Climate change reshapes the investment landscape
“Global warming remains firmly onto the political agenda and makes it important for all charities to think about carbon in their investment portfolios”, explains Tom Rutherford, Head of Charities UK at Lombard Odier.
The excitement around achieving collective agreement at the COP21 Paris Summit to limit global temperatures has continued into 2016. The summit took place last December as part of a United Nations-driven effort to refocus governments and the corporate world on the fight against global warming. The US and China have both confirmed that they will sign the protocol, while China has also announced plans to adopt western-style standards around limiting car pollution.
A number of foundations and charities also confirmed their intentions to divest from companies that burn coal, oil or gas from their investment portfolios. Once the preserve of a few family foundations and university endowments with active student bodies, now many pension funds, investment managers and sovereign wealth funds are carefully considering their investment exposure to fossil fuels.
The dilemma of stranded energy assets
Shifts in energy production as discussed at the Paris Summit could lead to a surfeit of unmined coal, oil and gas reserves termed as “stranded assets”. Drilling companies impacted by reduced fossil fuel demand face the potential of lost revenue and writing down the value of their mining licences and future profits. Of course many energy, mining and utility companies have been a staple in equity portfolios for decades and their handsome dividends have proved popular with charities. As a result, even charities whose missions are not environmentally aligned may find their investments impacted.
Meanwhile, the wholesale exclusion of all fossil fuel companies may not be the most socially responsible reaction, considering the large scale dependency upon old technology and the role oil majors and utilities are playing in developing alternative “green” energy substitutions.
Coal and tar sands in the cross-hairs
Many charities have decided to divest only from coal-producing companies because burning coal is an ugly practice in terms of carbon intensity. The coal industry is largely distinct from oil and gas production, so such public companies are readily identifiable and therefore easier to exclude. Further distinction can be made between less-popular, low-purity “thermal” coal commonly burnt to make electricity and more acceptable “coking” coal that is primarily used in the steel manufacturing process and which contains less sulphur.
Some investors also exclude newer and ecologically contentious practices such as “tar sands” surface mining for oil. Again incurring higher levels of carbon intensity, the mining here is often directed by private companies.
Not all bad – new opportunities through change
New technologies, improved extraction methodologies, and efficient energy use can provide investment opportunities. Here, energy transmission, monitoring and storage as well as carbon capture and emissions mitigation systems all have an equally valid application for domestic, commercial and industrial use.
These present benefits for those quoted companies committed to achieving meaningful environmental improvements through reducing their carbon emissions. Larger energy groups might therefore acquire these technologies, thereby diluting their overall carbon intensity. This, in turn, rewards pioneer environmental investors and provides capital for cleaner forms of energy, at the expense of traditional approaches. Energy profitability is partly dependent on the costs of production; importantly production costs are increasingly impacted by carbon taxes which will vary depending on the volume and carbon content of those emissions.
Approaching carbon with positive investment selection
It makes sense to consider which oil and gas producing or combusting companies are proactively reducing CO2 emissions, thereby making their businesses more sustainable. Comparison requires careful analysis across the underlying projects of companies, as well as to assess whether the stated commitments of management actually result in meaningful outcomes.
Activist shareholders can attempt to influence company policy through engagement with directors. Clearly, this is a task beyond most charities and trustees who are not energy experts and without the relevant access or resources. But trustees and investment committees can ask questions of their investment managers. And those managers that incorporate environmental, social and governance criteria within their investment processes should be able to respond constructively.
How should charities react in the face of increasing carbon scrutiny?
Admittedly, this subject is complicated and any discussion will likely be hostage to diverse and strongly held views among charity trustees. Absolute positions can be problematic but framing parameters by posing the following questions may help trustees consider the right approach for their charity and protect against unwanted outcomes:
- Does your investment policy consider carbon intensity and reflect our values?
- Do you seek to control your carbon intensity or exposure to particular practices such as thermal coal mining or tar sands mining?
- Is your investment manager able to reflect your values and investment policy concerning carbon?
- Does your investment manager have a strategy to consider the risks of stranded energy assets?
- What will be the portfolio impact of any change to your investment policy, also to the income generated?
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