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Should investors be thinking about climate change?

By Elena Berton

BlackRock won't divest all fossil fuel holdings in the overhaul of its investment strategy. But investments funds are gradually shifting away from fossil fuels

BlackRock, the world’s largest asset manager, is overhauling its investment strategy to focus on climate change in a move expected to accelerate the “green” investment decisions of other asset managers, pension funds and small investors.

“What will happen to the 30-year mortgage – a key building block of finance – if lenders can’t estimate the impact of climate risk over such a long timeline, and if there is no viable market for flood or fire insurance in impacted areas?” Larry Fink, BlackRock’s chairman and CEO, wrote in his annual letter to corporate executives.

Investors are increasingly facing up to these questions and recognising that climate risk is an investment risk, Fink concluded.

But does this mean the time has come for investors to sell all fossil-fuel holdings?

For starters, BlackRock isn’t pursuing an across-the-board divestment of energy companies that produce fossil fuels and isn’t even getting out of thermal coal investing, either.

Its discretionary active investment portfolios will sell out of all companies that get more than 25 per cent of sales from thermal coal, meaning that its holdings in diversified miners like Anglo American and BHP Group, which also rank among the largest coal producers, won’t be affected.

Phasing out coal investments

In his letter, however, Fink made the case for phasing out coal investments in the long term.

"With the acceleration of the global energy transition, we do not believe that the long-term economic or investment rationale justifies continued investment in thermal coal," he wrote.

Investors’ growing interest for sustainable investments reflects the move by lawmakers around the world to curb emissions, which will hit industry sectors that are too reliant on fossil fuels.

In their plans to make the economy less reliant on fossil fuels, some governments have shifted their attention to coal. A year ago, the German government unveiled plans to shut down all coal-fired power plants by 2038 at the latest and is in talks to offer utility RWE significant compensation to shut its coal plants.

UBS analysts think Europe could be the starting point for a global ban on fossil fuel capital spending.

Although restrictions on new fossil fuel investment are unlikely to be an overnight blanket ban, they would be enough to reduce cumulative fossil capex by about $10tn between now and 2050.

“We expect to see increasing legal and financing restrictions on fossil capex – taking effect more quickly than any moves towards a global carbon tax, and inevitably accelerating convergence of the energy and utilities sectors,” the analysts wrote.

Fossil fuel divesting unrealistic

But while in the long term investors should expect highly polluting fossil fuels will be phased out this century, the technology to replace them isn’t there yet.

"Under any scenario, the energy transition will still take decades. Despite recent rapid advances, the technology does not yet exist to cost-effectively replace many of today’s essential uses of hydrocarbons," Fink said in his letter.

BNP Paribas Asset Management, the investment management arm of the French bank, last year said it would stop investing in companies that obtain more than 10 per cent of their revenue from thermal coal.

But unlike many pension funds, sovereign wealth funds and universities that have sold their oil, gas and coal stocks, the French asset manager is keeping most of its energy holdings because divesting them now would be unrealistic.

"At a time when we cannot do without the oil industry, an alternative to divestment consists in actively supporting its transformation, particularly through shareholder engagement, and reserving exclusion for the worst forms of energy production such as coal and oil sands," it said.

Oil companies, which are responsible for 42 per cent of global emissions, have also come under pressure from shareholders and regulators to cut emissions or lose investors to companies with better environmental credentials.

In response, Spain’s Repsol last year became the first oil company to commit to net-zero emissions by 2050. It was followed by Norway’s Equinor with a plan to reduce the absolute greenhouse gas emissions from its operated offshore fields and onshore plants by 40 per by 2030 and 70 per cent by 2040 and to near zero by 2050.

Oil underperformance

While the oil and gas industry is responding to climate concerns and preparing for the looming energy transition, the longer-term return scenario may not be attractive anymore.

Blackrock manages around $7trn on behalf of investors. Of these, around $87 billion could still be linked to fossil fuels as of late 2019, according to data from shareholder intelligence firms Influence Map and Proxy Insight.

BlackRock's investments lost investors an estimated $90bn over the past decade "due largely to ignoring global climate risk," according to a report by the Institute for Energy Economics and Financial Analysis.

Around 75 per cent of these losses were the result of BlackRock's investment in just four companies — ExxonMobil, Chevron, Royal Dutch Shell and BP — which have "all underperformed the market in the past decade," IEEFA's report said.

There is also a growing appetite for “green investments” and their potential for better returns compared with fossil fuels.

A BlackRock spokesperson told the Financial Times that the existing portfolios that focus on the environment "are among our fastest-growing, which reflects clients choosing to move in that direction."

Green investments

Maarten Bloemen, portfolio manager and research analyst at Franklin Templeton Investments, said mainstream investment “wisdom” used to view any consideration of environmental, social and governance factors as irrelevant or even harmful to financial performance. However, this conventional wisdom is being turned on its head.

“The most important implication of global industrial and economic restructuring for investors is this: the entire basis of corporate competitive advantage is being recalibrated, and companies that can create the greatest economic value with the fewest carbon emissions are already reaping the benefits,” Bloemen wrote in a research note.

Global institutional investors plan to divest 15.6 per cent of their portfolios from fossil fuels over the next 10 years, according to a recent report by UK asset manager Octopus Group, which surveyed investors representing $5.9 trillion (€5.3 trillion) in assets.

The report pointed at renewable energy infrastructure as the sector that will benefit from this asset shift. Institutional investors are planning to ramp up allocations to the sector to 5.3 per cent over the next 12 months, which will more than double to nearly 11 per cent by 2029.

This represents $643bn of investment into renewables from respondents over the next decade.

However, other fund managers are far more pessimistic on the long-term prospects for fossil fuel holdings and are calling for a quicker shift to investments in renewable energies.

Renewables cheaper than oil

Oil and gas stocks could be worthless in as little as five years, according to James Anderson, manager of the Scottish Mortgage Investment Trust.

“Within the next five years, just about everywhere in the world, for every single different energy source, it will be cheaper to build solar or wind plus storage than to just carry on operating even gas facilities, let alone oil,” said Anderson, who counts Tesla as one of the largest stocks in his portfolio.

Another of his top-10 holdings is Ferrari, which is developing an electric supercar in a move to stay relevant amid the auto sector’s shift away from oil.

“Unless you can be at the cutting edge of transport engineering, it won’t last. And that cutting edge is now electric. So, I think that we are seeing whole sets of industries being transformed,” he added.

"Oil shaming"

Does the nascent "oil shaming" trend mean that the oil and gas sector has become too toxic to trade?

Unlike fund managers, who have to respond to clients' demands for sustainable and responsible investments, individual investors may take comfort from the lnternational Energy Agency's latest report.

"The momentum behind clean energy is insufficient to offset the effects of an expanding global economy and growing population," the agency concluded in the World Energy Outlook 2019.

Particularly for emerging countries, fossil fuel-based energy will continue to be the least expensive and most readily available resource to support the economy.

FURTHER READING: WEF: Climate dominates risks to world economy

FURTHER READING: Climate change will threaten banks' profitability

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