Carbon Tracker’s ultimate vision is a climate-secure energy and financial system. This does not mean fossil fuels being switched off overnight, but does involve contraction within the 2ºC carbon budget.
Carbon Tracker’s research aims to switch off fossil fuel capital by aligning capital with a carbon budget that avoids dangerous levels of global warming as just outlined in the IPCC synthesis report. It is clear that this will require capital to be redirected away from fossil fuels. This can happen at a number of levels, of which divestment is perhaps the most visible and vocal expression.
Divestment campaigns have been hugely successful in putting the issue of unburnable carbon on the agenda of investment institutions. However most investment mandates would not permit exclusion of a sector on purely ethical grounds. Foundations and endowments who can take such action send an important signal. Indeed it could be argued that such a step is long overdue.
There is also another approach which is less widely known or discussed, that of engagement. The volume of engagement activity by investors is larger than divestment, but much of it takes place below the radar. However true engagement needs the pressure created by divestment. Engagement without divestment is like a criminal legal system without a police force.
The majority of funds therefore have to look at different responses to managing this risk, which they will continue to be exposed to. The Fossil Free campaign has been critical in driving the need and expectation that funds should be able to articulate their position on this issue. Carbon Tracker’s analysis has demonstrated the financial relevance for institutional investors.
As a result it is no longer acceptable to maintain a head in the sand position, do nothing on climate change risk and simply pay lip service to engagement. The financial risks becoming clearer also allows investors to act, as they can make a prudent financial case for reducing risk – which may indeed include some degree of selling particular stocks (otherwise known as divestment).
Carbon Tracker has seen a range of responses around the world which reflect the different investor cultures – its horses for courses. A number of institutional investors have conducted their own internal assessments of exposure but have not made them public. The horses currently in the race include:
- Carbon Asset Risk Initiative, an engagement programme coordinated by Ceres and Carbon Tracker with support from IIGCC in Europe and IGCC in Australia/New Zealand
- AP4 announcing it will decarbonise its portfolio & AP2 excluding 20 companies
- US shareholder resolutions
- Storebrand selling companies with the highest exposure to coal and oil sands
- MSCI and FTSE launching fossil free indices
- Aviva reviewing exposure to stranded assets
- DivestInvest movement announcing divestment from particular types of fossil fuel activity
- Hesta superfund restricting new investments in thermal coal companies
Similarly it is worth noting that not all companies are the same. One of the reasons Carbon Tracker produce the carbon cost curves is a response to investors wanting to know who the winners and losers are in different scenarios. Not all companies are equally sensitive to a low demand, low price, low carbon environment.
The big diversified coal, oil and gas companies are not going to disappear overnight, but they do need to continue to create value for shareholders. Carbon Tracker’s carbon cost curves indicate the high cost high carbon projects from which capital could be diverted. This can happen within the company at the direction of shareholders.
We have already seen that Total, Shell and Statoil have shelved massive oil sands projects in 2014; therefore it could be considered they have divested from over $30bn of oil projects. The importance of these capex decisions is that they determine whether the projects go ahead. Similarly Rio Tinto and BHPBilliton have already frozen capex for new thermal coal projects. These actions should be supported for protecting shareholder value, and used as the basis for engaging others with high cost exposure on the economic justification for approving new projects.
If the big players are pressing pause on oil sands and coal, it should be a warning sign. Shareholders need to make sure company management is managing the exposure to high risk options – keeping the company at the low end of the cost curve. Surprisingly in the past there has not been great transparency around what breakeven prices companies require for their projects.
Good housekeeping and incremental improvements in operations are not enough to deliver the energy future we need. The engagement and resolutions that this issue needs have to deal with the capital allocation of the fossil fuel industry and how they need to adapt it to a low carbon future.
Carbon Tracker’s analysis is driving a new wave of engagement which targets the fundamentals of a company’s business model. Engagement doesn’t happen overnight, and it has already prompted lengthy responses from Shell and Exxon, bringing the debate out into the open, and exposing their assumptions on future demand and emissions levels. It has also set up an interesting competition between fossil fuels for the remaining carbon budget, with oil and gas companies pointing the finger at the coal industry as most exposed.
Conducting our research on the current status of the thermal coal industry showed us the perilous financial situation it is in. Given the growing consensus that the seaborne thermal coal market is facing structural decline, it is clear several producers are gambling on an upturn in the market that may never come. If companies continue to be in denial about future demand and price risks, then investors may well decide to exit.
For these reasons, we believe that a dual approach must be taken. In addition to the divestment movement raising the issue, we must grow and sharpen our efforts to engage shareholders and stakeholders backed by both a strong divestment movement and detailed financial analysis.
It appears to us that divestment is the bait and engagement is the fishing rod – divestment is vital in hooking people’s attention, and the engagement tools and analysis is essential to reel the capex in. Investors and NGOs now need to have the patience to catch enough fish.
