Carbon Tracker’s lexicon adopted by sell-side
The wasted capital and stranded assets analysis from April this year has continued to permeate the financial system, being recognised by a number of asset owners, investment managers and analysts as a quality piece of work. As Citywire put it in early October – we have caused a sensation. Mainstream coal and oil analysts at Goldman Sachs, Citi, Morgan Stanley and Deutsche Bank have already started engaging with the issues and we are seeing terms like ‘unburnable carbon’ and stranded assets’ appear in sell-side research, as well as questions around capex:
• Deutsche Bank Thermal Coal: Coal at a crossroads (May 2013)
• Goldman Sachs Commodities: The window for thermal coal investment is closing (July 2013)
• Morgan Stanley Oil & Gas: Something Has to Give: Analysing the Scope for Lower Capex (July 2013)
• Citi Commodities Research: The Unimaginable: Peak Coal in China (Sep 2013)
• Citi GPS: Energy Darwinism: The Evolution of the Energy Industry (Oct 2013)
This late August piece from Craig Mackenzie of SWIP comments on the step-change in the stranded assets debate as analysts have started taking a closer look at where projects appear on the cost curves.
Carbon Tracker has been teaming up with some brokers to continue to get the work out and have discussions with individual investment institutions. Morgan Stanley and CA Chevreux took us to see some of their European clients in June/July and debate how a low demand, low price scenario would impact their analysis. JP Morgan ran a seminar in late September for its US clients led by Mark Fulton, following an event in London. Unburnable Carbon was cited by most brokers and sell-side analysts as the most innovative piece of research in the 2013 SRI-Connect IRRI survey, with James Leaton picking up 6th place in the SRI Research analyst ranking in a large field.
The geography of investor responses
Wholesale divestment is not the answer for most investment institutions, but we are seeing a range of responses already emerging, which we expect to gather momentum over the next year. Mark Campanale, is also speaking at the Seattle Divestment Forum, Seattle being perhaps the largest city to commit to divesting its fossil fuel holdings. The ‘Fossil free tour’ arrives in Europe this Autumn, starting in Berlin on October 27. Stemming from Bill McKibben’s ‘terrifying math’ article on Carbon Tracker’s first unburnable carbon report, vociferous debate remains around the merits of a fossil fuel divestment campaign.
The Smith School at Oxford University and WWF-UK published the report ‘Stranded assets and the fossil fuel divestment campaign’, studying whether divestment affects equity valuation. The report concludes that while divestment could be successful in stigmatising the fossil fuel industry, it will be largely limited in having any direct market impact. Some European views are presented here by Mark Nicholls. The recent debate between Calsters and Storebrand on this issue brings out some of the different investment approaches and how they respond to this issue.
As is so often the case, Scandinavia is ahead of the curve. Norwegian firm, Storebrand’s, much heralded exclusion of 19 ‘financially worthless’ coal and oilsands businesses from its investment strategies in July has been followed up with an announcement they will also evaluate their utility holdings for potential ‘stranded assets’. In addition to this the Norwegian government engaged Rystad Energy to analyse the consequences of a two degree scenario on coal, oil and gas prices to then identify those assets most at risk of stranding. These efforts have all cumulated to ratchet up pressure on the Norwegian Government Pension Fund, currently standing at £760bn, which has 10-15% currently exposed to coal, oil and gas. Norway’s new government has since announced they will create a programme in the Fund to invest in sustainable companies and consider a separate mandate for investments in renewable energy assets.
Just next door in Sweden, the same message about the long term risks of exposure to fossil fuel assets is being heard loud and clear. The beginning of September saw the Swedish Center Party call for all national pension funds to sell off their holdings in fossil fuel corporations to ‘climate proof’ and protect the value of their investments. The AP4 pension fund just announced in October that it plans to invest in a tailored emerging markets fund comprising companies that have both low-carbon emissions and low fossil-fuel reserves. This retreat from high carbon show how funds can reduce their exposure from those they see most at risk (typically pure coal or oilsands operators) without wholesale divestment from all fossil fuels overnight.
Watch this space for new initiatives in the US and UK, with our partners CERES and Share Action to drive further change on carbon assets and climate risk, in the forthcoming weeks.
Carbon Avoidance: Accounting for emissions hidden in reserves
Carbon Tracker has been working alongside the Association of Chartered Certified Accountants (ACCA) to understand the current reporting landscape for fossil fuel reserves. This report launched in October provides an essential perspective on the way financial reporting, accounting standards and industry methodologies inter-relate to provide opportunities to factor in climate risk. At present the value of reserves is not obvious within the financial statements, and therefore it is difficult to adjust the level of assets according to demand and price assumptions.
A debate on the topic hosted by Sarasin & Partners with panellists from Sarasin, Deloitte and CDSB exposed the limited ability of current accounting practices to be forward-looking. There was strong sentiment that markets were still looking for stronger policy signals, even though it is reasonable to conclude that measures to constrict the market for fossil fuels will increase. It was felt that basic disclosure of the emissions potential of reserves was a relatively simply measure that could be introduced, however this would of more value if companies then took the opportunity to explain the significance of that metric for its business model and future revenues. Further analysis of the narrative reporting of companies was therefore suggested, to assess whether they are providing satisfactory information in this regard. More application of sensitivity analysis which varies price assumptions was also felt useful to produce a range of valuations.
The accountancy profession follows hot on the heels of the actuaries in picking up this issue, with our analysis making the front page of The Actuary in September.
How big is your budget?
The UN Intergovernmental Panel on Climate Change (IPCC) AR5 report in late September marked a significant step forward in the use of the carbon budget approach. The report concluded that global warming is ‘unequivocal’ and set a budget equivalent to 987GtCO2 to 2100 to have a 66% chance of remaining within the internationally agreed 2°C target. This rules two thirds of total global fossil fuel reserves unburnable. We don’t have space for a full comparison of carbon budgets here, but there are a number of variables which account for the slight variation in numbers, (see our analysis here for more details). The important thing is the conclusions that the majority of fossil fuels are unburnable to limit global warming to 2°C are still the same.
The inclusion of carbon budgets has resulted in a number of commentators predicting they will now form a central pillar in the UNFCCC’s global negotiations – the bulk of media coverage on the IPCC’s carbon budgets can be seen here.
Thinking the unimaginable
In early September Citi produced research called ‘The unimaginable – peak coal in China’- calling the peak in Chinese coal demand by 2020 – on which Carbon Tracker commented for China Dialogue – and new coal-fired power plants were banned in the three major Chinese industrial areas of Beijing, Shanghai and Guangzhou over air quality concerns. Carbon Tracker will be looking at how China is dealing with reconciling its air quality and carbon emission targets with its energy production in more detail over the coming months.
‘There is a looming decision…stranding [fossil fuel] assets or stranding the planet’
To sum up, this quote from Secretary General of the OECD, Mr. Angel Gurria, reiterating the risks of not acting on high-carbon asset stranding risk at his recent speech on the challenge to achieve zero emissions. In this he spoke of the challenge low-carbon technologies face to grow, in the face of incumbent technologies. He mentioned Carbon Tracker’s work in revealing the scale of capital expenditure over the next 10 years to ensure this does not happen. And that the risk of ‘unburnable assets’ would have a significant impact on the valuation of companies. He says that ‘any new fossil fuel resources brought to market…risk taking us further away from the trajectory we need to be on’.