By Bruce Duguid
As universal investors, most pension funds and endowments believe that climate change poses a major long term risk not only to the value of individual companies and sectors, but also to the health of the wider economy. For this reason, investors have long been genuine and vocal supporters of efforts to tackle climate change.
Most policy-makers agree, as demonstrated by the latest contribution from the Governor of the Bank of England, Mark Carney, when he said that the challenges posed by climate change “pale in significance compared with what might come”. Unfortunately, political and economic reality has not kept pace with investor ambition. So the question for investors is what to do about it? In response, many asset owners are debating whether to divest from fossil fuel companies or to remain invested and to engage with them on their response to the threat of climate change.
Divestment based on a hard-headed analysis of the prospects of a company is the very essence of the investment industry. However some institutions appear to have taken a policy decision to exit whole classes of investments exposed to certain types of fossil fuel, regardless of price or the specific opportunities that may be available either now or in the future. Certainly this sends a strong message to policy-makers of investors’ exasperation at the failure of government policy on climate change. It can also be motivated by an ethical desire to avoid adding further fuel to the bonfire of emissions deriving from fossil fuels.
Unfortunately, divesting from fossil fuel based companies is not likely to materially affect either the supply or demand of fossil fuels. Firstly, divestment involves passing on an interest in a security or asset to another buyer who will most likely be less concerned about the long-term risks of climate change. Secondly, the vast majority of investment in fossil fuel supply is sourced from retained earnings or additional debt, not fresh equity. Therefore, the level of investment in fossil fuels is primarily determined by dividend and leverage policies. To affect this decision, it is important to remain engaged as an owner of the company. Finally, although climate change involves profound ethical issues, even the lowest carbon scenarios published by the International Energy Association show the need for ongoing, albeit diminished, levels of investment in coal, oil and gas. Whilst the fossil fuels are black, the ethics are anything but black or white.
Decarbonising the global economy is a complex challenge without a simple solution. It will take decades to slowly transition away from fossil-fuels to cleaner sources of energy. Remaining invested opens up the opportunity to press for the change that investors want to see, both to protect the value of the investment and to play a role in delivering the wider transition. Through engagement with companies, we have seen demonstrable examples of progress. Over the last year or so, oil and gas majors have embarked on a much deeper conversation with shareholders on the challenges posed by climate change. At this year’s AGMs, the management teams of BP, Shell and Statoil agreed to support shareholder resolutions which require more detailed disclosures around their management of climate change risks and opportunities. This includes conducting analysis of portfolio resilience to climate change risks against a range of low carbon scenarios. In May this year, following investor pressure to play a leadership role in public policy, six leading European oil and gas majors committed to work together with the UN to develop a global carbon pricing system. Whilst in the mining sector, BHP Billiton published its exposure to climate change scenarios in September.
Of course the task is not complete. The transition to a low carbon economy will require investors to dig-in for the long process of corporate stewardship, leading and supporting companies along the journey that will ultimately revolutionise the world’s energy system. This also gives investors the legitimacy to continue to contribute to the public policy debate. We believe these are the necessary and constructive steps that must be taken by investors to secure the long term future of their investments in beneficiaries’ interests. In the case of fossil fuel companies, the analogy of a fine Swiss watch comes to mind, as in some senses the investor never actually owns the company, but merely passes it on to the next generation. What matters is the condition in which it is passed on
Bruce Duguid is sector lead: mining, pharmaceuticals at Hermes EOS
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