We are winning the war against tobacco, at least in the developed world. The percentage of adults who smoke has fallen across the OECD from 50% post 1945 to 20% in 2013. Yet, we are losing the war to keep global warming to less than 2°C1.
Why the difference? The reduction in smoking wasn’t achieved by persuading tobacco companies to stop selling cigarettes. True, when ethical and now mainstream investors like AXA cut tobacco out of their portfolios, on the basis of risk analysis, it helped stigmatise tobacco. But the biggest success came from regulation – plain packaging, forcing smokers out into the cold – and from falling demand, as people were persuaded that smoking was bad for health and happiness.
Fossil fuel and tobacco companies have several things in common – they are locked into a product that, because of its harmful effects, has no long term future and they employ the same anti-science to block change.
Learning from history, we’d expect focus among responsible investors on the companies supplying fossil fuels, with strategies like divestment and portfolio decarbonisation to the fore, to be more than matched by the focus on the two things that worked with tobacco – regulation and demand reduction.
Tighter regulation of fossil fuel emissions would be helpful and investors have started lobbying for regulation, a rational response taking account of the systemic risks to portfolio value that climate change involves. Similarly, investors could do more to force a reduction in demand.
The Task Force on Climate Related Financial Disclosures (TCFD) put investors in a strong position to demand increased scenario analysis disclosure. But, this doesn’t go far enough. To accelerate a reduction in demand, investors need to see transition plans – outlining specific targets and timelines for emissions reduction – from high impact sectors.
Appropriate stewardship requires asking utility executives to show how their transition plans will not only cope with the opportunities and risks of a 2°C world, but also help mitigate global warming, how all this will be incentivised, and how lobbying will be brought into line with the 2°C pathway. Incentives and lobbying are important and missing from scenario analysis disclosure.
In the US, the case for action on demand is clear since its energy utility sector produces 63% of all American emissions of greenhouse gases. In 2016, a group of investors committed to a strategy of putting down sectorwide resolutions. The results have been significant. Nine resolutions, covering over 35% by market cap of the sector, calling for 2°C scenarios or transition plans, achieved positive votes approaching, or in one case exceeding, 50%.
One targeted company, DTE, has committed to cut emissions by over 80% by 2050, and others are working on decarbonisation. In 2018, we hope to see at least one dominant investor switch its vote, and push several resolutions over the 50% line. To encourage accountability, Preventable Surprises will be publishing research showing the divergence in approach between the 10 largest investors in this sector.
What about Europe? As in the US, there are leaders and laggards in the energy utility sector. Collectively CDP (formerly the Carbon Disclosure Project) estimates that the 14 largest companies will overshoot their carbon budget by 14%2. This may sound small, until we consider that this is a sector where almost all the technology needed for the transition exists, unlike sectors such as cement or aviation.
So if the energy utility sector can’t transition in full, the likelihood of other sectors doing so, and thus keeping warming to 2°C or less, is small. Moreover, companies that don’t embrace the future, risk extinction3. While investment managers have benchmark related excuses for this, surely no asset owner can be complacent about this failure of fiduciary duty by their fund managers.
Shareholder resolutions are not common in continental Europe, so a direct mapping of the US strategy is unlikely to materialise. Equally, constructive or private engagement has not yet curbed the appetite for fossil fuels in the biggest demand sector to the degree needed. So investors who take seriously the climate related systemic risks to portfolio value need to find new ways, beyond private, one-to-one engagement, to push companies to reduce their demand for fossil fuels.
Such approaches are likely to share two characteristics of the US shareholder strategy. One is collective action – mobilising a majority of shares behind proposals for ‘action by making’ would be free riders take a stand. The second is public accountability – setting clear objectives for engagement which are related to real world needs rather than incrementalist assumptions about “what is possible” and then showing what has been achieved. Hopefully the Climate Action 100 initiative will help to road test these approaches, assuming that key European utility companies are included in the list.
If asset owners and investment managers can innovate in this way, they will create a model that can be used, not only for other sectors – such as transport – but also other issues in Europe and importantly Asia where shareholder resolutions are frowned on. If investors fail to address the demand for fossil fuels, they will, rightly, have little credibility with customers or legislators/regulators when they claim to be climate aware.
2 Charged or Static, CDP, 2017
3 Flip the Switch, Preventable Surprises, 2017
Raj Thamotheram and Carolyn Hayman are co-chairs of Preventable Surprises