Investors will play an increasingly important role in getting energy companies to ditch fossil fuels in favour of renewables and energy efficiency in line with the Paris climate agreement, says Ingrid Holmes, Head of Policy and Advocacy at Hermes Investment Management. This will also help companies manoeuvre their businesses onto more sustainable footings and away from the tyranny of short-term returns

The Intergovernmental Panel on Climate Change (IPCC) special report on the impacts of 1.5°C global warming above pre-industrial levels indicates that the risks facing society from temperature increases of 2°C are more severe than previously thought. Moreover, the report highlights that for the 1.5°C target to be feasible, collective action to reduce emissions cannot be delayed any longer, action is needed now. This will require rapid and far-reaching transitions in energy, land, buildings, transport and industrial systems. The transitions needed will be unprecedented in terms of scale, implying deep emissions reductions in every sector, a wide portfolio of mitigation choices and a significant upscaling of investments in those options. The Paris climate change agreement committed its signatories to hold the increase in the global average temperature to well below 2°C above pre-industrial levels and called on them to endeavour to limit the rise to 1.5°C. This ground-breaking agreement has since been ratified by 181 countries. Investors played a key role in securing the global political support needed to get the agreement over the line and they will play an integral role, along with other stakeholders, in ensuring the targets are delivered. For the 1.5°C target to remain in reach, it is imperative that global emissions start to decline by 2020. Progress in energy markets will be key since decarbonising the energy supply will unlock the opportunity to decarbonise other major emitting sectors including transport and industrials. Energy markets are already adapting and the economics of energy are now materially shifting in favour of clean energy solutions. According to research by Carbon Tracker, a UK think-tank, in its Mind the Gap report, over half of the operating coal capacity in Europe had a negative cash flow in 2017. We are starting to see investors, companies and consumers take note of the value-add and benefits clean energy solutions can provide. In September 2018, on the back of higher carbon prices, wind and solar become cost competitive with existing coal and gas prices in Germany. DONG Energy made the transformation from an oil and gas industry leader to a clean energy company in 2017, renaming itself Ørsted in the process. Scottish Power has now followed suit, becoming the second major European energy company to exit fossil fuels. Governments are also responding with more ambitious climate and energy policies with the aim of creating wider, long-term societal benefits, including improved air quality, increased energy security and high quality jobs, thereby creating a virtuous circle and transition momentum. Concerns regarding air quality and its impact on public health is likely to further propel policies and policy makers in the near term to limit the use of fossil fuels in cities and urban areas.

Climate Action 100+

Investor-led initiatives, such Climate Action 100+, of which Hermes is a member, will play a key role in advocating that other major energy firms take immediate action and follow the examples set by Ørsted and Scottish Power to keep the 1.5°C target in sight. In 2017, Climate Action 100+ launched a five year initiative via which investors will engage with systemically important greenhouse gas emitters and other companies across the global economy that have significant opportunities to drive the clean energy transition and help achieve the goals of the Paris agreement. These investors are calling on companies to improve governance on climate change, curb emissions and strengthen climate-related financial disclosures. This means that investors in active, high-level engagements with companies should encourage those firms to integrate sustainability, climate and wider environmental, social and governance concerns into their business strategies and capital expenditure planning. In return, investors can agree to align their expectations on financial returns and the capital allocation time-frame, which has been laid out by companies. Essentially, this gives executives and boards room to manoeuvre their businesses onto a more sustainable footing and away from the tyranny of short-term returns. There are a number of strategically important energy companies that will require greater engagement over the course of the coming years on these very issues. It is likely there will be a greater number of shareholder resolutions that challenge energy companies in the upcoming AGM season. These should focus on pushing companies to take climate change seriously and establish robust strategic responses to transition to Paris agreement aligned business models. These companies and their peers must now position themselves to play an active role in ensuring an orderly and just transition to a low carbon economy, and should involve making concrete commitments to eliminate carbon emissions from their asset base in line with the imperatives set out in the IPCC report. With increasing expectations on investors to step up action on climate change, such as through the European Commission’s sustainable finance package, which is currently making its way through the legislative process, the pressure will only increase to make significant changes to safeguard the future of our society and environment for generations to come. The views and opinions contained herein are those of the authors and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.

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