How could environmental risk hurt your portfolio?

Long-term investors need to think about their company’s social license to operate, and long-term industry trends.

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Because Australia is a country with a high proportion of mining or mining services companies, one of the most significant risks facing ASX investors is environmental risk. The main ways that environmental risks manifest are through protests, litigation and regulation (although often the three are intertwined).

The indebted Whitehaven Coal Limited (ASX: WHC) saw another protestor arrested yesterday, after the 63-year-old archaeologist locked on to a water pump. The protests at the Maules Creek expansion are attended by both farmers and environmentalists, who are worried about the destruction of the Leard State Forest, and the impact the new mine will have on underground aquifers: “The issue of water is too important to ignore,” said the protestors’ spokesperson. “We will not be going anywhere until the new Maules Creek mine is stopped.”

The protests come at a time when Whitehaven is trying to reduce its operating costs. The clear aim of protestors is to hamper its efforts. According to The Australian Financial Review: “Questions have been raised about Whitehaven’s ability to fund Maules Creek given it has more than $500 million in interest-bearing liabilities and an interest cover of 1.14 times.”

Another way environmental risk can impact a company is where the costs of preventing environmental damage undermine profitability. For example, The Guardian reports that: “A nickel refinery owned by Clive Palmer has released toxic wastewater into the Great Barrier Reef marine park on several occasions despite being forbidden from doing so, government documents have revealed.”

According to The Australian: “The threat of a massive rain dump from Cyclone Dylan a fortnight ago prompted Mr Newman to castigate Mr Palmer for not upgrading the refinery’s ponds.” Given that the Great Barrier Reef Marine Park Authority refuses to permit the refinery to pump the toxic sludge into the Marine Park, it is quite possible that a large capital injection will be required to reduce environmental risks.

Mr Palmer purchased the refinery from BHP Billiton Limited (ASX: BHP) in 2009, and according to The Guardian: “The Queensland Nickel refinery… made unauthorised discharges of nitrogen-laden water into the world heritage area in 2009 and then again in 2011.” It may be that BHP foresaw the need for capital expenditure (with regard to reputational risk), and was keen to divest itself of the responsibility.

Foolish takeaway

Just last month The Australian Financial Review ran with the headline “Whitehaven results silences critics,” on the basis of increased quarterly coal production. Yet one swallow does not a summer make: Whitehaven Coal remains a poor investment in my view. Even after record-breaking coal output, the company reported a loss of over $11 million for the first half of 2014, and debt increased by about $85 million.

In a sign of potential future coal price weakness, air pollution in Beijing has reportedly reached “unbearable” levels. Indeed, Xinhua News reports that in a bid to fight Beijing’s pollution, 147 industrial companies have cut or suspended production. Such issues are of minimal concern to short-term traders. However, long-term investors should look for companies with long-term tailwinds such as the ageing population, or increased data usage. From the looks of it, China will be reducing its reliance on coal over the next decade or two, and Whitehaven will continue to be hampered by protests.

Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article, and welcomes feedback from all readers.

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