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Investors' new climate calculation: Engage or divest?

Climate change is changing the math associated with fossil fuel assets. But those trying to offload potential stranded assets now might be stuck with short-term losses.

The concept of stranded assets, as described in a 2011 analysis by Carbon Tracker, is straightforward: If we are to avoid the worst effects of climate change by limiting global temperature increases to no more than 2°C, then as much as 80% of the reserves already counted as assets by fossil fuel companies will have to stay in the ground.

If that calculation is indeed accurate, then investors would appear to be faced with two alternatives: divest, and move their assets into the renewable energy infrastructure that will replace current power generation; or engage, and somehow persuade fossil fuel companies to finance and operate that new infrastructure.

Addressing the problem of financing a clean energy infrastructure at a recent Environmental Finance event in London, James Cameron, the Chairman of Climate Change Capital, asked, “Who is going to do that work if it is not the European utilities?” Cameron noted that while financial institutions have taken the lead in acquiring clean energy assets, it seems unlikely that they will evolve into companies that will actually operate the infrastructure.

I previously wrote about the discussion, about the risk to investors of stranded assets, in the first part of this series. The roundtable continued as a debate over whether investors should engage or divest. During the second discussion, Cameron said, “I do not believe the answer is going to lie with the incumbents...No, you want solar companies out there that will absolutely cream them in the market.”

The issue, host Peter Cripps said, comes down to this: “Is it a question of rebalancing your portfolio, or using your power as an investor in that company, or both?”

“If the company is in the indices, then, from a fiduciary perspective, if we are not mandated to divest on ethical or moral grounds we have to have a really strong conviction that these assets will become stranded,” Cathrine de Coninck-Lopez, the sustainable and responsible investment officer at Threadneedle Investments, said. “So engagement is possibly the easier approach.”

In the US thus far, the issue of stranded assets has received the most intention through the growing divestment movement, which has spread from college campuses to foundations and religious organizations. On the engagement side, ExxonMobil responded to a shareowner resolution co-filed by As You Sow by agreeing to produce what turned out to be an inadequate report on the risks of stranded assets.

Overall, however, according to Kate Brett of Mercer Investments, very few mainstream institutional investors are yet addressing the issue of stranded assets. At least in part, this may be due to what Cameron described as “the power of the incumbents.”

“They dominate our psychology, they make us think there is no future without them, they make us think we will have to wait ten years, 20 years when we cannot,” he said. “It is a fantasy, we cannot.”

Fortunately for those who believe as Cameron does—that to delay for decades the transition to a low-carbon economy would be disastrous—the analysis provided by CTI in its 2011 report, as well as the series of analyses the organization has produced since then, focus on financial risks. Several of the roundtable participants noted that issues raised by CTI that once were discussed only in private conversations with select analysts have now become public information.

“Some of the companies we have spoken to are saying, ‘A year ago we did not have to talk about break-even prices and capex allocation; that was a private debate we had with a few analysts. Now it is a public debate; we have to publish long reports, discuss it in the media or discuss it with shareholders,’” James Leaton of CTI said.

As formerly private information becomes mainstream knowledge, “I do see some people who have just become fund managers and they want to tweak their model with a range of different things, such as social and qualitative indicators,” Schroders analyst Solange Le Jeune said. “I mean that a new generation of analysts and investors is starting to look at valuation models differently.”

“You tend to think that the economy is always going to grow, the market is always right,” Miguel Santisteve of NASDAQ said. “Even though there are so many facts out there telling you otherwise, in terms of human population, arable land, access to water, scarcity of resources. It is obvious and in front of you: we need to change the economic model.”

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