yields, increase in vector
  borne disease, increased demand for energy

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IMPACTS HERE IS ONE EXAMPLE

• European 2003 heat wave
• Severely reduced grain production (cutting 20
  million tons off world harvest) Source The
  Independent
• Nuclear power stations forced to shut due to
  cooling logistics
• Heat related deaths
• Forest fires in France
• Insurance industry reports close to 400 million
  in subsidence claims Source Association of
  British Insurers
• By 2060, temperatures such as the 2003 European
  summer will be unusually cool. Source UK Hadley
  Centre Met Office, 2004

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WHATS IN STORE FOR THE FINANCIAL MARKET

• Uncertainty!
• Global temperatures will continue to rise
• Impacts will grow in scale
• Depth of economic structural change required is
  significant
• All sectors affected

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TIME HORIZONS

• These vary depending on the type of climate risk
  associated with an investment portfolio
• Regulatory risk is the most proximate and certain
• Reputation and competitive risks may occur in the
  near to medium term
• Timing of physical risk is the most uncertain

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KYOTO

• The Protocol has led to development of market
  based instruments
• Emissions Trading Scheme (ETS)
• Carbon energy taxes
• Incentives for renewables
• Removal of perverse subsidies
• A framework for factoring financial impacts of
  climate change

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SOUTH AFRICA - CARBON INTENSIVE

• When developing countries are called to act,
  reductions based on status quo, will be
  challenging

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SOUTH AFRICAS - VULNERABILITY

• SA coal-based economy is vulnerable to carbon
  regulation in the rest of the world
• Coal demand fluctuations
• Investment, trade and aid patterns
• Non-tariff trade barriers
• Global sourcing of inputs (reduced demand for
  high CO2 footprint goods)

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CLIMATE CHANGE AND SHAREHOLDER VALUE
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FINANCIAL RESEARCH ADDRESSING CLIMATE CHANGE

• Different analytical processes use predominantly
  three methods
• Corporate governance.
• Management systems to plan for risk
• Emissions
• Emissions profiles in the context of regulatory
  environment
• Financial analysis
• Financial impacts (predominantly relating to
  emissions)

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GOVERNACE BASED RISK ASSESMENTS

• Examples
• Ceres/IRRC
• Corporate Governance and Climate Change, 2003
• Assesses 20 of the worlds largest emitters.
  Checklist of 20 specific governance actions
• Carbon Disclosure Project
• Climate Change and Shareholder value, 2002 and
  2004
• 95 Institutional investors representing 10
  trillion
• Targeting FT500 asking for investment relevant
  information concerning emissions. Includes a
  Climate Leadership Index.
• Analysis of sector risk
• Preliminary analysis of changing input costs and
  impacts on share price

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EMISSIONS BASED RISK ASSESSMENTS

• Examples
• JP Morgan
• CO2 Emissions No windfall for European
  Utilities, 2003
• Ranks utilities based on variety of inputs
  including pollution content
• Standards and Poors
• Emissions Trading Carbon will become a taxing
  Issue for European Utilities, 2003
• Ranking of emissions from 25 largest EU
  utilities, and indicates those most at risk under
  the ETS

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FINANCIAL ANALYSIS

• Examples..
• ABN AMRO
• Climate Change and Analysis, 2003
• A framework for analysts
• Assess the environmental, regulatory and climate
  change opportunity for sectors including metals
  and mining, construction, real estate and
  chemical and insurance industries
• West LB
• Carbonomics Value at Risk through Climate
  Change, 2003
• Modelling of macroeconomic risks both direct
  impacts and regulatory impacts
• Up to 915 billion of the worlds equity markets
  are at risk

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FINANCIAL ANALYSIS PUT FORWARD BY WEST LB
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FACTORS AFFECTING SHAREHOLDER VALUE

• Asset mix
• Position in the value chain
• Location of operations and sales
• Management foresight

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INVESTORS TAKING INITIATIVE

• Carbon Disclosure Project
• Third campaign launched 1 February 2005
• 143 institutional investors with assets of 20
  trillion
• Pension funds urge SEC to issue a clarification
  that climate change is a material risk (Section
  20F)
• Increasing number of shareholder resolutions
• 28 resolutions filed in the US in 2004
• Doubling of resolutions raised by public pension
  funds

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SA COMPANIES

• Little disclosure
• Impossible to know the levels to which this is
  being factored into risk management
• Shareholders do not communicate the interest
• Exception
• Those companies with offshore listings and strong
  international shareholder base

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SASOL

• A significant emitter in global terms
• 80 million tonnes CO2 per annum
• Sasols disclosure on the issue reflects
• An ability to manage
• Awareness of the materiality of the issue

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SASOL DISCLOSURE

• Kyoto Protocol noted as a material sustainability
  related risk and opportunity
• Greenhouse gas position statement with specific
  goals, actions and targets
• 17 reduction of CO2 equivalent per ton of
  production in 2004 compared with 2002

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SASOLS EXPOSURE TO CLIMATE CHANGE RISK AND
OPPORTUNITY

• Ability to respond
• Efficiency improvements, alternative energy
  sources, technology flexibility, carbon storage
• Business mix
• Oil-gas-coal mix, strategic market opportunities,
  erosion of fossil fuel market
• Location of operations and sales
• Exposure to GHG emission regulations, CDM
  opportunities, access to natural gas reserves
• Source G Barker, 2004 Research Project UCT GSB,
  Methodology put forward by West LB

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.EXAMPLES OF SECTOR INITIATIVES
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METALS AND MINERALS

• Responsive practices reported by the Carbon
  Disclosure Project
• Carbon shadow pricing incorporated into
  investment decisions
• Factoring carbon regulation into demand and
  supply forecasts for coal
• Forecasting impacts of carbon taxes
• Location of operations is a key risk factor
  (short term)
• High input costs vulnerable to water and energy
  pricing

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BANKING AND FINANCE

• Responsive practices reported by CDP
• Interviewing corporate clients to analyse
  potential climate impacts
• Incorporating carbon risk into risk assessments
• Mapping economic effects
• Exploring structural finance market for renewable
  energy

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INSURANCE AND REINSURANCE

• Responsive practices reported by CDP
• Integrating climate change risk as a
  supplementary criteria for investment mandates
• Researching potential risk-transfer load from
  sectors such as agriculture, real estate and
  tourism
• Integrating carbon finance into a range of
  insurance and financial functions
• Exploring increased coverage and lending
  opportunities.

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CONSTRUCTION AND WEATHER RISK

• Extreme weather leads to delays
• Additional resources, penalties, delayed cash
  flow, impact on operating results
• Weather derivatives and insurance
• Define exact type of weather that effects a
  project
• Quantify the relationship in monetary terms
• Identify relevant weather variable's (strike
  value)
• Define incremental cost associated with
  incremental weather variable (tick value)

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• INVESTORS
• WHAT COURSE OF ACTION?

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PROTECT INVESTMENTS

• Improve understanding of impacts
• Assess physical and policy risks of climate
  change in company, sector and portfolio holdings
• Network with others
• Communicate issues pertaining to climate risk /
  Ask companies to identify material risk
• Reduce climate risk exposure

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RESPONSIBILITY OF FINANCIAL SECTOR

• Companies are accountable to shareholders
• Response (and disclosure) from companies will be
  limited as long as this issue is not understood
  to be a shareholder concern

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THE WAY FORWARD

• Look to the results achieved by the Carbon
  Disclosure Project
• A collaborative communication from investors
• Companies made aware
• Disclosure improves
• This in turn provides enhanced understanding for
  financial community
• Scope for collaboration and joint engagement
  within South Africa

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DISCUSSION