Daniel J. Tulloch

Stranded Assets and Thermal Coal in Japan: An Analysis of Environment-Related Risk Exposure

The principal aim of this report is to turn the latest research on environment-related risk factors facing thermal coal assets into actionable investment hypotheses for investors. By examining the fundamental drivers of environment-related risk, creating appropriate measures to differentiate the exposure of different assets to these risks, and linking this analysis to company ownership, debt issuance, and capital expenditure plans, our research can help to inform specific investor actions related to risk management, screening, voting, engagement, and disinvestment. To our knowledge, this report contains the most comprehensive and up-to-date analysis of the environment-related risks facing thermal coal companies that is publicly available.

The impact of regulatory change on EU energy utility returns: the three liberalization packages

ABSTRACT The European Union’s (EU) energy sector is changing due to major policy reforms. In this article, we examine the impact of major legislative changes which were designed to induce competition in the energy sector: the three liberalization packages. Competition was expected to benefit the industry by phasing out inefficient firms. EU citizens were also expected to benefit as competition was likely to promote a more efficient energy sector and more consumer choice of energy products and services. However, this legislative change occurred during a period of extreme market turmoil. We examine the impact of all these changes on the risk profile of the sector. Our results show that the liberalization legislation significantly increased systematic risk exposure of the sector, reducing its role as a defensive investment asset. We also show that commodities had relatively little impact on sector returns, but this was expected as utilities can offset commodity risk in hedging markets. We compare our results to those obtained in neighbouring EU sectors and find the impacts are isolated to the energy sector. This article makes a major contribution to energy policy by empirically showing the change in risk as a result of sector liberalization.

Carbon Pricing in New Zealand's Emissions Trading Scheme

The New Zealand Emissions Trading Scheme (NZ ETS) is an intensity-based system and the second oldest national ETS. It is unique in that it is highly international (with unlimited use of Kyoto allowances) and it incorporates forestry. We provide the first empirical analysis of the determinants of allowance prices on the NZ ETS. Our results indicate that imports of offsets rather than fundamentals have been the major price determinant. Moreover, the pricing of New Zealand units (NZUs) can be placed into three distinct periods, delineated by two structural breaks. In the first period, the system is largely autarkic; in the second period, as international offset prices drop below the NZU price, the system becomes a ‘price taker’; in the final period, following some policy interventions, the system regains some independence. The case of the NZ ETS shows both the power of linking ETSs and the dangers of doing so.

Modelling Sector-Level Asset Prices

We present a modelling approach for sector asset pricing studies that incorporates sector-level risk factors, sub-group portfolios, and structural break point tests that are better at isolating the time-varying nature and the firm-specific component of returns. The sub-group portfolios show considerable subsector heterogeneity, while the asset pricing model using local risk factors and inductive structural breaks results in a superior model (R2 of 80.42% relative to R2 of 68.79% of ‘conventional’ models). Finally, we show that 28% of the variance of residuals, normally assumed to be the firm-specific component of returns, can be attributed to the changing relationship between sector returns and risk premia.

Current and Future Challenges Facing the European Union's Energy System

The EU energy system is in the middle of a period of profound change. Financing the transition to a low-carbon EU economy is expected to require

Risk Factors in Energy Utility Returns: An Augmented-Four-Factor Model

2.2 trillion by 2035, requiring substantial private capital. However, investors are hesitant to commit capital due to many challenges facing the energy system. This review provides a high-level discussion regarding the challenges and the potential solutions to address them. We identify four main challenges: 1) structural challenges and reduced capacity adequacy, 2) an incorrect market framework to value flexibility, 3) the inability to finance the energy transition, and 4) the role of transitional fuels. Against these challenges, four potential solutions are: 1) capacity remuneration mechanisms, 2) demand-side response and consumer empowerment, 3) reforms in emissions trading and renewable subsidies, and 4) improved physical interconnections and governance. The EU’s ability to address these challenges will directly impact its position as a global leader in green energy investment.

The Impact of Liberalization and Environmental Policy On Financial Risk-Return Profiles of European Energy Utilities

In this paper we utilise the risk factors from both the finance and energy economics literatures to develop an improved asset pricing model (the Augmented-Four-Factor Model or AFFM) in the context of the European energy utility sector. In addition, we undertake inter-sectoral and inter-temporal analyses using the risk factors in our AFFM. Our results show our AFFM captures the greatest proportion of returns relative to other models. Further, stock market risk factors (most notably the market, size, value and momentum premia) explain a much greater proportion of average returns than term and commodity risk factors. Our inter-sectoral results show that, relative to other sectors, energy utilities are defensive stocks over the period analysed (1996 to 2013). However, our inter-temporal analysis shows that market beta has been increasing through time, from 0.710 in 1996 to 1.037 in 2013; the European energy utility sector is becoming increasingly exposed to systematic risk. Further, despite regulatory changes, designed to counteract the dominance of big energy utilities, the size premium has increased over time. Finally, the value and momentum premia are evident one to two years after the three EU energy sector liberalisation packages of 1996 and 1998, 2003, and 2009. In particular, the energy sector becomes extremely distressed following the third liberalisation package.

A GARCH analysis of the determinants of increased volatility of returns in the European energy utilities sector since liberalisation

We examine the impact of liberalization, energy efficiency, renewable energy, and security of supply legislations on the risk-return profiles of European energy utilities over the period 1996 to 2013. Results show that, after controlling for equity market and commodity risk factors, the EU policies which focused on liberalization and environmental objectives have increased return and return volatility of energy utilities. This reflects a fundamental change in these companies’ risk-reward tradeoff. Specifically, liberalization and energy efficiency policies impact financial return and volatility in the short- and long-term. Renewables and security of supply policies provide the largest impacts on long-term volatility and returns, respectively. We highlight a tension between liberalization and environmental objectives. Increased volatility raises the cost of capital for utilities, negatively impacting their ability to raise the estimated €1.3 trillion investment capital needed to transition to a decarbonized ‘smart’ energy system.

Carbon pricing and system linking: Lessons from the New Zealand Emissions Trading Scheme

This paper used panel regression and GARCH analysis to investigate changes in volatility of total returns of European energy companies due to energy sector liberalisation events. The paper constructed an index of 24 energy companies and calculated a 22 days rolling standard deviation of daily total returns over a 21 year period. Eight liberalisation events were identified. An unbalanced random-effects panel regression was used to analyse liberalisations impact on the standard deviation. A GARCH (Generalised Autoregressive Conditional Heterosce-dasticity) analysis was used on the constructed index to measure volatility clustering and conditional variance. The panel regression showed that overall volatility has increased, however some liberalisation events decreased volatility. The GARCH analysis demonstrated that returns increased over the time period and found high autocorrelation, but no conditional variance using a 1 day lag. Our analyses show that both risk and return have increased during liberalisation with the largest increases in volatility and return occurring when businesses and households could freely choose suppliers.