ENERGY WATCH #3 - December 13, 2018
Investors are becoming increasingly pivotal in the climate change debate as the risk data available improves in quality and quantity. That data points towards growing risks to high-carbon companies they are invested in and therefore to their returns. It provides an important counterpoint to the efforts by some of the world’s largest fossil fuel producers – the US, Russia, Saudi Arabia and Kuwait – to water down climate commitments. The reality is, these companies must either plan in the risk arising from climate policies or see the money go elsewhere.
On many issues, business bends with the political wind because it knows that opinion will swing one way or the other depending on who is in power. On climate change, though, they know it’s happening, and that action is needed. If it doesn’t happen now, it will have to happen later, and it will likely cost more and be more disruptive.
The dangers, increasingly evident in extreme events such as this summer’s global heatwave, including in the Arctic Circle, are backed up by the Intergovernmental Panel on Climate Change’s most recent report, which shows that there are huge benefits, socially and economically, from keeping average temperature rises as low as possible.
That’s why more than 400 global investors with assets under management of $32 trillion – Boston Consulting Group calculated that the global total at the end of 2017 was $79.2 trillion – have called on governments around the world to address the “ambition gap” and step up action to address climate change, in particular by phasing out thermal coal power, putting a meaningful price on carbon and phasing out fossil fuel subsidies.
Investors are starting to take their own action to minimise their risks, in part by divesting from high-carbon companies and investing in lower-carbon alternatives. New York State Comptroller Thomas P. DiNapoli, who runs the $207 billion New York State Common Retirement Fund, says: “Despite the misguided policies of the Trump Administration, global efforts to address the very real threat climate risk presents to the economy, financial markets and investment returns are ongoing. Investors who ignore the changing world do so at their own peril.”
But while the world’s largest emitters are firmly in the spotlight thanks to initiatives such as Climate Action 100+, and are starting to respond (see last week’s story about Shell’s new climate targets), investors have been warned that they may be missing risks in many ‘overlooked’ industries, which are indirectly affected by the transitional risk of climate change, but not being recognised – and that means that companies in these sectors will soon come under increasing pressure to change.
MSCI says these ‘overlooked’ carbon-dependent industries are those which have low direct carbon emissions, but high revenue dependence on companies with carbon intensive operations and/or products. These industries include oil & gas equipment and services, heavy electrical equipment e.g. steam turbine manufacturers, and auto-parts and equipment.
One of the most striking illustrations of this is the recent reversal of fortunes at GE, which has had to write off billions of dollars and has cut thousands of jobs, including that of its CEO, after its bet on fossil fuel power generation – purchasing the power assets of Alstom – went bad as demand for steam turbines plummeted. Its rival Siemens, despite facing many of the same issues, has fared much better because it recognised much earlier that there would be a switch away from fossil fuels.
Remy Briand, head of ESG at MSCI comments: “Companies in these overlooked industries could pose an equally high risk to investors as those from the more traditional high carbon industries. Climate change risk is no longer simply determined by assessing historical carbon footprints.”
However, part of the problem for companies is that the signals from investors are inconsistent, with Influencemap pointing out that the world’s largest asset management groups – with a combined $40 trillion in capital market assets – have actually increased the holdings of thermal coal reserves in their funds by more than 20% (with fund inflows accounted for) since the Paris Agreement. They include investors that have very publicly called on companies to reduce their impacts, such as Blackrock and State Street.
A lot of this is to do with the rise of passive investing, where “universal” investors buy into entire benchmarks, regardless of companies’ carbon commitments. But Influencemap found that even some funds marketed as low-carbon have significant amounts of fossil fuel assets in them.
“Both index providers such as MSCI and S&P and the asset managers that use them to market climate themed funds are likely to be more carefully scrutinized on these funds and fossil fuel reserves contained within them in light of the IPCC’s latest statements on thermal coal,” the research group says.
Michael Liebreich, founder of Bloomberg New Energy Finance, says that what’s going on in Katowice is just a sideshow. “Climate economics precede climate diplomacy, not the other way around, and the economics keep looking better and better…shareholders and lenders are becoming increasingly uncomfortable with high-carbon business models,”
The signals from investors may be unclear for the moment, but with improved data bringing greater clarity on who is investing in fossil fuels and what the risks are, energy companies will face tough questions from their shareholders about how they are tackling climate change.