The net zero carbon emissions movement has finally entered the mainstream for investment professionals. Despite a U.S, delegation declaring its intention to burn more fossil fuels at an environmental conference in Poland, sounding like the energized, fossil fuel advocate and former Alaska governor Sara Palin saying, “Carbon? You betcha!”, on December 20 a group of 93 institutional investors with $11.5 trillion under management published a letter in the Financial Times. The letter stated strongly that “we require power companies… to plan their future in a net zero carbon economy…. We expect specific timelines and commitments…”
These institutional investors, typically a fairly conservative group, stated more or less accurately that the electric power generating sector accounts for one-quarter of global carbon emissions. And that sector had better clean up its act, so to speak, and do it with relative haste. For example, the investors want all coal-fired power generation owned by portfolio companies shuttered by 2030, that is, within the next decade.
Furthermore, these enviro-investors assert that action on climate change remediation delivers offsetting economic benefits. To them, carbon reduction should not be seen at all as an economic negative. This, however, is not the first demand for carbon reduction by investors, and probably will not be the last.
Although $11.5 trillion of investments sounds like a large number, it pales in comparison with the total world market for stock and bonds, which totals about $160 trillion, more or less. The anti-carbon investment movement does not, at least at this point, speak for all investors. (The market value of all US electric utility company stocks and bonds totals about $1.2 trillion, incidentally.)
But also consider the dynamics of investment management. Managers do not like to take public positions that annoy important clients. It’s kind of a basic rule. Large oil companies, for example, might not retain pension fund managers who speak out aggressively about global warming. But above all else, investment management resembles a sport. It is all about the team’s performance on game day. No one wants or can long afford to underperform their competitors, occurs by retaining positions in companies which, so to speak, never saw it coming. And managers charged with acting in a fiduciary capacity seldom relish explaining why they failed to anticipate elevated risk and declining return prospects in a significant portion of the stocks comprising their portfolios.
There is an enormous amount of money currently dedicated to passive investing with portfolios that essentially mirror the existing market or relevant subset thereof. In the US, the electric utility industry despite its importance for the economy and overall welfare of the population, comprises a rather small portion of the equity market, only 2-3%.
In other words, it is possible for institutional investors to build robust portfolios that approximate the market’s composition without owning any electric utility stocks. The electric utility industry is barely a factor with respect to broad market indices like the S&P 500. Investment managers wishing to avoid controversy and investors expressing environmental preferences can now both jettison fossil-fueled electricity generators and suppliers from their portfolios without affecting performance.
As an aside we should point out that this new attitude toward carbon emissions could soon put electric companies in the so-called “sin bin” along with liquor distillers, cigarette manufacturers and casino operators — stocks that cause offense to one group or another. Future investors will have to account for not only the usual panoply of business and operating risks. But now there is the additional stigma. And electric company executives may also begin to see diminishing prospects to both their careers and their finances.
Electric utility companies in the US and Europe are already moving away from coal and other fossil fuels. As a boiler fuel coal is rapidly losing market share to natural gas. This switch alone reduces CO2 emissions by roughly one half. However, the future of electric power generation over the next decades may turn out to be a rather unpleasant competition between natural gas and the declining cost curves of renewables. These dynamics spring from engineering progress and changing economics rather than investor activism alone. In short, pressure from investors may accelerate a trend already underway.
Leonard Hyman & William Tilles for OilPrice.com