Getting out while you can
As long as it was just the pension funds of the Church of England or Stanford University announcing to ditch investments in fossil fuel companies, it was easy to shrug off the trend as feel-good investing. Not anymore, now that Europe’s second-largest insurer AXA and Norway’s $880 billion sovereign wealth fund are doing the same.
They may still talk about doing the right thing. But global warming and the fight against it are likely to hurt the bottom lines of companies contributing to rising levels of carbon dioxide in the atmosphere – even if political action against climate change remains lacklustre.
The coal industry is likely to take the first and biggest hit, as it has a particularly heavy carbon footprint. In the United States, the historic link between GDP growth and coal demand broke down in 2007, and the North American coal industry has basically been in crisis since then. The industry’s global prospects are even bleaker: consultancy Mercer estimates that anti-climate change policies will erode between 26 and 138 percent of the sector’s annual returns to shareholders over the next decade.
From an investor’s perspective, climate change creates two different kinds of risk.
One is political. Future regulatory actions – be it carbon taxes, subsidies for green power or outright emission caps – may make it more expensive to operate carbon-heavy business models.
So far, policymakers have been slow to agree on binding political measures against global warming. But in a historic pledge, the leaders of big rich countries on June 8 promised to phase out fossil power during this century. Those are big words while real actions are far less certain. The December Climate Conference in Paris may provide more content-light commitments.
But timidity would not necessarily be good news for the shares of carbon polluters. If the academic consensus on global warming is right, dithering now implies more radical action later. The eventual transition period would be shorter, and the adjustment harder and probably more costly. The lack of clear policy now only increases uncertainty.
The other type of risk is technological. Whatever politicians do in the future, the billions of dollars spent on developing green power and energy efficiency will bear carbon-reducing fruit. Already, Germany needs almost a fifth less energy to produce one euro of GDP than in 2000.
The price for solar panels has come down by two-thirds between 2006 and 2014. In the coming decade, costs will fall by another 19 to 36 percent, the German Fraunhofer Institute for Solar Energy Systems predicts. In sun-rich regions such as Chile, solar parks are already competitive without subsidies. And onshore wind parks are nowadays roughly as cost-efficient as gas power plants.
The increase in green power alters the dynamics on electricity markets fundamentally. Once installed, wind turbines and solar panels generate electricity at very low additional costs. They can squeeze out rivals which have to pay for their fuel, even if the owners of renewable energy sources are not earning a high return on their original investments.
The woes of Germany’s legacy utilities give a foretaste for the world. In Europe’s largest economy, hefty subsidies for renewables have expedited the transition to a low carbon system. Green power currently generates 26 percent of all electricity and operating hours of gas-fired plants have fallen drastically. Wholesale electricity prices have collapsed and peak prices have come down.
The business models of traditional utilities have been undermined. They are closing many fossil plants prematurely. Investors have suffered. Over the last five years, the share prices of E.ON and RWE have fallen 45 percent and 64 percent respectively, while dividends tumbled. Engineering giant Siemens has given up any hope it will ever be able to sell a new gas turbine in its home country. Lignite coal is next in line for the cull.
The global fossil fuel industry does not seem to have noticed the risk. The Carbon Tracker initiative in April 2015 compared Exxon Mobil’s> long-term demand forecasts for oil with the International Energy Agency’s baseline scenario, which takes into account existing policy commitments to reduce greenhouse gas emissions. Even relative to that moderate benchmark, the oil major’s 2040 demand forecast for oil is 6.8 percent higher than in the IEA’s scenario.
Companies which underestimate the green effect are likely to make the wrong investments. Carbon Tracker estimates that in 2013 alone, the 200 biggest oil, gas and mining companies spent up to $674 billion on projects that climate change may turn into financial dead ends.
Moreover, investors who take that effect into account will pay less for companies with a big carbon footprint. Investor caution will raise costs of capital, cutting into growth prospects.
But most investors are not yet all that cautious. This creates investment opportunities for the far-sighted. Or, to be more precise, disinvestment opportunities.