BlackRock has warned that companies with high-cost fossil fuel reserves are at risk of being devalued, adding that "climate change has arrived as an investment issue".
The world's biggest asset manager believes that, as efforts to tackle global warming gather pace, "regulatory risks are becoming key drivers of returns" and there is the potential for fossil fuel assets to be devalued, or rendered 'stranded', as policies are brought in to reduce emissions.
However, the report – called The Price of Climate Change – argues that because the transition to a low-carbon economy will be gradual, "fossil fuels will likely be part of our energy infrastructure for decades to come".
What would make Paris a good COP?
The national emissions reduction targets being submitted ahead of the Paris climate change summit in December are likely to be "lowball" offers, says BlackRock.
"This is not necessarily a bad thing," adds the report. "Some proponents of emissions cuts would say it is better to pick something achievable, and ratchet up the target once you have proven it is possible to cut emissions without hurting growth."
An indicator of whether the treaty "has teeth" will be whether delegates can agree on regular reviews that ratchet up the targets, it adds.
BlackRock is also looking out for the adoption of accounting guidelines that help price climate risks across the financial system. "International financial regulators appear to be moving toward eventually incorporating an assessment of climate risk into accounting standards," it notes.
"Oil and gas companies with low-cost reserves should do fine as a result, we think," says the report. "We are, however, cautious on companies with high-cost reserves." It does not name any specific companies.
BlackRock has so far seen no evidence of a "climate change risk premium" for equities. But "this does not mean there will be no premium in the future. In fact, we think there will likely be one," it adds, as more countries adopt carbon taxes or cap-and-trade programmes.
The report goes on to say that its Scientific Active Equity team has found evidence that companies that have reduced their emissions intensity – defined as emissions divided by sales – by the greatest amount over the past couple of years have outperformed laggards (see chart). The team has now started to measure water risk.
The paper adds BlackRock's influential voice to the 'stranded assets' debate, which has swept through the investment community in recent years amid warnings from think-tanks such as the Carbon Tracker Initiative that the majority of fossil fuel reserves will need to be left in the ground if global warming is to be kept to 2°C.
BlackRock's response to the debate is nuanced. It suggests that although divestment of fossil fuel holdings is an option for investors, for large asset owners, it "makes sense" to engage and influence fossil fuel companies, because "the biggest polluters have the biggest capacity for improvement".
The report also acknowledges efforts to decarbonise portfolios, such as the Portfolio Decarbonisation Coalition championed by Swedish pension fund AP4. But it says carbon data needs to improve, pointing out that CDP data does not look at indirect, 'scope three' emissions.
The giant asset manager says it takes environmental, social and governance (ESG) data seriously, and that sustainable investing is not a fad.
"We view ESG as a mark of operational or management quality", it says, adding that improving data will help build resilient portfolios of the future. BlackRock is currently integrating ESG data into its Aladdin operating system, which provides data and tools for investors.
When it comes to opportunities for investors from climate change, the report points out that renewables and energy efficient technologies have the potential to benefit from emissions-penalising legislation. But it warns that renewables companies are prone to bubbles.
It concludes: "Warren Buffett's ex-post advice to investors seeking to profit from the nascent car industry in 1900 – short the horse – is worth considering."