A Shortage of Green Investments in the ASX 300

By Victor Bivell

Eco Investor April, 2008 Edition

Although there are around two hundred companies listed on the Australian Securities Exchange (ASX) that could be described as environmentally positive investments, research by Eco Investor Magazine shows that only 16 of these companies are in the S&P ASX 300 Index, the broadest measure of institutional grade investments on the ASX.

The research shows environmental investors have only a small universe of investment grade opportunities to choose from - highlighting the difficulty of creating a well-diversified portfolio of environmentally focused investments, and revealing how large is the scope to broaden the range of available environmental investments.

This is an issue for the growing number of direct investors who have added an environmental theme to their share portfolios or who see the environment as a driver of share growth. It also affects indirect investors as most professionally managed share funds are based on the S&P ASX 300 Index or one of its subsets such as the S&P ASX 200 or S&P ASX 100 Index. So at best most managed Australian share funds would have only a small proportion of environmentally positive investments in their portfolios.

The methodology to identify the environmentally positive companies, developed by Eco Investor, is based on three key criteria:

1. Environmentally positive activity - where the core business activity is recognized as a solution or part solution to an identified environmental problem;

2. Environmental focus - where the company is wholly or largely focused on this environmental activity; and

3. Environmental commitment - where the company has a commitment to being an environmentally positive business.

Unfortunately not all of the 16 companies passed all three criteria easily, with several being border line on the issues of environmental focus and or environmental commitment. These were given the benefit of the doubt until management proves itself one way or the other.

Another 24 companies in the S&P ASX 300 Index were identified as having one or more environmentally positive activities but did not meet the required standard for environmental focus or environmental commitment.

In these companies the environmental business activity is not the dominant activity, or where it is strong there is a lack of commitment by management to divest assets or activities that are environmentally damaging.

These 24 companies were left out of the core group as environmental investors prefer companies to have both a focus on and a commitment to their environmental business; and the structure of these companies makes it difficult to measure the environmental, financial and investment contribution of the environmental business activity, and how this may be offset by the other business activities.

A look at the top 16 investments shows they are very concentrated by industry sector. Using the ASX's Global Industry Classification Standard (GICS), nine are classified as Utilities; four under Energy; and one each under Materials; Industrials; and Food, Beverages and Tobacco.

Environmental Investments on the S&P ASX 300 Index

Source: Eco Investor

Looked at another way, 13 are in energy and utilities, reflecting the huge impact of climate change and the need to reduce greenhouse gas emissions. Two companies are in waste management, and one is in aquaculture, with two also having divisions that deal with water management.

A more detailed breakdown shows:

* Three gas pipelines businesses - APA Group, Envestra, and Duet Group

* Three coal seam gas companies - Arrow Energy, Queensland Gas Company, and Sunshine Gas

* Two energy retailers - AGL Energy and Origin Energy

* Two with both gas and water businesses - Hastings Diversified Utilities Fund, and Transfield Services Infrastructure Fund

* One landfill gas and coal seam gas company - Energy Developments

* One wind farm fund - Babcock & Brown Wind Partners Group

* One geothermal energy developer - Geodynamics

* One metals recycler - Sims Group * One waste management company - Transpacific Industries

* One aquaculture company - Tassal Group.

The leading sector is the transmission and retailing of gas, seen as a low carbon energy source compared to coal and oil. But quite spectacular is the rise of coal seam gas, a sector that did not exist only a few years ago. Along with wind power, landfill gas and geothermal energy, it is the most successful to date of the alternative low and zero carbon energy sources, particularly as the ASX 300 at present does not offer a pure investment in hydro power.

The two energy retailers, AGL and Origin, are both very strong in gas and the leading renewable energy sources. Both retain some high carbon energy sources but their leading roles as long time supporters of clean energy give them a very high rating for environmental commitment and a pivotal role in Australia's transition to clean energy.

Waste management is one of the oldest environmental issues, making notable the presence of Sims Group, which is the world's largest metals recycler, and the rise of Transpacific Industries as Australia's largest waste management company.

The other company, Tassal Group, is the only aquaculture business in the Index. The rise of aquaculture is expected to continue as wild fish stocks are depleted and a growing number of small aquaculture companies join the ASX.

The list also shows that the sector is still immature.

Only three of the companies, AGL, Origin and Sims, are in the S&P ASX 100 Index; and three of the companies, Geodynamics, Sunshine Gas and Tassal, only entered the S&P ASX 300 Index at the last rebalance in March. And two of the companies, Sunshine Gas and Geodynamics, despite their large capitalizations, are not yet producing revenue.

There has been strong growth in the number of environmentally positive investments on the Index in recent times and this should continue. Over the next few years and decade it will be interesting to see how many of the two hundred environmentally positive companies on the ASX make it into the Index and in what sectors they emerge.

The immaturity of the sector is also clearly evident in the financial analysis of the group.

S&P ASX 300 Index - Environmental Investments - Key Financials $M

* Results for 2007 calendar year; ** 2006 calendar year

Source: Eco Investor, company annual reports, AFR

There is a very wide range in market capitalizations, from $7.9 billion for Origin Energy to only $308 million for Tassal. By size, most of the companies would fall into an institutional mid cap or small cap fund.

Likewise with net assets, the range is from $6.9 billion for Origin to only $66 million for Sunshine Gas.

Nor are all the companies profitable. The three top 100 companies made very substantial 2006-07 profits from $591 million to $254 million, but at the other end five of the companies made losses, albeit small. This improved in the 2007-08 first half with only two companies making a loss.

Dividend performance is also very wide. Six of the securities are well known as high yield investments, several others pay good franked and partly franked dividends, but four pay no dividend at all and are still seen as emerging growth stocks. If the growth of these companies continues it could still be a few years before they mature into profit making and dividend paying entities.

The expectation is that over time the strength of environmental issues as a driver of growth should see more environmentally positive companies in the Index, and more of these companies become substantial businesses and enter the top 200 and top 100 indices.

Environmental Credentials

Below is a discussion of why each company was selected as an environmentally positive investment.

Energy Retailing - Origin Energy, AGL Energy

Origin and AGL are both energy producers as well as energy retailers, and have for many years been developing and supporting low and zero carbon energy sources.

Origin Energy is a major producer of natural gas and LPG, operator of gas power stations, and retailer of gas and LPG. It is a developer of many alternative and renewable energy sources including coal seam gas, solar, geothermal, and cogeneration, and is the majority shareholder of New Zealand’s Contact Energy which generates all of its power from low or zero carbon sources including hydro, gas, LPG and geothermal. Origin is also a major retailer of clean energy.

On the environmentally negative side, Origin is an explorer and producer of oil and appears committed to this activity, despite it accounting for a small portion of its revenue.

In terms of commitment to being an environmentally positive business, Origin has long demonstrated that it is well aware of the issues and has for many years been active in supporting the development of many of the leading low emission and renewable energy sources and supporting the introduction of a carbon pricing mechanism.

AGL is also a diversified energy producer and retailer. It produces natural gas and LPG, operates gas fired power stations, and retails gas and LPG. For many years it has been developing a range of renewable energy projects including coal seam gas, hydro power, wind farms, landfill gas, biomass, biogas and cogeneration. It also retails clean energy.

Its environmentally positive focus is reduced by its ownership of the Loy Yang A brown coal power station in Victoria, and coal accounts for 18 per cent of its fuel for energy generation. It is also a small producer of oil in Papua New Guinea but recently said it is considering selling its PNG oil and gas assets.

AGL has been a corporate leader in its commitment to being environmentally positive. It says it has Australia’s largest privately owned portfolio of renewable energy assets, and is committed to increasing the percentage of its energy generated from low and zero carbon sources, which is currently 52 per cent gas and 30 per cent renewables.

Origin and AGL are both committed to clean energy and are crucial to Australia’s transformation to a low carbon economy.

Gas Pipelines - APA Group, Envestra, Duet Group

APA Group and Envestra are Australia’s largest owners of gas pipelines and gas distribution networks, while DUET is owner of both gas pipelines and electricity distribution networks. APA describes gas transmission as its core business and it also has two gas fired power stations, two gas processing facilities, an LNG facility, and is also a significant shareholder in Envestra and operates the Envestra gas network.

APA and Envestra are well focused on gas based activities. APA is also involved in interstate electricity distribution, about 2.6 per cent of its revenue. It says it is looking beyond pipelines for asset diversity but on the positive side these are also in the gas sector including gas fired power stations, gas storage and processing and coal seam gas transmission.

APA supports the role of gas as a transition fuel to a low carbon economy and its managing director is on the Prime Ministerial Task Group on Emissions Trading. Envestra has been a long time promoter of gas as an environmentally friendly fuel.

Both businesses rate highly for environmental activities, focus and commitment.

DUET is a less pure environmental play. Its focus is energy utilities. It owns 62.1 per cent of the Dampier to Bunbury Natural Gas Pipeline and 25.9 per cent of AlintaGas Networks, both in Western Australia, and 79.9 per cent of the Multinet gas distribution business in Victoria. Together these comprise about 55 per cent of its earnings.

DUET also owns two electricity distributors: 66 per cent of United Energy Distribution in Melbourne and 29 per cent of Duquesne Light in Pennsylvania, North America. Electricity distribution itself is an environmentally neutral activity and its value depends on the energy source of the electricity. Most of Victoria’s electricity is generated from coal, as is the electricity carried by Duquesne Light. This reduces its environmental positiveness as its revenue is dependent on environmentally damaging activity. The Melbourne electricity distribution business does have an environmental positive in its introduction of smart metering to improve efficiency. Duquesne Light has a 2.5 per cent interest in a 42 megawatt coal plant and a 3.8 per cent interest in a 66 megawatt coal fired power plant. Although these are small interests they are also a clear negative.

DUET has some excellent gas assets, and while the major part of its business is an environmentally positive activity, it does not have a clear focus on this.

In terms of commitment to being environmentally positive, DUET has made no statement about moving to clean energy assets. Thus we have placed DUET on an environmental watch status to see whether future acquisitions or divestments increase or decrease its proportion of clean energy assets and environmentally positive activities.

Gas & Water - Hastings Diversified Utilities Fund, Transfield Services Infrastructure Fund

Hastings Diversified Utilities Fund (HDF) has two major assets: 100 per cent of gas pipeline business Epic Energy and 50 per cent of major UK water utility South East Water.

The Fund’s business is focused on these assets. The acquisition of Mid Kent Water, recently merged with South East Water, was financed through the issue of ASX listed TAPS securities, which give investors a pure exposure to a water utility investment.

HDF is managed by Hastings Funds Management which has a long track record in infrastructure and understands the environmental issues involved. The Fund’s acquisition strategy is to acquire gas, electricity, water, hydro and wind power assets, which augers well. It rates highly on all three criteria of environmental positiveness, focus and commitment.

Transfield Services Infrastructure Fund (TSIF) fully owns four power stations, two of which -Townsville in Queensland and Kemerton in WA - are coal seam gas and gas fired; it has a 30 per cent interest in the gas powered BP Kwinana Cogeneration Plant in WA; owns four wind farms in SA, Vic and Qld and is negotiating to buy 50 per cent of a fifth in WA; and has 50 per cent of two major water filtration plants in Sydney and Melbourne.

However the Fund it is not fully focused on environmentally positive assets: it has 100 per cent of the coal fired Collinsville Power Station in Queensland and 14.03 per cent of the coal fired Loy Yang A Power Station in Victoria. These two assets contributed 22 per cent of its cash flow before the acquisition of the wind farms.

Transfield is not a pure environmental investment but it has been included because its most recent acquisitions were the wind farms, indicating that its asset mix is heading in the right direction. The Fund says it will focus on further wind farm developments and the Fund’s manager, Transfield Services, has acquired 14 prospective wind farm development sites.

TSIF has not made any comment about the future of its coal fired power stations, suggesting it intends to keep them.

The Fund has some excellent environmentally positive assets and has indicated an interest in participating in the new Federal Government Mandatory Renewable Energy Target. But we have the Fund on environmental watch for environmental focus and environmental commitment to see if the mix of its assets continues to trend positively with future acquisitions or sales.

Transfield Services Infrastructure Fund’s wind farms

Coal Seam Gas - Queensland Gas Company, Arrow Energy, Sunshine Gas

Queensland Gas Company, Arrow Energy and Sunshine Gas have quickly risen to become Australia’s leading coal seam gas companies. Each has significant coal seam gas reserves.

Queensland Gas has two projects producing coal seam gas in Queensland and extensive reserves. The company is focused on coal seam gas production, and is looking to expand into harvesting water from its operations for major community purposes. QGC describes itself as a supplier of clean energy, which seems to indicate a strong commitment to its environmental activities.

However QGC recently took a 7.13 per cent interest in Victoria Petroleum NL, which is a coal seam gas explorer and joint venture partner with QGC in one permit. However Victoria Petroleum is an oil as well as natural gas producer.

Despite this Eco Investor rates QGC highly on all three environmental criteria but with an ongoing interest in its strategy for Victoria Petroleum.

Arrow Energy has four producing fields in Queensland with plans for more, extensive acreage in Qld and northern NSW, a half share in the Braemar 2 power station and gas pipeline and a 13 per cent interest in coals seam gas explorer Pure Energy Resources. It is also exploring in India, China, Indonesia and Vietnam.

The company is fully focused on coal seam gas, and in terms of commitment, has expressed a desire to deliver cleaner energy and be a leader in moving Australia to a sustainable future.

Arrow Energy rates highly on all three criteria.

Sunshine Gas has several coal seam gas and conventional gas exploration fields in Queensland and is developing its first coal seam gas production facility. It is also assessing the development of an LNG plant at Gladstone.

However, the company is not totally focused on coal seam gas and gas as it has an onshore oil division that is exploring for oil in the Cooper Basin. It recently sold all of its offshore oil division which has interests in UK oil exploration areas. The company says it retains its Australian oil exploration division but this is not doing much as its focus is on developing its coal seam gas assets.

The company appears to have a lot of potential as a future coal seam gas producer, giving it a high rating for activity. It rates better on focus now that it has sold its UK oil division. But as it retains its onshore oil exploration acreage, and because the company’s commitment could change if oil is found, Eco Investor has these two criteria on environmental watch to see how the company develops.

Landfill&Coal Seam Gas - Energy Developments

Energy Developments is a well established company that has for many years been developing landfill gas, coal seam gas, liquefied natural gas and compressed natural gas power projects, particularly in remote areas of Australia as well as internationally. These are its sole business activities, and the company describes itself as being “at the forefront of the renewable and clean energy industry in Australia”.

The company rates highly for environmental activity, environmental focus and environmental commitment.

Wind Energy - Babcock & Brown Wind Partners Group

Babcock & Brown Wind Partners Group is one of the five largest specialist wind farm owners and operators in the word. It is focused solely on wind power assets and is committed to this strategy. It rates highly for environmental activity, environmental focus and environmental commitment.

Geothermal Energy - Geodynamics

Geodynamics was Australia’s first geothermal energy explorer and developer, and is now the most advanced of a growing number of emerging geothermal companies. It is focused solely on commercializing its geothermal project, and is an advocate for clean energy.

It rates highly for environmental activity, environmental focus and environmental commitment. Metals

Recycling - Sims Group

Sims Group is the world’s largest metals recycling group, and the world’s largest E-recycler of electronic and electrical equipment. It is also involved in tyre recycling, and has a 50 per cent interest in a biogas power generation business. The company is focused on its environmentally positive activities and has had a long standing commitment to these. It aims is to be “the world’s leading recycling company”.

The company rates highly for environmental activity, environmental focus and environmental commitment.

Waste Management - Transpacific Industries

Transpacific Industries is now Australia’s largest waste management business, with a wide range of operations in industrial waste management, solid waste, liquid and hazardous waste, organics and site remediation, and energy from waste including used mineral and cooking oils. It is also a manufacturer of vehicle bodies and recycling equipment.

While these environmentally positive activities account for around 75 per cent of its revenue and 90 per cent of its earnings, Transpacific is also an importer and distributor of large commercial trucks and industrial engines. This reduces its environmental focus.

TPI says recycling will be a major focus going forward, so the company displays commitment to its environmentally positive activities.

Eco Investor rates the company highly for environmental activity and environmental commitment, but because of the commercial truck activities believes its environmental focus could be stronger.

Aquaculture - Tassal Group

Tassal Group is Australia’s’ largest aquaculture business and specializes in the farming and selling of Atlantic Salmon. Tassal is fully focused on aquaculture, an activity that helps to reduce the demand on wild fish stocks.

The company recently acquired the Superior Gold brand in Australia which imports and supplies salmon and trout. The fish are sourced from Norlax of Denmark, said to be Europe’s largest manufacturer of smoked salmon and trout at 3,000 tons per year. Norlax says around 75 per cent of its fresh salmon come from Norwegian breeders, and the rest from Scotland, the Faroe Islands, Alaska and wild fish from Canada. However Tassal told Eco Investor that all of its product from Norlax will be sourced from Norwegian breeders and that this is part of the agreement. Likewise, the trout are sourced from Danish trout farms.

The three year supply agreement allows Tassal “to supply up to 30 per cent of its own salmon under the Superior Gold brand after the first year”.

This arrangement alone seems to indicate that Tassal understands the value of aquaculture and its role in reducing pressure on wild fish. The company is rated highly for environmental activity, environmental focus and environmental commitment.

This article was also published in Eureka Report, 19 May 2008