The Chernobyl disaster in 1986 and the Fukushima accident in Japan 25 years later were turning points in public attitudes towards nuclear energy. The human cost and widespread environmental impact of those disasters sparked protests around the world. They also forced a shift in energy policy. South Korea, Germany, Switzerland, Austria, Sweden, Belgium and the Philippines joined Japan in announcing plans to phase out nuclear energy in the aftermath of the Fukushima disaster.
Fast forward 11 years and attitudes towards renewable energy appear to be thawing. While the consequences of the climate crisis are now far more tangible than they were in 2011, the aftermath of the pandemic and the war in Ukraine have sent the price of energy through the roof. Faced with the acute risk of gas shortages, energy security appears to be the order of the day. Many of the countries that were once committed to ending nuclear energy production have decided to keep such plants open for longer.
Japan has gone a step further by intending to build new nuclear power plants, despite the Fukushima disaster still fresh in the memory. And Germany, the country once so committed to the Energiewende – the transition to renewable energy – now intends to keep its last nuclear power plants open, albeit temporarily.
The UK is particularly exposed to rising energy prices, with gas powering almost a third of the national grid, according to Ofgem, the energy regulator. And the effects of wholesale gas prices soaring by more than 70% mean that household energy bills were set to rise by 80% in October.
However, in September, Britain’s new prime minister, Liz Truss, announced the end of a ban on fracking and the launch of new oil and gas licensing. This followed her predecessor announcing significant subsidies for fossil fuel extraction and the construction of nuclear power plants.
Does the new focus on energy security mean that investors are turning their backs on renewable energy?
Floating upstream
On the surface, major oil and gas companies can prove a lucrative investment. Not only are energy companies relatively resilient to recession risks, they have also booked record profits. For example, Shell made a £9.5bn profit in the second quarter of 2022 while BP’s earnings tripled to £6.9bn in the first six
months of this year and British Gas owner Centrica’s profits rose fivefold to £1.3bn during the same period. Those not directly exposed to the energy sector could still receive a boost with the sector accounting for almost 10% of the FTSE100.
But a closer look reveals a much more nuanced picture, as Tancrède Fulop, senior equity analyst of European utilities at Morningstar, argues. “Generally speaking, the upstream segment of the market; companies that extract oil and gas, have been profiting a lot more from higher energy prices while downstream companies, especially those with a large retail segment, are profiting less,” he says.
This is due to price caps in the retail market putting downstream margins under pressure, leaving energy companies like Octopus to book losses. Meanwhile, those with an upstream operation, like Shell, BP and Centrica, have benefited from rising wholesale prices of gas and oil.
And in the short run, this has been profitable for institutional investors who continue to maintain exposure to the fossil fuel industry. Gustave Loriot-Boserup, who is responsible investment manager at London CIV, explains why the local government pension pool continues to invest in fossil fuels, despite pursuing a net-zero agenda.
“Historically, ESG funds were constructed on the basis of low carbon indices, so you can easily reduce your carbon footprint by losing your exposure to these sectors. But lately, there has been a much clearer understanding that you are not going to build a net-zero economy by investing in healthcare and IT companies,” he adds. “You need to maintain exposure to the companies that contribute on a material basis to these greenhouse gas emissions.” This has also been embedded in the criteria for becoming aligned to other metrics, Loriot-Boserup explains. “Paris aligned funds need to maintain exposure to high-climate impact revenue streams, which is a requirement by the EU Paris-Aligned benchmark regulation,” he adds.
But energy companies with big retail operations are also facing growing pressure from windfall taxes and political intervention. France, for example, has decided to nationalise energy provider EDF, while in the UK energy firms could face a consumer boycott. The Times reports that up to 1.7 million British
households will not pay their energy bills in October, although this was written before the energy cap was announced. Campaign group Don’t Pay UK estimates that if people feel the cap does not go far enough then a boycott could cost energy firms more than £2bn. These political factors are key risks for investors to consider, warns Fulop.
This view is shared by his colleague, Allen Good, who is an energy strategist at Morningstar. “If you look at oil companies, for the past 10 to 15 years over-investment and a lack of capital discipline was an issue. If you then get into a situation where you are being coerced into investing in lower returning renewables, that is certainly going to raise investor concerns,” he says, adding that US firms don’t face similar pressures.
But there is also the hope that energy firms could utilise the windfall profits to invest in the transition towards renewable energy, says Jon Cunliffe, managing director of investments at B&CE, the company behind The People’s Pension. The master trust has outsourced its shareholder engagement to the asset managers running its funds. Nevertheless, he has a view on how the extra money should be spent. “While we have not been directly engaging with the companies, we would hope that the increased profits they have seen this year as a result of supply issues is used in a way that helps to meet the targets they have set in terms of decarbonising and aligning themselves with a transition to a net-zero economy.”
But, for the time being, there is little evidence that they will do so. For example, while BP has booked record profits it has only invested £300m in renewable energy – 2.5% of its profits. Yet it has invested more than 10 times as much in new oil and gas projects, a Channel 4 report shows. Moreover, its expenses on
share buybacks and dividend payments far exceed the investments in renewable energy.
But for Joel Moreland, principal consultant at Social & Environmental Finance, buybacks might not be a bad thing. “There are a lot of people who have hoped for a decade or two that oil and gas companies will transition. But what is the evidence that they will? “Actually, the best thing that they can do is to do share buybacks and pay dividends because investors are much more likely to invest in renewable energy than they are,” he says.
Impact on ESG exclusion funds
Meanwhile, the effects of rising energy prices have been far from straightforward for ESG-compliant funds. For the first time in years, European ESG funds booked €5bn (£4.3bn) of outflows in the first half of 2022, according to ESMA, the European securities market regulator. This is in part due to equity funds excluding fossil fuels failing to capitalise on the record profits earned in the oil and gas sector, but also being more heavily invested in tech companies, which have performed poorly.
Moreover, market volatility, rising interest rates, inflation and a fall in issuance have taken their toll on ESG bond funds. But the regulator points out that funds with an ESG impact objective and Article 9 funds performed much better throughout the period. One area of the market which has benefited from the transition are private market investments in renewable power generation, particularly strategies that include an inflation hedge, explains Pruthvi Odedra, who manages London CIV’s private market assets. Some of the assets Odedra manages are held in the £399m LCIV Infrastructure fund, which is 40% exposed to renewable energy. “So the portfolio is benefiting from the unforeseen energy price increases,” he says.
“Our latest secondary investment in our renewables portfolio has benefitted hugely as it is a UK portfolio of energy generating assets in wind and solar. Its valuation saw an uplift of lowteen digits in the first half of this year due to the strong operating income of the assets from merchant power exposure but also renewable obligation certificates that are index linked to inflation,” Odredra adds.
But there are, nevertheless, pitfalls for investors to consider. One key risk is the potential impact of rising interest rates. “With these high interest rates, your discount rate will also increase on these assets, so particularly in the longer-dated assets, we might see a fall in valuations,” he says.
A bump in the road
In the short run, the current crisis offers challenges for the transition to renewable energy, as Faith Ward, chief responsible investment officer at local government pension pool Brunel, acknowledges. In an interview with Asset TV, she revealed that this crisis has forced the pool to review its ESG stance.
“We’ve always recognised the need to be pragmatic and agile,” she said. “What we have been experiencing over the last few months, particularly the knock-on impacts of the invasion of Ukraine, is a bump in the road towards energy transition. In a sense, it illustrates some of the challenges in setting a long-term plan.”
London CIV’s Odedra also predicts that the focus on energy security could benefit conventional sources of power generation. “Unfortunately, there will be some need for the development of conventional power assets, as speed is of the essence.
Within the UK, we are seeing a huge increase in renewable enabling infrastructure, particularly, battery storage projects as part of the energy crisis in this country is due to intermittency of renewables. We have had low wind speeds and we have not stored enough energy to circumvent that.”
Paying the price
Does all this mean that institutional investors are turning their backs on renewable power? Far from it. If anything, there appears to be an overwhelming sense that the key players in the energy extraction market have failed to adapt and have, therefore, no place in the low carbon economy of the future.
“People who are buying into them now might have missed the chance,” Moreland says. “Investors holding them got lucky, but once the war goes away and the system has adjusted to the pandemic’s recovery, who is going to be the buyer? “Is now the chance to sell oil and gas companies at a profit that you never imagined? The question is, what is going to be the next driver for the longer term. Ultimately, we have to have a low carbon transition and the downward pressure on these companies will come back again,” he says.
For investors who continue to hold fossil fuel companies, this represents a difficult balancing act, Loriot-Boserup says. “Obviously, companies operating in the oil and gas sector have benefited during the last [ few] months, but to be completely transparent with you, when we build these low-carbon, Paris-aligned
strategies, we don’t think about the short term, we think about the long-term. And if these companies don’t change their business model, they are not going to be part of the net-zero economy. Climate change represents a systemic risk, and companies with high carbon emissions will ultimately pay the price,”
he says.
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