The transition from a fossil fuel-based economy to one powered by renewable energy fast enough to stop runaway climate change can only be achieved by action from everybody in society. In a three-part series we examine the roles to be played by governments, business and investors, and civil society to ensure timely and effective action. This week the spotlight is on business and investors.
Change:
Businesses and investors should lead the transition to a clean energy economy, not simply wait for policy signals. This will benefit the climate and their bottom line
Missing link:
Investors need energy projects that make financial sense in order to employ their capital to good effect. Better market monitoring is vital to demonstrate that pledges to decarbonise and divest fossil fuel assets are being fulfilled and are driving wider change
Key quote:
“The acceleration of finance put into the transition needs to happen urgently. There needs to be $7 trillion a year between now and 2030 to stay on track. Private investors are trying to transition their portfolios, but there is not enough out there to invest in.”
Business is playing a well known role in the transition to a low carbon economy. It leads research and development, drives innovation and deploys capital to best effect. But it has another role, too. David Hone, chief climate change advisor at Shell, says it is also important for business to step up and take the lead rather than simply reacting to government proposals. He believes this is starting to happen with certain companies calling for carbon pricing, for example. In response to US President Donald Trump’s decision to leave the Paris climate agreement, more than 2000 businesses signed the “We Are Still In” declaration, showing their commitment to the deal. Power firm PG&E, Royal Caribbean Cruises, Allianz, Amazon, PayPal and Walmart are among the signatories. Recent years have seen an increase in campaigns that encourage business to divest fossil fuel assets and a push towards greater climate risk disclosure. “There is real value and effectiveness in raising overall business and investor awareness of climate change,” says Nat Keohane, Washington, DC-based senior vice-president at Environmental Defense Fund (EDF), a not-for-profit organisation. Divestment campaigns have elevated the issue in boardrooms, but Keohane is unconvinced they are changing capital flows. In the run up to the 2015 UN climate talks, institutional investors pledged to decarbonise billions of assets under their management and redirect capital to cleaner investments, with an array of pledges made at a special UN summit of world leaders in September 2014. While tracking of these individual pledges has been scarce, analysis by think tank Climate Policy Initiative, for its Global Climate Finance: An Updated View 2018 report, found that climate finance flows are steadily increasing. It estimates that 2017 saw $510-530 billion worldwide in capital directed at clean investments. Renewable energy and electric vehicles were the main beneficiaries, while private sector actors accounted for just over half of all climate investment. Of the contributions from public sector finance, the report says that 89% came from development finance institutions, primarily via national development banks. 
Unclear divestment results
The picture is murkier for divestment monitoring. The Portfolio Decarbonization Coalition (PDC) was formed at the 2014 UN climate summit by the United Nations Environment Programme’s Finance Initiative, the UK-based Carbon Disclosure Project, Swedish pension fund AP4 and asset manager Amundi. Its latest report from December 2017 offers information about progress by its 32 members, which represent more than $800 billion in assets under management to be decarbonised. But the data supplied varies from member to member, making it impossible to make comparisons, and fails to include analysis of the wider geopolitical or policy contexts. The report recognises these lacuna. “There is limited information on how the portfolio decarbonisation efforts of PDC signatories are affecting the real economy, as measured by, for example, changes in greenhouse gas (GHG) emissions, changes in the GHG-intensity of economic activity, the diversion of financial flows in the real economy, or changes in the share price of high emitting or high impact companies,” it states. “That summit was great, in a sense — all of [the pledges] helped create momentum that got us over the line in Paris,” says Anthony Hobley, co-chairman of the board that advises the Carbon Tracker Initiative (CTI). “But has anyone greened their portfolios? Maybe at the edges.” Hobley credits CTI’s work on divestment with helping to raise awareness of climate risk in the financial sector. “The way we have helped to reframe this with the stranded assets narrative, the carbon bubble narrative — this is not just a nice story, you can show it in the numbers,” he argues. He cites CTI’s Powering Down Coal report from late 2018, which estimates that 42% of the world’s coal-fired plants were unprofitable in 2018, ramping up to 72% by 2040 on the back of falling renewable energy costs, policies targeting air pollution and carbon pricing. “The reality we are seeing is that clean technologies are cost competitive, if not cheaper, than fossil fuels,” Hobley says. This is weighing on the equity values of utilities, he adds, pointing to the declining values of European utilities over the past decade. “This idea of economic tipping points is important — if you look at previous technology changes, what typically follows an economic tipping point is a political one,” he says. “People are realising that this is happening with energy now.” It is disrupting the old paradigm of needing policies to support clean technology.
Climate risk disclosure
Another “d” which has risen up the agenda in the finance community is climate risk disclosure, described as “absolutely fundamental” by Jon Williams, a partner at consultancy PwC, who is a member of the Task Force on Climate-related Financial Disclosures (TCFD) operated by the Financial Stability Board, a creature of the 2009 G20 summit. “Unless people providing the investment know the risk, it is hard to price that capital correctly.” Williams acknowledges that disclosing climate risk is by no means a new concept, but says the TCFD has tried to standardise the what and how. He believes that disclosure will help drive the transition by empowering investors to say: “You have that risk and unless you act on it, we may have to move our capital.” But he admits this is a transition process. “We’re not expecting everyone to do it in year one,” says Williams. “I would like to think that once people have the information and analyse what it means for the value of their investment, they take action.” As of June 2019, 792 organisations had signed on as supporters of the TCFD, ranging from financial services firms, businesses with climate risk liabilities and industry associations. Williams estimates that the financial institution supporters represent some $110 trillion of assets. “If those companies actually act on the commitments they have made, it will be incredibly powerful,” he says. In its second status report, the TCFD notes that 340 investors, with $34 trillion of assets under management, have come together under the Climate Action 100+ coalition to call on the largest corporate emitters to strengthen their climate disclosures as proof of investor demand for increased information. Hobley welcomes the TCFD’s work, He calls it, “A fundamental shift, as most climate disclosure has always been backwards looking.” Yet climate risk is forward-looking and needs to tackle issues such as legal risks and fiduciary responsibilities. “[The TCFD recommendations] are a good starting point. How you operationalise [those] is what is next,” he says. “There is growing recognition that climate change is a systemic risk,” says Erwin Jackson, policy director at the Investor Group on Climate Change in Australia. Company boards need to develop climate risk plans and decisions about how investors should respond to entities that do not manage their exposure. “This goes beyond disclosure, it goes to how a company pivots to a low emissions world,” says Jackson. One firm reviewing how its targets for investment manage their climate risk is Legal & General Investment Management, which has £1 trillion of assets under management. Over the past year, it has divested from 11 firms for climate inaction, including ExxonMobil. Institutional investors are also taking a stand: Norway’s sovereign pension fund is ditching fossil fuel investments from its portfolio — a bit rich, say some, given where its funding has come from. Williams says, however, that the focus on divestment misses an important piece: that there is a buyer on the other side of the transaction and the company still ultimately retains the investment. “I much prefer engagement,” he says. 
Investment and engagement
“The potential game-changer is investment,” says Hobley. He cites the Climate Action 100+ coalition as a good example of engagement in action. In its mission, signatories state that they are aware of the risks climate change poses to their portfolios and values and that they support the low-carbon transition. “There is more and more evidence that those which have greened their portfolios have had great returns,” says Hobley. “Is it mainstream? Not yet. Is it about to be mainstream? All the signs are that it is set to be.” The ability to making a decent return is important as EDF’s Keohane highlights. “If we are really going to change how capital is deployed, we need to have people who are finding ways to make money by identifying material risks and investing accordingly,” he says. “Green finance, or funding of systems transition, needs to accelerate,” says Wendy Miles, a partner at Debevoise & Plimpton. “Some figures estimate around $7 trillion a year between now and 2030 to stay on track … to get to the $7 trillion, every $1 from a sovereign or development fund needs another $30 from private investment.” She adds: “Private investors are trying to transition their portfolios, but there is not enough out there to invest in.” Part of the problem is that while the Nationally Determined Contributions (NDCs) put forward by governments under the aegis of the Paris agreement lay out the steps each country will take to reduce emissions, they do not translate well for investors, Miles says. “We need to find a way to translate NDCs into investment proposals that investment committees can find acceptable in terms of their key performance indicators,” she states. The flip side is that governments need a legal framework to enable climate finance flows and “international uniformity on market mechanisms” under the Paris agreement, she adds. “You have to price carbon to have any influence on demand. The transition is primarily demand-driven.” Shell’s Hone says: “Businesses are designed to respond to the market.” For Williams, “regulations and pricing are what will have the greatest impact on the transition”, agreeing that the Paris agreement, once fully implemented, will help deliver the first part. As for pricing, he cites how the falling value of coal is affecting the creditworthiness of mining firms, causing investors to pull their capital. Elena Giannakopoulou at BloombergNEF in London says the introduction of policies in countries such as the UK, Canada and France to phase out coal is also having an impact, while a moratorium on coal in China in 2016 reportedly wiped out half of its coal pipeline. “It is a combination of policies and financial institutions which do not want to be exposed to risky investments,” she says, both in terms of market risk and reputation. 
Shareholder activism
The next challenge is oil and gas, which Hobley says still accounts for a large share of investment portfolios. In a February 2019 report, CTI looked at 40 oil and gas firms around the world and found that 92% incentivised increased reserves growth or production, or both. Shareholder activism is leading to a slow shift, amid a growing number of shareholder resolutions on climate change. In early July 2019, mining giant BHP was reported to be pulling out of thermal coal, following the lead of competitor Rio Tinto. ExxonMobil, Shell, BP and Chevron have all seen shareholders raise climate change at AGMs in recent years, with varying degrees of success. Shell has agreed to tie emissions cuts to executive pay subject to a vote on a revised remuneration policy at its 2020 AGM, while BP’s shareholders overwhelmingly voted for the firm to align its business strategy with the Paris agreement’s goals. Shell has also pledged to invest $300 million in nature-based climate solutions such as wetlands and reforestation to act as carbon sinks. This accounts for a mere 1% of its 2018 income. Overall, the oil major is aiming to reduce its net carbon footprint by 2-3% by 2022. Williams cites Shell’s plans as an example of how some firms are taking steps to mitigate their climate impact. “That is a company in transition,” he says, but warns that time is of the essence. “If we only have 12 years left [to avert catastrophic climate change], we do not have the time for people to have five years to think about it,” he says.
TEXT
Katie Kouchakji