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Investors should divest fossil fuel-intensive assets, says Generation IM

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Investors should divest fossil fuel-intensive assets to mitigate or eliminate risks related to carbon, Generation Investment Management has suggested.

Al Gore, chairman at Generation IM and former US vice-president, said: “We recognise that can be complex and difficult for some asset owners, and we recommend that, for such owners, they can consider phasing in a transition over a period of time and focusing first of all on the most carbon-intensive forms of energy like tar sands and coal.”

This is one of the four actions the firm recommends investors implement, arguing that carbon-related risks significantly threaten valuations in fossil fuel-based industries, and that ”stranded” carbon assets are therefore a risk to investors.

 The four steps are to:

  • Identify the extent to which carbon risks are embedded in current and future investments across all asset classes
  • Engage corporate boards and executives on plans to mitigate and disclose carbon risks
  • Diversify investments into opportunities positioned to succeed in a low-carbon economy
  • Divest fossil fuel-intensive assets to mitigate or eliminate risks related to carbon

The paper entitled ‘Stranded Carbon Assets – Why and How Carbon Risks Should Be Incorporated in Investment Analysis’ says that, as the case for curbing carbon emissions continues to gain support on economic and scientific grounds, the commercial viability of carbon-intensive assets – particularly fossil fuels – will be increasingly threatened, creating stranded carbon assets.

The paper says regulation, market forces such as lower renewable prices and socio-political pressures such as divestment campaigns could drive stranding.

Gore added: “Investors have an independent responsibility, and, as they assess the risk involved in carbon-intensive investments, they should look at what they believe is likely in the way of government action. [The removal of government subsidies] is yet another risk. Today, the estimates are that there is about $500bn (€363.5bn) annual subsidy by governments around the world […]. But there are increasing pressures in many countries, including in the US, for the removal of those subsidies. But, regardless of what governments do or don’t do, investors have an independent responsibility to be prudent in analysing the risk in their portfolios, and the risk of a sub-prime carbon asset bubble is very, very high, and it is being missed by many investors today who should recognise a responsibility to take the steps we recommend in this paper.”

The paper states: “Maintaining the status quo, whereby investors fail to properly account for the risks inherent in owning carbon-intensive assets, will cause the ‘carbon asset bubble’ to grow until the artificially high valuations for these assets can no longer be sustained. The presence of a bubble is often not recognised by the market due to classic behavioural finance decision-making biases, such as endowment bias and system justification theory.”

”However,” it adds, ”the carbon asset bubble presents not only risks but also opportunities. In particular, investors have the chance to strategically reallocate their capital in advance of these risks materialising sooner than anticipated and irreversibly impairing the value of carbon assets.”

Stranded carbon assets are defined as assets, which would likely absorb the majority of losses associated with carbon risks given the intensity of their CO2 emissions.

This term includes fossil fuels, as well as those assets which, given their dependence on fossil fuels and subsequent carbon-emissions intensity, would be stranded in the event fossil fuel valuations plummeted.

Given this definition, the paper’s focus is on the impact carbon stranding would have on those industries primarily driven by fossil fuels, such as non-renewable energy, mining, utilities, industrials, materials and transportation.

But it admits that, within this group, there are differing levels of vulnerability to stranding.

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