Richard Lindberg, CongressEA: Stranded Assets and Impact Investing – Preventing our pensions from going up in flames

Do institutional investors like pension funds fully appreciate the perils of large exposure to the fossil fuel sector? It’s a question of enormous environmental and economic importance that also highlights a systemic challenge. A more nuanced and long-term investment approach that balances economic and environmental returns is needed. Impact Investing answers the call.

Economic crises are notoriously hard to predict, even in the face of warning signs that in hindsight seem obvious. It’s time to raise the alarm again, a possible bubble is forming that could make the recent subprime crisis look like a minor bump in the road. The components are as follows:

  • In order to limit global warming to 2 degrees, GHG emissions need to come down 40-70 % by 2050 and close to zero by 2100, in relation to 2010 levels (IPCC, 2013/14).
  • We are addicted to fossil fuels, spending around half a trillion dollars a year on subsidies – six times more than renewable energy subsidies (IEA, 2013).
  • A quarter of the world’s total reserves are held by publicly traded fossil fuel companies and equal 762 Gigaton (Gt) emitted CO2. The level is set to double as further reserves are developed (Carbon Tracker Initiative, CTI).
  • To have an 80 % chance of limiting global warming to 2 degrees the allocation of above companies would range between 125 and 225 Gt (CTI, 2013).

The environmental calculus obviously doesn’t add up. Then consider the economic side of the problem. Carbon reserves held by fossil fuel companies are estimated to be worth 20 trillion dollars and according to the IEA up to 80 % of fossil fuel reserves could be write offs in the 2 degree scenario. That is a 16 trillion dollar nightmare.

This is the foundation of the Stranded Assets theory, pioneered by Oxford University. It argues that assets (reserves) of fossil fuel companies risk becoming worthless, a loss on their balance sheet, if legislation and other factors like a global carbon price leaves the carbon unburnable.

The huge market capitalization of multinational fossil giants, in large part because of their proven reserves, means that they are part of institutional investor portfolios, including our Swedish pension funds, AP. If the write-offs become reality, share prices might tumble, causing immense shareholder loss. Talk of a fossil fuel bubble has therefore been gaining traction as of late.

Through the Carbon Asset Risk Initiative institutional investors recently asked 45 fossil fuel companies to share their own assessments and Exxon Mobile made headlines by starting to report on climate related risks to its business. Their conclusion – there is no risk of their assets becoming stranded due to lack of political will.

Frustration with too little progress has led to the divestment campaign, initiated by Bill McKibben. It calls for investors, cities, funds etc to take their money out of fossil fuel companies, to send a more direct message. Cities like Seattle and San Francisco have chosen to divest. Norwegian financial services firm Storebrand with over 30 billion dollars in assets has announced that it will reduce its exposure to fossil fuels in the interest of long-term returns.

Regardless of the number of divestments, the campaign has brought about a key message – to avoid a calamitous economic downturn prudent investors need to understand these long-term risks and stress-test their investments. Movements like socially responsible investing, ethical funds and ESG compliance are steps in the right direction. However, they are still based on an old investment paradigm that neglects the positive feedbacks loops between environmental/social impact and financial returns. As we destroy natural capital we also erode the long-term foundations for economic prosperity and therefore a new approach that doesn’t place short-term financial returns over all else is desirable.

Impact investing is an investment philosophy well suited for this particular challenge. It means investments into companies and funds with the explicit intent to generate quantifiable social and/or environmental positive impact alongside financial returns. It encourages investors to analyze vital interdependencies across sectors and time. By emphasizing non-economic metrics like saved emissions it gives the investor a more complete risk analysis, paving the way for smarter investments. Pension funds with particularly long investment horizons would be well advised to adopt this form of analysis to safeguard their holdings and simultaneously help steer both the financial community and the energy sector into a more sustainable path.

Richard Lindberg,
Congress for Environmental Advancement

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