The Future of Risk: Energy

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Divestment:
the decarbonisation imperative opportunities


Our Experts

Jennifer O’Neill
Senior Investment Consultant Global
Investment Practice
+44.131.456.3034

Geri McMahon
Principal
UK Responsible Investment
+44.207.086.1036

Mark Jeavons
Senior Investment Consultant
UK Retirement Solutions
+44.207.086.9563

"If the world is to meet the Paris Agreement’s commitments to limit global temperature increases to 1.5 C, approximately 80% of oil and gas reserves – valued at USD 900 billion - would necessarily be stranded."

In light of the science and rising levels of public and political pressure, divestment away from energy is gaining ground and it is apparent that the pace has quickened since the Paris Agreement of 2015.

There is now a clear imperative to ‘green’ the financial system and this push is increasingly evident in the questions being asked by investors - and pension scheme trustees in particular - when it comes to the make-up of their investment portfolio.

Pension funds and other institutional investors are now looking to quantify, understand and mitigate their exposure to climate risk and – in varying, but growing, degrees – are starting to divest away from those industries with a significant carbon footprint.

Some organisations have publicly committed to full divestment away from energy. Others have done so partially and away from more polluting areas, such as tar sands. A final group has carried out targeted divestment, while remaining shareholders of energy firms in order to constructively engage with the sector as it navigates the carbon transformation.

According to data from 350.org, an environmental organisation, institutions pledged to divest USD 11 trillion from fossil fuels – on a full or partial basis – in 2020. This is up from USD 52 billion in 2014 and forms part of a broader push away from areas such as defence, gambling and tobacco, which together total USD 20 trillion.

 

Environmental groups and faith-based organisations have led the divestment movement, but it has in recent years gained ground among local government and university endowment funds – and is even beginning to make headway in the corporate pension space.

Total value of assets divested between 2013-2020

Around 50% of university endowment funds have committed to some form of divestment and UNISON, the UK’s largest trade union with 1.4 million members, has also pushed local government pension funds to divest and more closely consider climate change issues within the portfolio.

Pension funds do however have a fiduciary responsibility to pursue maximum returns for pension contributors. As such, ethical considerations have tended to take a backseat, as their primary responsibility has been the pursuit of returns.

This is changing however, as governments grapple with what must be done to meet the Paris Agreement. Regulators are increasingly asking investors to explain what they are doing in their investment mix to tackle the challenge of climate change. Add in the potential for reputational risk linked to investment decisions, and pension funds are more closely considering the issue of climate change risk.

 
Implementation of TCFD by country

And from 2022, requirements under the Task Force on Climaterelated Financial Disclosures (TCFD) are set to become mandatory, obliging an increasing number of firms and large asset owners to share details with stakeholders regarding their financial exposure to climate change risk. It is apparent that the door is now open for more significant discussions around the issue of climate change risk and divestment.

Adoption of its principles vary, but the FSB Task Force on Climate-related Financial Disclosures (TCFD) will develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders.

Source: CISL (2018)

 

“According to data from the TPI, the energy sector is also falling behind others in its response to the Paris Agreement. Of the 50 energy firms considered by the TPI, 39 were not aligned with the Paris Agreement, 9 had not made disclosures and only 2 had committed to the Paris Pledges, putting the sector well behind other carbon-intensive industries.”

Constructive divestment

Within the divestment movement, there are groups that are taking a more constructive approach to the climate challenge.

Other pressure groups, such as the Transition Pathway Initiative (TPI), are focused on encouraging industries to sign-up to decarbonisation. A significant strand of the initiative is looking at global oil subsidies and financial support, from both governments and banks. Global energy subsidies are significant and the TPI is putting pressure on governments and financial institutions not to fund new oil and gas projects. This could see further sources of financial support for the sector dry up.

The Church Commissioners in the UK, which manages a USD 10.3 billion investment fund, are shareholders in ExxonMobil for example. Rather than comprehensive divestment, they have instead opted for partial divestment and investor activism that is pushing the firm to engage with the issue of climate change.

Other pressure groups, such as the Transition Pathway Initiative (TPI), are focused on encouraging industry to sign-up to decarbonisation. A significant strand of the initiative is looking at global oil subsidies and financial support, from both governments and banks. Global energy subsidies are significant and the TPI is putting pressure on governments and financial institutions not to fund new oil and gas projects. This could see further sources of financial support for the sector dry up.

According to data from the TPI, the energy sector is also falling behind others in its response to the Paris Agreement. Of the 50 energy firms considered by the TPI, 39 were not aligned with the Paris Agreement, 9 had not made disclosures and only 2 had committed to the Paris Pledges, putting the sector well behind other carbon intensive industries. As such, it seems highly likely that energy will continue to be a target for divestment and pressure on subsidies and financial support.

Fortunately, there are alternatives to rising divestment. Perhaps the most obvious answer for energy firms is a search for combinations with the power sector and an increase in renewables. Typically, firms with greener credentials are less of a target for divestment, but they do need to pay more than lip service to decarbonisation in the face of possible shareholder activism.

Investors are looking for firms to decarbonise, but also to diversify their income streams. Alternatives such as hydrogen and renewables will do exactly that and there is an opportunity for existing energy infrastructure – such as using petrol station forecourts as electric car charging points or converting LNG facilities to carry hydrogen – to propel the decarbonisation agenda forward.

Divestment pathways
5 years

Rising levels of divestment are apparent across Europe, making it increasingly challenging for energy firms – particularly those at the carbon-intensive end of the spectrum - to source capital.

10 years

By 2030, government will need to reflect on commitments made in Paris and milestones reached. It is likely that there will be an acceleration in climate policy, as governments seek to set global temperatures on the right path. This will lead to greater pressure to divest, ‘green’ the system and meet climate change targets.

25 years

It is likely that we will begin to experience more severe impacts from climate change if we remain on the current 3C pathway, forcing firms to consider the material financial impact of climate change on their balance sheet.

Divestment – an energy perspective

“Over the coming two decades the old oil majors will inevitably evolve into companies containing a mixture of refineries, petrochemical, exploration and production, and power assets. This will see smaller firms combining to pursue common projects, and cash-rich sections of the energy-power industry building out a broad portfolio of mixed production.”



Our Expert

Our Expert
Henric Gard
Head of EMEA Energy
+46.8.697.4811

The divestment challenge has certainly begun to open the eyes of energy firms, particularly those that are publicly-listed. Pressure has led firms to pay increasing attention to sustainability and encouraged increasing investment in green technology.

Energy firms realise that if they don’t invest in cleaning equipment, carbon capture, renewables and an emphasis on more environmentally-friendly forms of fuel, they will be forced to do so by investor activism, and regulatory or public pressure - and they would rather do so willingly, than be forced.

And while it unlikely the divestment movement will result in a wholesale move away from oil and gas, firms will be increasingly looking to green their portfolio and explore synergies with power and alternatives - such as hydrogen - to head-off divestment pressure.

Over the coming two decades the old oil majors will inevitably evolve into companies containing a mixture of refineries, petrochemical, exploration and production, and power assets. This will see smaller firms combining to pursue common projects, and cash-rich sections of the energy-power industry building out a broad portfolio of mixed production. By doing so, they can diversify their sources of supply, pep-up their return on equity, stave-off divestment and green their portfolio.

Against this backdrop however, there will remain the economic imperative to support future energy projects – be they new-builds or upgrades – as energy demand continues to increase globally. It seems likely that COVID-19 and future economic downturns will still trump immediate environmental concerns.

A major north European steel producer with a significant carbon footprint has managed to secure investment and partnerships by aiming to produce fossil-free steel by the late 2020s. Energy firms are taking note, and some are considering how they can bring green investors on board in order to increase capital availability through green investments, acquisitions and technology.

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