Don’t get stranded by climate change
After decades of debate and denial in the public arena, there is now an almost unanimous consensus that humans are warming the Earth’s climate.
Almost every climate scientist is now on board – a 2021 review1 of scientific literature by academics at Cornell University in the US concluded that there is now “greater than 99% consensus” amongst scientists that global warming is being accelerated by human activity. The United Nation’s Intergovernmental Panel on Climate Change (IPCC) has published a report that stretches to over 4000 pages of evidence from thousands of scientific sources, concluding that “it is unequivocal that human influence has warmed the atmosphere, ocean and land”2.
Global leaders have recognised this, too. Although the recent 2021 COP26 meeting3 in Glasgow disappointed some observers by not taking more drastic steps to solve climate issues, the conference formally expressed “alarm and utmost concern” at the impact of human activities on climate change. Immediately after COP26, we spoke to Hannah Simons, Head of Sustainability Strategy at Schroders and we discussed what COP26 achieved, and of course what it didn’t. Listen to our interview here.
There are now significant efforts underway to limit the impact of climate change on the planet. The COP26 meeting confirmed a desire to limit temperature increases to 1.5oC above ‘pre-industrial’ levels, and reached a number of encouraging agreements: government fossil fuel subsidies are to be phased-out; coal power is to be phased-down around the world; there will be strengthening of markets for carbon emissions; and many countries enhanced their emissions commitments, with over 90% of the world (as measured by GDP) now covered by ‘net zero’ commitments4.
These efforts will change the investing world forever. By 2023, developed countries expect to channel $100bn a year into climate solutions for developing countries5. This will include both public and private money – governments cannot do the work alone here – and regulators around the world are now supporting investors to make informed investment decisions with respect to climate change. At an international level, a new International Sustainability Standards Board6 will set minimum standards on climate disclosures for companies, to better promote climate-friendly capital flows.
In the UK, ‘ESG investing’ continues to grow rapidly7. It is now set to become more transparent, too; the Financial Conduct Authority ('FCA') is consulting with the investment industry around a new labelling system for funds, to foster meaningful and honest support of ESG investment strategies by private investors. Omnis fully supports the FCA's initiative. Omnis continues to work hard to ensure that its fund range is positioned transparently and with a minimum level of sustainability integrated into each fund’s investment processes.
Government programmes to mitigate climate disaster and influence investors are going full steam ahead:ow will this affect companies in investors’ portfolios?
The OECD8 warns that as policies change and ethical standards improve around the world to meet carbon goals, many companies will be left with ‘stranded assets’ – i.e. assets that cannot be recovered as planned. A common example of a stranded asset is oil reserves that will never be extracted (and therefore written-off) due to prohibitively high taxation, reduced demand, shareholder activism, or potential reputational damage. Venezuela, which is thought to have the largest proven reserves in the world9, may end up being a prime example of this – expert analysis of 104 global crude oil sources10 assessed Venezuelan oil as some of the most carbon-intensive to extract, which in time may lead to investors discounting the value of the oil to the point where there is no appetite to extract it. We must also remember though that demand for oil will continue for decades and that oil is also required to help the world transition to cleaner energy. A balance between moving forwards with cleaner energy production and the need for oil needs to be managed over the next few decades.
Technological and manufacturing capabilities can become stranded, too. The Wall Street Journal11 reported on a $1bn investment in 2019 by General Motors in an internal-combustion pickup truck facility, only to announce a year later that it would go “all-electric” within 15 years, with analysts accordingly expecting write-downs in the value of the new assets. Given current trends, examples are conceivable across every industry from central heating to cattle ranching to ‘fast fashion’.
In Jakarta, the capital of Indonesia (the world’s fourth most populous country12), climate projection models tell us that some assets will become stranded in a more literal sense. It is estimated that a combination of land subsidence and rising sea levels could make 95% of the city’s northern side uninhabitable within 30 years if action is not taken13.
Stranded assets do not have to be physical in nature. In a June 2021 report14, the European financial activist group Reclaim Finance highlights the significant reliance that banks have on fossil-fuel-linked financing on their balance sheets. They warn that as organisations respond to changing stakeholder demands and retreat from fossil-fuel-linked business, such banks will be left with deteriorating and hard-to-sell assets. Some governments may find themselves adrift from the capital markets, too – research from the International Monetary Fund15 suggests that nations with lower resilience to climate change may face higher borrowing costs.
Some fund managers will explicitly exclude those companies from their portfolios that have significant reliance on oil and gas assets. Others will spot the potential advantage that companies with leading practices may have over their rivals, such as a traditional fossil fuel distributor which diversifies into distributing cleaner fuels or building electric car charging points, with the hope of enjoying superior returns.
Others will carefully build climate-change-related risks into their risk modelling tools. For example, when assessing prospective equity investments, they may build scenario tests that estimate a given company’s value should carbon taxes rise or oil prices change significantly due to climate change. Perhaps more importantly, many fund managers, including those we work with at Omnis, will use their power as investors to drive climate change agendas in the companies they invest in. This is something we expect all our investment managers to do and to be able to demonstrate how they have voted and engaged on climate-related issues, amongst other ESG factors.
Whilst some of these approaches might drive ethically desirable outcomes, they are all also designed to improve financial returns for investors. In order to be successful, fund managers will have to carefully navigate these approaches, and others, and apply them in a world where responses to climate change are evolving rapidly.
1https://iopscience.iop.org/article/10.1088/1748-9326/ac2966 2https://www.ipcc.ch/report/ar6/wg1/downloads/report/IPCC_AR6_WGI_Full_Report.pdf page 5 3https://www.un.org/en/climatechange/cop26 4https://ukcop26.org/wp-content/uploads/2021/11/COP26-Presidency-Outcomes-The-Climate-Pact.pdf page 5 5https://ukcop26.org/wp-content/uploads/2021/11/COP26-Presidency-Outcomes-The-Climate-Pact.pdf page 5 6https://www.ifrs.org/groups/international-sustainability-standards-board/ 7https://esgclarity.com/sustainable-funds-see-highest-flows-across-categories/ 8https://www.oecd.org/finance/Financial-Markets-and-Climate-Transition-Opportunities-Challenges-and-Policy-Implications.pdf 9https://www.strausscenter.org/energy-and-security-project/venezuela/ 10https://www.spglobal.com/commodity-insights/en/market-insights/latest-news/oil/021522-infographic-chasing-the-lowest-carbon-crudes 11https://www.wsj.com/articles/trillions-in-assets-may-be-left-stranded-as-companies-address-climate-change-11637416980 12https://data.worldbank.org/indicator/SP.POP.TOTL 13https://www.weforum.org/agenda/2018/08/jakarta-world-fastest-sinking-city/ 14https://reclaimfinance.org/site/wp-content/uploads/2021/06/Report-Fossil-Assets-the-new-subprimes.pdf 15https://www.imf.org/-/media/Files/Publications/WP/2020/English/wpiea2020079-print-pdf.ashx
