The 2015 Climate Change Conference of Parties (COP21) put global warming firmly onto the political agenda and made it important for all charities to think about carbon in their investment portfolios, says Tom Rutherford.

The COP21 delegates in Paris last December agreed to limit global temperature increases by reducing harmful greenhouse gas emissions. In recent years, the approach of removing, or “divesting”, companies from investment portfolios that burn coal, oil or gas has gathered a following.

Such thinking was once the preserve of a few charities and university endowments with active student bodies, but, increasingly, pension funds, investment managers and sovereign wealth funds are carefully considering their investments in fossil fuels.

The dilemma of stranded energy assets

Shifts in energy production as implied by Paris could lead to a surfeit of unmined coal, oil and gas reserves, termed “stranded assets”.  So drilling companies impacted by reduced fossil fuel demand face the potential of lost revenue and writing down the value of their mining licences and future profits.  

Of course many energy, mining and utility companies have been a staple in equity portfolios for decades and their handsome dividends have proved popular with charities.  
As a result, even charities whose missions are not environmentally aligned may find their investments impacted.

Yet the wholesale exclusion of all fossil fuel companies may not be the most socially responsible reaction.

Coal and tar sands in the cross-hairs

Burning coal is an ugly practice in terms of carbon intensity. The coal industry is largely distinct from oil and gas production, so such public companies are readily identifiable and therefore easier to exclude.  Further distinction can be made between less popular, low-purity “thermal” coal commonly burnt to make electricity and more acceptable “coking” coal that is primarily used in the steel manufacturing process and which contains less sulphur.

Some investors also exclude newer and ecologically contentious practices such as “tar sands” surface mining for oil.  Again incurring higher levels of carbon intensity, the mining here is often directed by private companies.

Not all bad – new opportunities through change

New technologies and improved extraction methodologies offering better energy efficiency can provide investment opportunities, in our view.  

Here, energy transmission, monitoring and storage as well as carbon capture and emissions mitigation systems all have a valid application for domestic, commercial and industrial use.

These present benefits for those quoted companies committed to achieving meaningful environmental improvements by reducing their carbon emissions. Larger energy groups might therefore acquire these technologies, thereby diluting their overall carbon intensity. This in turn rewards pioneer environmental investors and provides capital for cleaner forms of energy, at the expense of traditional approaches. Energy profitability is partly dependent on the costs of production (importantly, production costs are increasingly impacted by carbon taxes which will vary depending on the volume and carbon content of those emissions). Paris stands to reinforce this relationship through its policy intent.

Approaching carbon with positive investment selection
It makes sense to consider which oil and gas producing or combusting companies are proactively reducing CO2 emissions thereby making their businesses more sustainable. Comparison requires careful analysis across the underlying projects of companies, as well as to assess whether the stated commitments of management actually result in meaningful outcomes.  

Activist shareholders can attempt to influence company policy through engagement with directors. Clearly this is a specialist task that requires the support of energy industry experts, however, trustees and investment committees can ask questions of their investment managers. Those managers that incorporate environmental, social and governance criteria within their investment processes should be able to respond constructively.

Lower oil prices should accelerate the change

Since profit expectations determine the commissioning of new drilling projects so the carbon intensity within the energy supply chain should decrease unless oil prices suddenly climb towards previous highs.  As this seems unlikely anytime soon, the pace of “market-led” carbon deleveraging should continue.  

This implies the consequences for stranded assets will only become more prevalent in the medium term.

How should charities react in the face of increasing carbon scrutiny?

Admittedly, this subject is complicated and any discussion will likely be hostage to diverse and strongly held views.  
Absolute positions can be problematic but framing parameters by posing the following questions may help the trustees consider the right approach for their charity and protect against unwanted outcomes:

1.    Does our investment policy consider carbon intensity and reflect our charity’s values?
2.    Do we seek to limit our carbon intensity or exposure to particular practices such as thermal coal mining or tar sands mining?
3.    Is our investment manager able to reflect our values and investment policy concerning carbon?
4.    Does our investment manager have a strategy to consider the risks of stranded energy assets?
5.    What will be the portfolio impact of any change to our investment policy, also to the income generated?

Tom Rutherford heads the charities team at investment manager Lombard Odier

Civil Society Media wishes to thank Lombard Odier for its support with this article.