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Research: Driving an energy transition

Jane Ambachtsheer discusses the outcome of an initiative to raise investor awareness of climate change and focus efforts on clean energy investment

During 2014 a group of investors initiated the ‘Divest Invest’ project to heighten investment industry awareness of climate risk and leverage the power of the financial sector towards climate action1. Today this movement numbers over 500 organisations with $3.4trn (€3trn) in assets. This article discusses the outcome of a workshop that focused on the motivations, barriers and opportunities for Europeans in relation to the project. 

Investment pools often serve a social purpose, be it to fund university research, pay pensions or support charitable endeavours – often into perpetuity. Meeting these aims is generally the sole focus of those responsible for overseeing the assets, often involving a fiduciary duty to do so. What does this have to do with climate change? Historically – very little, but times are changing. 

The Paris Agreement – struck in December 2015 by 196 governments and covering over 95% of global emissions – sets out an ambitious target of limiting global warming to well below 2°C over pre-industrial levels, and preferably 1.5°C. Achieving this will have significant implications for different sectors of the economy2 . According to Mercer’s 2015 ‘Investing in a Time of Climate Change’ study, a 2°C scenario would see significant potential erosion of returns for materials, utilities and fossil fuel-based energy sectors with strong gains to renewables. 

An energy transition is already underway. A record $329bn (€289bn) was invested in renewable energy in 2015, an increase of nearly 30% over 2014, according to Bloomberg New Energy Finance. For the first time, in 2014, economic growth was decoupled from emissions growth – the economy grew while energy-related emissions did not – a trend observed by the International Energy Agency again in 2015. 

Jane Ambachtsheer

Jane Ambachtsheer

This aligns with the rapid introduction of solar and wind power sources, with the latter taking over the fossil fuel based power installations in the US in 2015 (Bloomberg New Energy Finance). In the automobile sector, the market cap of Tesla – whose mission is to accelerate the world’s transition to sustainable transportation – is now half that of General Motors. 

The speed of take up of new technologies has increased significantly over the last century. It has happened faster than predicted by many analysts, suggesting we can expect to see the overall share of non-fossil fuel based energy technologies continue to accelerate at a swift pace – perhaps most rapidly where these technologies involve distributed generation more akin to consumer products, for instance portable solar panels you put on your roof. 

Mercer surveyed 21 current and prospective signatories to Divest Invest and the results provide interesting insights for asset owners and managers3

Key motivations for committing to Divest Invest reflect wide ranging concerns and ambitions:

• 77% – ethical: “We do not want our investments to undermine the work of our philanthropy and grant making”; 

• 59% – financial: “We are gravely concerned about the risks posed to fossil fuel investments by likely changes to policy and by the increasing competitiveness of the alternative energy market”; 

• 59% – political: “We want to send a loud, public signal to governments, policy makers and business leaders about the future we want them to enable”.

Divestment progress is still in the early stages: 

• 60% of respondents have conducted some form of portfolio assessment for fossil fuel exposures;

• 90% of respondents have other restrictions in place (such as tobacco or arms), which can complicate divestment from fossil fuels (for example many fossil fuel-free strategies do not include other exclusions);

• All respondents except one have some form of pooled fund, which can limit the ability to sell individual holdings;

• Variation exists among what might be divested from, with coal and tar sands oil topping the list (each at 88%), followed by extraction of oil/gas (both at 75%), utilities generating/distributing energy from fossil fuels (75%) and distribution of fossil fuels (69%).

The investment component is making good progress, although barriers exist: 

• Many investors have made positive allocations to low-carbon or fossil-fuel-free assets by asset class (75% to equity; 43% to fixed income or private equity; 36% to infrastructure) and by theme (38% to renewables; 31% to sustainability themed equities) 

• The barriers identified towards further allocations included: higher fees; a perception of poor(er) returns; lack of choice or poor availability of products. 

Although signatories are early in the process of divestment from fossil fuels and investment in climate solutions, they are committed to it. The final part of the workshop focused on two key priorities – helping the signatories to implement the commitment and looking at how the initiative can help move the market towards better managing and pricing climate risk.

The workshop reviewed the investment products and approaches which already exist to support these efforts by UK- based charities (our particular focus in this workshop), and an assessment of gaps in the four key asset classes respondents are invested in – global equities, UK equities, fixed income, and private market investments. Our analysis determined that: 

• There is an adequate supply of active fossil-fuel free global equity options;
• There is a lack of fossil-fuel free UK equity options (passive and active); 
• There is a lack of fossil-fuel free fixed income options in general;
• There is a significant number of global private market thematic fossil fuel free options 

The key priority agreed was to collaborate on the development of appropriate, accessible and affordable passive vehicles available to UK investors.  

The group also discussed steps that could help move the market towards better managing and pricing climate risk. For example, industry narrative is dominated by the assumption that oil price changes are cyclical, without much focus on what the strength of the Paris Agreement means for long-term demand. The industry should increase its awareness of the potential investment ramifications associated with the low/zero-carbon energy transition in order to provide sound advice to investors. 

Climate change is a financial issue that is not going to go away, and is one Mercer suggests be added to a pension fund’s risk register. Momentum in the investment community was a contributing factor to the success of the Paris Agreement, and is continuing. Regulators are also beginning to focus on how investors are considering the investment risks associated with climate change4

Divest Invest supporters believe that redirecting capital from fossil fuels into clean energy investments is the most effective way of limiting global temperature rises to below the 1.5°C above pre-industrial levels target agreed in Paris. The development of additional investment products to help them do so is inevitable.

Looking ahead, climate change is a topic that seems set to remain on the agenda of European investment committees. 

Footnotes:

1 Specifically, they commit to: make no new investments in the top 200 oil, gas, and coal companies; Sell existing assets tied to these oil, gas, and coal investments within 3-5 years and invest in climate solutions, such as zero carbon energy, energy efficiency, sustainable agriculture, water efficiency and more.

2 A 2015 study by University College London (www.bartlett.ucl.ac.uk/sustainable/sustainable-news/nature_fossil_fuels) concludes that a third of oil reserves, half of gas reserves and over 80% of current coal reserves globally should remain in the ground and not be used before 2050 if global warming is to stay below the 2°C target agreed by policy makers.

3 Respondents were primarily UK charities.

4 The phase one report (April 2016) of the Financial Stability Board Task Force for Climate Related Financial Disclosures (available at https://www.fsb-tcfd.org/) explains that the Task Force’s review will focus both on how companies report their management of climate related risks, as well as how this information is reported across the investment chain (ie, by investors and their service providers).

Jane Ambachtsheer is a partner at Mercer Investments 

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