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Investment Funds Divested From Fossil Fuels "Will Perform Better"

David Thorpe's picture

Writer for Energy Post, The Fifth Estate, author of Earthscan Expert Guides to Solar Technology, Sustainable Home Refurbishment, Energy Management for Buildings and Industry, The One Planet...

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  • Jul 17, 2013 12:00 am GMT

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Lord Nicholas Stern
The author of the influential Stern Review on the Economics of Climate Change is also calling for Europe to decarbonise the power sector by the 2030s.


Research by leading investment and asset management firm has shown that fund managers divesting fossil fuels from their portfolios, and replacing them with an actively managed portfolio of renewable energy and energy efficiency stocks, will reduce risk and achieve positive financial benefits.

The conclusion will support a call issued last Friday by Lord Nicholas Stern for Europe to “re-ignite growth by investing in the transition to a low carbon economy”.

The author of the influential Stern Review on the Economics of Climate Change, said in his statement that “low-carbon growth is the only credible medium-term growth strategy” and called for a European goal of decarbonising the power sector by the 2030s.

Pressure is building on institutional investors to assess their exposure to companies that extract fossil fuels, as concerns rise about the likely effects on the climate from greenhouse gas emissions.

In parallel, financial analysts are increasingly warning investors of the risks that tighter regulations on carbon dioxide emissions and falling demand for fossil fuels could make fossil fuel reserves substantially less valuable, or even ‘stranded’, and ultimately rendered worthless.

Impax Asset Management, which won the Sustainable Investor of the Year accolade at the FT/IFC Sustainable Finance Awards last month, has assessed the relative performance over the last seven years, in terms of returns and volatility, of four alternative portfolio structures.

Its analysis of the historical data found that, over the past seven years, eliminating the fossil fuel sector from a global benchmark index would actually have had a small positive return effect.

Furthermore, much of the economic effect of excluding fossil fuel stocks could have been replicated with ‘fossil free’ energy portfolios consisting of energy efficiency and renewable energy stocks, with limited additional tracking error and improved returns.

The four alternative scenarios were:

a completely fossil free portfolio: based on the MSCI (formerly Morgan Stanley Capital International) World Index without the fossil fuel energy sector;

fossil free plus alternative energy ‘passive’ portfolio: replacing the fossil fuel stocks of the MSCI World Index with a passive allocation to renewable energy and energy efficiency stocks;

fossil free plus alternative energy ‘active’ portfolio: as [2] but actively managing the portfolio;

fossil free plus environmental opportunities ‘active’ portfolio: as [2] but actively managing a portfolio of stocks selected from a wider range of resource optimisation and environmental investment opportunities.

The best performing alternative was [3]. As a result, the company believes that investors should consider reorienting their portfolios towards low carbon energy by replacing fossil fuel stocks with energy efficiency and renewable energy investments.

The announcement follows news last week of two more financial institutions, Storebrand and Rabobank, divesting from fossil fuels.

Awarding the Sustainable Investor of the Year to Impax in June, Martin Dickson, US Managing Editor of the Financial Times and co-chair of the Sustainable Finance Awards judging panel, said: “The world faces not only persistent economic uncertainty but also unparalleled resource constraints that are putting pressure on social systems across both developed and emerging markets. This situation makes sustainable investment, and these awards, even more relevant.”

Managers of college endowments and municipal and state pension funds are increasingly finding themselves the target of fossil fuel divestment campaigns from within US universities, similar to the calls for divestment of stocks of companies that supported apartheid in the 1980s.

The Fossil Free campaign maintains that it is “morally wrong to profit by investing in companies that are causing the climate crisis”.

Independently, mainstream analysts are now building on research from the Carbon Tracker Initiative, which has warned that regulations to limit carbon emissions could significantly impact the market value of fossil energy companies as it becomes uneconomic to extract their reserves.

It calculates that 80% of the world’s proven fossil fuel reserves cannot be consumed without exceeding the international target to keep global warming to within 2°C above pre-industrial levels, implying that the world’s listed fossil fuel companies, whose share prices are partly based on their proven reserves, are grossly overvalued.

These mainstream analysts include:

HSBC, whose oil and gas analysts warned that European energy companies could see their market capitalisation fall 40-60% if oil prices drop to $50/barrel, as a consequence of climate policies commensurate with the 2°C goal;

Citi, which examined the value at risk from climate policies among Australian extractive companies within the ASX200 index;

Standard & Poor’s, which predicted that smaller oil companies, especially those heavily exposed to high-cost unconventional oil production, could face credit downgrades within a few years under its ‘stressed’ carbon reduction scenario;

and Aviva Investors, Bunge, Climate Change Capital and HSBC, which are funding research at Oxford University’s Smith School of Enterprise & Environment into risks posed to investors by high-carbon stranded assets.

The Impax report concludes: “Given the growing consensus around climate change science, it is rational for investors to expect much tighter carbon regulation, with profound economic effects, in many regions of the world. These regulations … are only moving in one direction: towards a lower carbon world.”

Picture from Wikimedia
caption: The author of the influential Stern Review on the Economics of Climate Change is also calling for Europe to decarbonise the power sector by the 2030s.

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Elias Hinckley's picture
Elias Hinckley on Jul 17, 2013

Makes sense, even if it’s just to de-risk a portfolio from the growing policy risk overhang that a shifting global dialogue on climate change is accelerating. Interesting to see how this plays out, as there is of course a balancing point where enough investment exits that even with the policy risk adjustment the returns work (but I think a lot of money moves before we get there).  World is definitely changing. 

Elias Hinckley's picture
Elias Hinckley on Jul 17, 2013

Those policy tools are being used to correct an inefficiency in energy markets – emissions are not accurately priced (there is no natural way to do it without a policy tool), so whether that is in the form of an additional tariff for the emitting source or a taxpayer funded support for an alternative the expectation is that the market inefficiency – free emissions – is going to be corrected and that correction will dramatically impact asset values.

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