08 December 2014
In the second part of a round table on 'stranded assets', organised by Environmental Finance with support from HSBC, the Carbon Tracker Initiative and Climate Change Capital, participants discussed whether engagement or divestment is the best approach for institutional investors to deal with this risk.
Victoria Barron, utilities sector lead, Hermes Investment Management
Kate Brett, senior associate, responsible investment, Mercer Investments
James Cameron, Chairman, Climate Change Capital
Cathrine de Coninck-Lopez, sustainable and responsible investment officer, Threadneedle Investments
Graham Cooper, consulting editor, Environmental Finance
Tomas Gärdfors, partner, Norton Rose Fulbright
Solange Le Jeune, ESG analyst, Schroders
Zoe Knight, head, climate change centre of excellence, HSBC
James Leaton, research director, Carbon Tracker Initiative
Miguel Santisteve, associate director, corporate solutions, NASDAQ OMX
Geof Stapledon, vice-president, governance, BHP Billiton
Chaired by Peter Cripps, editor, Environmental Finance
Hosted by Norton Rose Fulbright, London
Peter Cripps: Looking at it from an investor's point of view, how do you deal with the risk of stranded assets?
Kate Brett: One of the biggest issues is the dislocation between the timeframe the investors are looking at and the impact of climate change. Even when you have long‑term investors, usually their assets are managed by asset managers who, typically, think in a shorter timeframe.
Some 'pioneers' are looking at stranded assets as a risk; however the majority of investors are not yet aware of it. It tends to be the ones that have been the focus of the fossil fuel divestment campaigns; so the charities, universities, faith-based investors, foundations, etc.
James Cameron: Not mainstream investors at all?
Kate Brett: Very few in the UK; perhaps slightly more so in the US where the divestment campaign started.
Victoria Barron: We represent a large number of international institutional investors, mainly corporate and public pension funds. We undertake engagement on their behalf and frequently speak to companies on the topic of stranded assets. We were recently having a conversation with a client who is concerned about the long term sustainability of oil and gas companies, and we touched upon the role of investors, i.e. do they wait for the companies to make the capex allocation decisions and change their business model, if they can, or is it up to investors to encourage them to change or just simply divest?
Peter Cripps: Is it a question of rebalancing your portfolio, or using your power as an investor in that company, or both?
Victoria Barron: Each of our clients will have their own policies on the question of rebalancing, but we, obviously, believe there is a crucial role for engagement in assessing the risks in their business models.
James Cameron: The idea that you would use your influence to make an incumbent do what you want it to do might work at the margins, but it will not lead a complete shift in direction, to an alternative technology.
Victoria Barron: One question which we ask quite a lot of the companies is: 'What proportion of your investor base is asking you questions about this topic?'
Conversations [about stranded assets] are happening with some asset managers but at the moment I could not say it is a majority - Geof Stapledon
Geof Stapledon: I would say it is certainly increasing. Very much so among the UK, Dutch and Australian investors. The conversations are happening with some asset managers but at the moment I could not say it is a majority.
Victoria Barron: With the asset owners, we start to get into the complications of mandates. Unless you, the asset manager, have a very specific mandate from the asset owner saying, 'No, this is the sort of risk that I would not want you to take,' then it is really up to the asset managers. So I am really wondering if the conversation is occurring at that level.
Cathrine de Coninck-Lopez: We can engage and we can ask questions about risks but, if the company is in the indices, then, from a fiduciary perspective, if we are not mandated to divest on ethical or moral grounds we have to have a really strong conviction that these assets will become stranded. So engagement is possibly the easier approach.
Peter Cripps: But is it actually working?
Cathrine de Coninck-Lopez: Well, to some extent. I think some of the oil majors are getting the message.
James Cameron: Sure, they are smart people but that is not where the transformation is going to come from. You have to reinvest somewhere else to find the kind of yields that will allow our fiduciary responsibility to be adhered to.
At the moment the closest you get is one or two companies emerging in the US out of the 'yieldcos' but, in the end, there have to be pure clean energy companies.
Victoria Barron: We are seeing quite a lot of investor interest in low‑carbon indices, but they are still in development.
Miguel Santisteve: But how many asset managers are asking these questions? The presence of asset managers that integrate environmental, social and governance issues in the oil and gas sector has actually grown in the last four years.
What I am seeing more and more … is investor engagement with companies on this topic. Even though the headlines make us think that everyone is divesting, actually it is so far having a tiny impact in relative terms.
Kate Brett: It is very early days, so people are saying, 'We will divest from fossil fuels,' but they have not yet done the analysis to understand the full impact on their portfolio.
Some 'pioneers' are looking at stranded assets as a risk - however the majority of investors are not yet aware of it - Kate Brett
James Cameron: That is where we are. What does it mean when the insurance industry, for the first time, steps up at the Climate Summit and says, 'We accept the connection between our investment and risk?'
In the past they always kept these absolutely separate; 'We have people who do investment, and we have people who do risk.' However, now they say they want to deploy their capital in ways that they say is 'climate smart'. But what does that mean? What asset classes would be beneficiaries of that? Is this fresh capital? Is this a big allocation away from something?
James Leaton: I think if you talk to Storebrand, for example, they would say, 'Well, the reason we are doing this is we think there is a financial case in the long term that these high‑carbon activities will underperform. It is not a moral decision for them. They will also say, 'We find it very easy to find other things to invest in.'
Peter Cripps: I think most big investors feel that they would miss the fossil fuel industry from their portfolios; they do not feel that divestment is an option for them. I therefore wonder what use engagement has if, ultimately, the bottom line is: you cannot divest?
James Leaton: We are not actually saying: 'Divest from everything.' We are not saying we are going to stop using oil or coal tomorrow. The oil majors have a range of options, a lot of it at the low end of the cost curve that fits within even lower demand projections. You would not actually miss the small percentage of pure coal companies; that are probably worth less than 1% of the market.
Cathrine de Coninck-Lopez: We should not underestimate the power of investors. We have certainly seen companies change their investment model and change their dividend policy in response to investors. They do listen, but it cannot just be the sustainability voice; it has to be the investor's whole voice. I think that is the real challenge.
Peter Cripps: Do asset managers feel they get good information when they speak to the extractive companies about break‑even points etc?
James Leaton: Some of the companies we have spoken to are saying, 'A year ago we did not have to talk about break‑even prices and capex allocation; that was a private debate we had with a few analysts. Now it is a public debate; we have to publish long reports, discuss it in the media or discuss it with shareholders.' So, I think it has driven a new debate, which we welcome.
Solange Le Jeune: One of the key things I like about Carbon Tracker is its break‑even products analysis. This is an area where we find engagement can be useful. We push for the companies to give us this information on oil production cost per project type and then to make it more public. Now we have estimates but they (the companies) will have much more accurate information, so we can ask: Is it the right capex? Is that the right asset allocation here? Do we need to invest that much in this asset?
Miguel Santisteve: I think they are definitely open to these messages and remain focused on profitability. We know some oil and gas companies are actively shrinking their balance sheets, selling assets and therefore reducing the size of the company because, at the end of the day, if the focus is on earnings per share and it takes a smaller company to do that, then that is what it takes.
Cathrine de Coninck-Lopez: Yes, the big oil majors are important dividend‑paying stocks and they would be massively slated if they suddenly said, 'No, we are not going to pay dividends, we are going to invest in solar.' I think, perhaps, that is the right thing to do in the long term. However, I am not sure the market would like that.
We should not underestimate the power of investors - Cathrine de Coninck-Lopez
James Cameron: I do not believe the answer is going to lie with the incumbents, 'You show us the way to the future; you do solar.' No, you want solar companies out there that will absolutely cream them in the market.
Cathrine de Coninck-Lopez: But they have so much money. Who else has that amount of money?
James Cameron: Indeed. Who has the money? Who knows how to make it deliver technological innovation and who is used to disruption? The real problem is the power of the incumbents. They dominate our psychology, they make us think there is no future without them, they make us think we will have to wait ten years, 20 years when we cannot; it is a fantasy, we cannot.
It is a standard innovation problem; it is combining different types of capital to get to scale to deliver basic needs at lower cost or at lower risk.
Victoria Barron: If those technologies do take off … what will be the impact on companies like the utilities, the miners and the oil and gas companies? That is when investors, I think, are really going to be saying … 'Hold on a second.'
James Cameron: Yes, then people start to move as well as money. They go to where they feel their best opportunities lie. However, it is all a question of timing and how much disruption will take place in the meantime.
Peter Cripps: So, is there a first‑mover advantage for people who want to put their money into this? Is it a leading edge or a bleeding edge?
James Cameron: But exactly the same thing happened in the Industrial Revolution. Even in the big infrastructure developments that we all think were tremendous, most of the early bond holders all lost their money.
Geof Stapledon: It is just a question of getting the timing right.
Solange Le Jeune: That is why research is so important. The threads need to be tied together; we need to talk more to each other and there is a need for more information and research to come through to make people more aware. Improved awareness is key to drive the sustainable investment and funding decisions
Tomas Gärdfors: We have a wide range of clients and we see a large number of investors looking for new yield opportunities.
The situation can change rapidly, however. In the case of solar power in the UK, for example, we continue to see a real 'run for the sun' given the Renewables Obligation Certificate deadline next March. New rules were introduced in the spring to manage the scale of solar investment and we now see a more mature market responding to the changing regulatory environment.
Zoe Knight: Can I ask the group, how much time have you spent talking to oil and gas analysts and sell‑side houses on this issue and what sort of responses are you getting?
James Leaton: We have spent some time doing that. I think there is an overlap with mainstream business risk analysis in terms of: should they be reducing capex, for example.
But it is still the tragedy of horizons that Mark Carney mentioned. If their model only runs for five to ten years and they put in high demand and price assumptions, the answer they get at the end is perfectly valid, but represents a short-term view at one end of the spectrum.
James Cameron: I used to use different techniques for valuing companies. I would ask probably more of a lawyer's question; I would say, 'But surely you would have factored in the possibility of a rule change,' a price on carbon in China, for example? 'No, that does not feature.' 'What about access to water – a critical factor in almost all fossil fuel production?' 'That is not part of it.' 'Okay, well, what about public protest and acceptability on the client side?' 'No that does not feature either.'
So there is a whole list of real‑world phenomena that clearly affect markets and they do not feature at all in the way the company's value is calculated by analysts. I do not understand that.
Victoria Barron: The auditors are now looking at proven and unproven reserves; it is on their radar. So we have asked analysts, 'What happens if, in the future, investors turn around and say, 'You gave us incorrect information, incorrect valuations?'
Solange Le Jeune: I would like to see a new way of modelling and valuing the oil and gas sector. Not talking specifically about this sector, but I do see some people who have just become fund managers and they want to tweak their model with a range of different things, such as social and qualitative indicators. I mean that a new generation of analysts and investors is starting to look at valuation models differently. But I find fund managers and analysts in the oil and gas sector tend to be more conservative. It is a risky exercise to change the way you model the sector but I think the response can come from the new generation
James Cameron: So you are saying another generation will come through and they say, 'We will do this.'
Solange Le Jeune: Hopefully, yes.
Zoe Knight: I do not think there is a lack of desire to do it; I just think that the day job takes over, in the sense that it takes time to think through new modelling approaches and techniques which means they can be put at the bottom of the list of daily priorities.
Solange Le Jeune: However, that is why I think it could work with a new generation of analysts. They might find developing a new model takes a year or two and then perhaps it has to be tweaked, but their career is just starting and they will have many years ahead of them to demonstrate the new way of analysing and valuing is relevant
Miguel Santisteve: I agree. I think there are not enough people thinking outside of the box. I think, being part of the financial sector, you have so many cognitive biases. So you tend to think that the economy is always going to grow, the market is always right. Even though there are so many facts out there telling you otherwise, in terms of human population, arable land, access to water, scarcity of resources. It is obvious and in front of you: we need to change the economic model. EF
Part 1 of this article can be found here.