Investment funds divested from fossil fuels "will perform better"

The author of the influential Stern Review on the Economics of Climate Change is also calling for Europe to decarbonise the power sector by the 2030s.

Research by leading investment and asset management firm has shown that fund managers divesting fossil fuels from their portfolios, and replacing them with an actively managed portfolio of renewable energy and energy efficiency stocks, will reduce risk and achieve positive financial benefits.

The conclusion will support a call issued last Friday by Lord Nicholas Stern for Europe to "re-ignite growth by investing in the transition to a low carbon economy".

The author of the influential Stern Review on the Economics of Climate Change, said in his statement that "low-carbon growth is the only credible medium-term growth strategy" and called for a European goal of decarbonising the power sector by the 2030s.

Pressure is building on institutional investors to assess their exposure to companies that extract fossil fuels, as concerns rise about the likely effects on the climate from greenhouse gas emissions.

In parallel, financial analysts are increasingly warning investors of the risks that tighter regulations on carbon dioxide emissions and falling demand for fossil fuels could make fossil fuel reserves substantially less valuable, or even ‘stranded’, and ultimately rendered worthless.

Impax Asset Management, which won the Sustainable Investor of the Year accolade at the FT/IFC Sustainable Finance Awards last month, has assessed the relative performance over the last seven years, in terms of returns and volatility, of four alternative portfolio structures.

Its analysis of the historical data found that, over the past seven years, eliminating the fossil fuel sector from a global benchmark index would actually have had a small positive return effect.

Furthermore, much of the economic effect of excluding fossil fuel stocks could have been replicated with ‘fossil free’ energy portfolios consisting of energy efficiency and renewable energy stocks, with limited additional tracking error and improved returns.

The four alternative scenarios were:

a completely fossil free portfolio: based on the MSCI (formerly Morgan Stanley Capital International) World Index without the fossil fuel energy sector;

fossil free plus alternative energy 'passive' portfolio: replacing the fossil fuel stocks of the MSCI World Index with a passive allocation to renewable energy and energy efficiency stocks;

fossil free plus alternative energy 'active' portfolio: as [2] but actively managing the portfolio;

fossil free plus environmental opportunities 'active' portfolio: as [2] but actively managing a portfolio of stocks selected from a wider range of resource optimisation and environmental investment opportunities.

The best performing alternative was [3]. As a result, the company believes that investors should consider reorienting their portfolios towards low carbon energy by replacing fossil fuel stocks with energy efficiency and renewable energy investments.

The announcement follows news last week of two more financial institutions, Storebrand and Rabobank, divesting from fossil fuels.

Awarding the Sustainable Investor of the Year to Impax in June, Martin Dickson, US Managing Editor of the Financial Times and co-chair of the Sustainable Finance Awards judging panel, said: “The world faces not only persistent economic uncertainty but also unparalleled resource constraints that are putting pressure on social systems across both developed and emerging markets. This situation makes sustainable investment, and these awards, even more relevant.”

Managers of college endowments and municipal and state pension funds are increasingly finding themselves the target of fossil fuel divestment campaigns from within US universities, similar to the calls for divestment of stocks of companies that supported apartheid in the 1980s.

The Fossil Free campaign maintains that it is “morally wrong to profit by investing in companies that are causing the climate crisis”.

Independently, mainstream analysts are now building on research from the Carbon Tracker Initiative, which has warned that regulations to limit carbon emissions could significantly impact the market value of fossil energy companies as it becomes uneconomic to extract their reserves.

It calculates that 80% of the world’s proven fossil fuel reserves cannot be consumed without exceeding the international target to keep global warming to within 2°C above pre-industrial levels, implying that the world’s listed fossil fuel companies, whose share prices are partly based on their proven reserves, are grossly overvalued.

These mainstream analysts include:

HSBC, whose oil and gas analysts warned that European energy companies could see their market capitalisation fall 40-60% if oil prices drop to $50/barrel, as a consequence of climate policies commensurate with the 2°C goal;

Citi, which examined the value at risk from climate policies among Australian extractive companies within the ASX200 index;

Standard & Poor’s, which predicted that smaller oil companies, especially those heavily exposed to high-cost unconventional oil production, could face credit downgrades within a few years under its ‘stressed’ carbon reduction scenario;

and Aviva Investors, Bunge, Climate Change Capital and HSBC, which are funding research at Oxford University’s Smith School of Enterprise & Environment into risks posed to investors by high-carbon stranded assets.

The Impax report concludes: "Given the growing consensus around climate change science, it is rational for investors to expect much tighter carbon regulation, with profound economic effects, in many regions of the world. These regulations ... are only moving in one direction: towards a lower carbon world."

Picture from Wikimedia
caption: The author of the influential Stern Review on the Economics of Climate Change is also calling for Europe to decarbonise the power sector by the 2030s.

Government should set a 2030 decarbonisation target

George Osborne's Liberal Democrat deputy, Danny Alexander will call for a target and criticise his boss's attitude to low carbon tech at the Lib-Dem party conference.

The role of gas-fired generation and the setting of a 2030 decarbonisation target for the electricity market has become the focus of a bitter battle between Lib Dems and George Osborne.

Yesterday, Edward Davey, Secretary of State for Energy and Climate Change, responded to a letter from the Committee on Climate Change, signed by its new Chairman, Lord Deben, criticising the recent Government statement that gas would continue to play an important role in the energy mix beyond 2030, not restricted to providing backup to renewables".

The letter added that this position could be illegal under the Climate Change Act 2008, and “weakens the signal provided by carbon budgets to investors" in clean tech.

It also recommends the setting of a clear carbon emission objective for electricity market reform, of around 50g of CO2 per kilowatt-hour by 2030.

Earlier this year George Osborne ruled out such a measure, expressing concern that such a target would undermine investor confidence in the gas industry, which he wants to build up.

In short, the argument between Osborne and DECC is about whether investment should be predominantly directed into renewables or gas. Gas, being cheaper, is favoured by Osborne.

But it is also an argument between the Lib Dems and Conservatives. Osborne's Liberal Democrat deputy, Danny Alexander, has signalled that he will call for a 2030 decarbonisation goal to be implemented when he speaks at the party's conference in two weeks.

He will also use his speech to attack the Conservatives for not acknowledging the economic benefits of investing in low carbon tech.

In reply to the CCC letter, Mr Davey, who this week adopted responsibility for renewables policy that was previously the ex-energy minister Charles Hendry's brief, issued a statement.

This said that a target is "under consideration" but argued that the Government's "existing plans are consistent with significant decarbonisation of the power sector".

Davey is known to believe that a limit on carbon emissions from the sector could be achieved using a statutory instrument instead of being included in the Energy Bill.

Osborne is currently sanguine about DECC's consultation on a carbon emissions limit for 2030, because he doesn't think it would make a material difference in practice.

But Davey's ace in his hand remains the carbon budgets that have been agreed by Parliament, which could trump Treasury policy provided that it is played with a strong suit.

Davey's response to the Committee's letter emphasises this, that the statutory carbon budgets that are set by the Committee, and agreed by Parliament, underscore all policy and planned market reforms.

“We have always said [our reforms] will include gas fired plant," the statement says, “which is quick to build and flexible." But "after 2030 we expect that gas will increasingly be used only as back up, or fitted with Carbon Capture and Storage technology.

"Alongside up-scaling of renewables, nuclear new build, and eventually with carbon capture and storage, gas has an important role to play in the transition to a low carbon grid."

But how much gas generation could be installed and still permit the UK realistically to meet its carbon budgets?

“Our numbers show that we can accommodate around 30 to 45GW of unabated gas over the next twenty years and still hit our carbon targets, but any further fossil fuels will need CCS, which is not yet commercially viable," Davey said on Wednesday.

This means over a dozen new gas-fired power plants in the next 15 years.

While the Committee's letter was greeted with approval by the clean tech sector, this response by Davey has been met with scepticism.

Utility company SSE tweeted that, contrary to the Treasury view, a "2030 decarbonisation target in EMR would provide much-needed certainty for low-carbon investors and developers".

Climate and energy campaigner for Greenpeace, Joss Garman, calculated that “where you have as much as 45GW of unabated gas in 2030 (and if you assume demand by then of around 420TWh), this would require that all those gas stations are only operating for 15% of the time if we are to keep on track with carbon targets. It also requires all of the UK’s coal stations are shut down or operating with fully functioning Carbon Capture and Storage (CCS)."

"The UK is already over-reliant on gas, which was the main driver behind recent energy bill rises," said Keith Allott, head of climate change at WWF.

The cross-party energy select committee, led by Tim Yeo, has also reiterated calls for a 2030 decarbonisation goal.

“Our gas generation strategy work is about providing certainty to investors to ensure sufficient investment comes forward, whilst also living within our legally binding carbon budgets,” concluded Ed Davey's statement.

To Garman and the other objectors, this seems like trying to have your cake and eat it.