Increasingly conscious of the risks of climate change, investors are telling companies to abandon carbon-emitting activities or face the consequences of investment being withdrawn
DIVESTMENT
Institutional investors are pulling funding from companies that fail to align their activities with climate change mitigation
INVESTMENT
Goldman Sachs expects renewable power projects to become the largest area of institutional energy spending in 2021, surpassing oil and gas
KEY QUOTE
Renewable energy investments are delivering massively better returns than fossil fuels in the United States, the UK and Europe
In November 2020 a group of mostly European investors managing $5.6 trillion in assets urged 12 companies involved in the construction of the Vung Ang 2 coal-fired power plant in Vietnam to withdraw from the project. They argued that construction of a coal power station is inconsistent with the carbon emission reduction goals of the Paris accord. “We respectfully urge you to declare your decision not to be associated with or involved in Vung Ang 2, as we find the project to suffer from high climate-related, financial and reputational risks,” wrote the investors in an open letter to the companies, which include Japan’s Mitsubishi Corporation. Several of the companies in receipt of the letter responded by promising to not involve themselves in projects that establish coal power plants, says Eric Pedersen, head of sustainable investments at Finnish financial services group Nordea Asset Management, one of the letter’s signatories. “We do not want to invest in new coal projects that are potentially left stranded within a short period of time,” Pedersen says. “If they [the companies] had not been willing to engage in a dialogue, we would have eventually withdrawn our investments.” The Vung Ang case is just one of a number of examples of investors, driven by concerns over climate change and the risk it poses to their investments, exerting pressure on companies in which they hold a stake and removing funding when their environmental ambitions are no longer aligned with company activities.
DIVESTMENT TIMES
At both Nordea and Danish pension fund PKA divestment decisions are made by top level management and often in collaboration with other investors. Withdrawing from an investment, “Is what you do if you lose confidence in the dialogue,” says Pedersen. “You can’t win on all points every time, but as long as we sense there is a genuine commitment to progress from the companies, we want to have influence and push companies in a more sustainable direction.” According to James Mitchell from the Center for Climate-Aligned Finance—set up in 2020 by the American clean energy non-profit Rocky Mountain Institute in collaboration with banks Wells Fargo, Goldman Sachs, Bank of America and JP Morgan Chase—the increased investment pressure on companies is essentially risk management. “Many of these same investors are responding to broader stakeholder pressure. This is why we are beginning to see a much deeper integration of climate into investment strategies,” he says. UK think tank Carbon Tracker agrees. Its analysis indicates that companies within oil, gas and coal could lose around two-thirds of their value in the next 50 years, plummeting from around $39 trillion to $14 trillion. Increasing interest in clean energy is very much driven by the growing financial risks of being exposed to fossil fuels, says Carbon Tracker’s Mark Campanale. “The years of oil, coal and gas companies dictating price due to near monopoly control of transportation and power is without doubt going.” During 2020 the global oil sector wrote down nearly $200 billion of assets and even after the covid-19 pandemic, its longer-term vision is gloomy. “Pension funds exposed to the fossil fuel system in the coming decade will face a roller coaster ride of disruption, write-downs, financial instability and share price de-ratings as markets adjust,” Campanale says.
LOW RISK AND LONG TERM
In June 2020, PKA and another Danish pension fund, Pensam, together invested €161 million in construction of a 335 MW wind farm in Texas through a partnership with Finnish Energy fund Taaleri Energia, French energy developer and operator Akuo Energy and American investment firm BHE Renewable, part of Warren Buffett’s Berkshire Hathaway holding company. “The investment is expected to provide a stable return of 4-7% over a number of years. Clean energy is a lucrative market of qualified projects with low risk and long term returns,” says PKA CEO, Jon Johnsen. PKA has currently invested around $5 billion in green projects, which makes up around 10% of the pension fund’s total investment portfolio. By 2025, PKA aims to invest $8 billion in renewables. As of early 2021, PKA had invested $2.74 billion in eleven renewable energy assets, up from $905 million in just three assets five years ago. Meanwhile, in 2020 PKA divested from 20 coal companies and decided not to invest in companies that have more than 20% of their turnover from coal. PKA has, to date, blacklisted a total of 89 coal companies, 68 oil and gas companies and a car manufacturer due to a lack of climate action. PKA is not alone among European and US investors boosting their clean energy portfolios and turning their backs on fossil fuels. US investment bank Goldman Sachs described 2020 as a, “Year of record shareholder engagement on climate change.” It expects renewable power projects to become the largest area of energy spending in 2021 among investment firms, surpassing gas and upstream oil for the first time in history. The International Energy Agency (IEA), an intergovernmental organisation, is tracking the trend. It says the volume of renewables capacity up for auction from January to October 2020 was 15% higher than for the same period last year and amounts to a new record total. “Investor appetite for renewables remains strong,” says the IEA, despite the economic uncertainties caused by the covid-19 crisis. “A number of investors have also started setting emissions targets for their whole portfolios and for specific asset classes. Additionally, we have seen the introduction of engagement targets and transition finance targets. This is definitely accelerating the energy transition,” says Mitchell. The claim is supported by Campanale, who believes that 2020 was only a taster for how investors will radically change the energy sector the coming years. “The costs of renewables have collapsed and this has disrupted the business as usual. Global climate ambitions, new regulatory policies and the huge losses we have seen within the fossil fuel sector will only advance clean energy investments further,” he says.
HIGHER RETURNS FOR LESS RISK
Research released in October 2020, by Imperial College London and the IEA, analysed stock market data to determine the rate of return on energy investments over a five- and ten-year period. It concluded that renewable energy investments are delivering massively better returns than fossil fuels in the United States, the UK and Europe. In Germany and France green energy investments yielded returns of 178.2% versus a -20.7% loss for fossil fuel investments, according to the study. In the US, renewables generated 200.3% returns compared to 97.2% for fossil fuels. Clean energy has gone from being a high-risk investment to low risk. According to Goldman Sachs, for renewables the so-called hurdle rates—a measure of risk based on the minimum acceptable rate of return on a project—are currently lying around 3-5% whereas fossil fuel projects are in the riskier 10-20% range. “Wind and solar have become sound and sensible investments. Their climate effect is well-known, the technologies are tested, they are easy to trade afterwards and there are projects in safe markets,” says Jens Pultz Pedersen, director of sustainability at professional services firm PwC Denmark. UK-based investor Octopus Renewables found that more than half of global institutional investors point to stable and reliable cash flow as a reason to invest in renewables, while 48% cite the sector’s long-term yield outlook. PKA’s CEO Johnsen considers the investment in the Texan wind farm more as a bond because the project has a lifespan of up to 30 years. “We can expect payment for the electricity produced and can count on stable earnings,” Johnsen says.
COLLECTIVE PRESSURE
At the beginning of 2020, US-based BlackRock, the world’s largest asset management company, said it would divest its holdings in the thermal coal sector and issued a threat to dump CEOs who fail to act on the financial risks posed by climate change. In October 2020, it identified 244 companies making insufficient progress integrating climate risk into their business models or disclosures. BlackRock took voting action against 53 and put the remaining 191 companies “on watch”. In his increasingly influential annual letter to CEOs, in 2021 BlackRock CEO Larry Fink said those firms that were not adapting to a net-zero strategy would lose the confidence of their stakeholders. A gap still exists, however, between investor expectations and demand for clean energy investments if the world is to meet its carbon emission reduction targets. Octopus Renewables found that globally, institutional investors expect to increase their share of renewables from 4.2% currently to 8.3% of their combined portfolio within the next five years and 10.8% in the next decade. “Despite the growing interest, there is still a long way to go. Especially when it comes to investments in more risky markets and less tested technologies. From 2003 to 2007 clean technology venture capital investments generated significant risks and some investors don’t forget easily,” says Carbon Tracker’s Campanale.
BOOMING MARKETS
As economies with the highest carbon emissions, such as the United States, China, Japan, South Korea, and the European Union, ratchet up their CO2 reduction commitments, they also breed confidence in the market for clean energy investments. “There is no doubt that the latest policy initiatives in several countries are creating new market opportunities and making clean investments even more interesting,” says PKA’s Johnsen, adding there is a growing competition with an increasing number of investors on the lookout for clean energy projects. “We used to have a lot of interesting potential investments in Europe, but in this market competition has really become intense. We are therefore looking increasingly towards the United States. It is a stable market and there are still several qualified and profitable projects,” he says. PKA is also talking with potential partners in Asia, including Taiwan and Japan. Today PKA has a low-risk strategy when it comes to clean energy investments and is primarily investing in solar and wind. Johnsen expects solar to be the main growth area over the next couple of years, but adds that PKA, noting the interest of major companies like Ørsted and Mærsk in so-called Power-to-X technologies that use renewables electricity to produce gas and in projects to store carbon emissions, are looking into these areas.
GREEN GOLD RUSH
With investor demand for green energy projects outpacing supply, appetite is growing for alternative, riskier energy investments. “Distributive power, battery storage, electrification and getting electrification to the end of the wire,” will all attract investor interest, says Campanale. Investments in clean heating solutions, alternatives to natural gas and water storage technologies are also set to grow in the next few years, he adds. Nordea is investing in clean energy projects globally as the volume of qualified projects grows, says Pedersen. The firm is also starting to look beyond solar and wind to find investments where the competition is less intense and where the potential returns may be higher. “We look broader than the classic wind farms in Europe. This is a must if we want to continue to grow our green investments,” he says, highlighting Nordea’s involvement in a Chinese energy efficiency software firm and another company that produces aircraft wings which could reduce fuel consumption. “Equity yields on plain vanilla renewables in OECD countries have been squeezed by so much capital chasing this space. It is no surprise that institutional investors are looking for emerging technologies or emerging markets to find better risk-adjusted returns,” says Mitchell from the Center for Climate-Aligned Finance. Areas such as US battery storage remain nascent markets. “There just aren’t yet enough operational gigawatt-scale portfolios on the market or developers mature enough to absorb a $100 million or $1 billion cheque,” adds Mitchell. “One route institutional investors have been taking is acquiring conventional renewables developers with strong pipelines of storage and solar-plus-storage.”
TEXT Anna Fenger