Climate change’s trillion dollar problem just got more urgent for investors

The money tied up in fossil fuels is everyone’s problem, writes Anna Isaac

Coal, oil and gas are all part of a problem the finance industry faces termed ‘stranded assets’ (PA)

There’s a £16 trillion problem that’s been keeping central bankers past and present up at night: “stranded assets”. It’s one made all the more stark by the UN’s Intergovernmental Panel on Climate Change (IPCC) warning on Monday that time’s nearly up if the world’s to avoid extreme climate crisis.

Investment in fossil fuels has made the world more polluted. Now the world’s biggest money managers are trying to work out how investments can help mitigate and limit the impact of climate change. Quantifying and tackling the issue of stranded assets are a big part of that calculation, and so is working out what actually makes an investment meaningfully “green”.

These are assets which, depending on the course of climate policy, could end of up either being valueless, such as oil, which might never be allowed to be extracted, or curtailed, such as a gas power station that might have its energy production life cut short.

Stranded asset is a term used to describe something which has a value tied to fossil fuels but it can also refer to something which is considered ethically unacceptable for other reasons, such as shares in a company, or bonds from a regime linked to human right abuses.

A report from Swiss bank UBS cites analysts’ belief that as much as 80 per cent of oil and gas reserves might end up stranded. The former governor of the Bank of England and finance adviser Mark Carney has also warned that these assets could pose a risk to financial stability if companies and funds don’t divest from fossil fuels at pace.

Pressure is building to try to reach an agreement on issues like investing in coal and wider investment in fossil fuel, ahead of the Cop26 climate summit. The UK is hosting the global meeting in autumn, but so far it’s struggled to get enough support from other parties to sign up to initiatives such as the Powering Past Coal Alliance Finance Principles. At the G20, the US and Japan blocked efforts to set a specific date for phasing out coal use.

A UK Treasury spokesperson told The Independent that the government is “committed to the UK being the best place in the world for green and sustainable investment and was the first country in the world to commit to fully mandatory reporting by businesses across the economy on the financial risks posed by climate change.”

Still, if a loan for an oil field that is subsequently shut down offers a clear-cut example of a stranded asset to be avoided, the wider picture of what constitutes dirty versus green investment is more complicated.

That’s in part down to the role investment can play in moving brown companies – which have some stranded assets within their activities – towards the greener end of the spectrum. That role is gathering attention ahead of Cop26.

Holding a pension, insurance product or a savings account could in some manner expose a person to the risk of stranded assets. At a grander level, for money managers who hold billions, if not trillions, of dollars in order to generate returns for their clients, stranded assets are also a growing concern. Even just personal investments like an exchange traded fund, which is linked to an index, such as the FTSE 100, would include exposure to companies which may hold stranded assets as part of their activities.

The question of how to handle them is neither as easy nor clear cut as it might seem. While there are some straightforward examples of stranded assets, these are often only part of hybrid or transitioning companies that might be in the process of cleaning up their operations.

Even if businesses are producing oil at the moment, there can be a difference between producing the oil necessary to keep the lights on today, versus the oil of a decade from now, via fresh extraction of oil and gas.

While the world reeled from the IPCC’s “code red for humanity” warning, oil companies have continued to report strong profits. And at present, when interest rates are low, it’s very hard for investors to generate a return on their money. That’s not great news if you’re trying to build up the cash in a pension fund, for example.

Exxon Mobil reported its biggest quarterly profit in more than a year last month and Saudi Aramco’s profits have jumped by almost four times in its latest set of results, as they ride the recovery in oil prices. Major economies have returned to guzzling fuels as Covid-19 restrictions have eased bumping up oil prices. This kind of stock and profit performance can be a great way for investors to generate cash.

Tackling stranded assets, or companies exposed to them, can be done in a range of ways. One option for cleaning up companies is, if they are listed, to back activist investment that seeks to force companies to report on why they are not transitioning away from fossil fuels. Asset manager Allianz Global Investors (AllianzGI) did this when an activist investor was recently trying to reshape the board of Exxon Mobil. It’s a method known as “stewardship”.

AllianzGI, which has around £500bn in assets under management, tries to take a nuanced approach: it holds back from investing in companies that get more than 30 per cent of their revenue from coal. This has placed coal in a similar bucket to makers of anti-personnel mines, cluster munitions, biological weapons and chemical weapons under AllianzGI’s “exclusion” policies.

Meanwhile, the European Union is trying to push investors towards green investment by requiring more detailed reporting by companies which sell financial products. The rules (sustainability-related disclosures in the financial services sector), which came into force in March, aim to better illustrate the sustainability risks that an investment might involve. The UK has introduced similar extra reporting requirements.

But these new rules miss out the sort of engagement activity that AllianzGI supported with activist investors, according to Mark Wade, head of sustainability research and stewardship at the asset management firm.

“Sustainable investing is really about getting to that middle point where you can finance transition,” Mr Wade says. Having investments in a company can be a way to push them from a focus on stranded assets towards cleaner activities. Companies will need to go green to maintain their licences to operate, he explains, and they need investors’ money to do that. It’s a “co-dependent” relationship.

Governments and investors are racing against time to strike a balance between job losses and financial losses, if companies don’t move from brown to green quickly enough. But if you want the biggest bang for your sustainability buck, some investors believe you should invest in companies that are dirty yet can be pushed towards greener activities.

Clumsy government regulation might not do that job so well, however. If it’s too sudden, and too fast, public companies might go private, with lower thresholds for reporting on their ties to polluting activities. If governments go further still, aiming for drastic or overnight attempts to stop most polluting activity, they will need a clear plan for millions of people left suddenly without work and potential shocks to the financial system as a whole.

The City of London Corporation, which governs the UK capital’s financial district, has tried to lead by example. It’s aiming for its operation to reach net zero by 2027, but to make its financial portfolio net zero by 2040. Its audit and risk committee put the imperative in simple terms: “Not meeting our 2027 target is primarily a reputational impact whereas not meeting our 2040 target could result in a financial impact.”

Speaking anonymously because they aren’t allowed to speak publicly, a senior manager at one of the EU’s largest asset management firms says “that’s about right for all of us”, in reference to any investment that’s dependent on fossil fuels. A fund manager at one of the world’s largest asset managers in the US puts it differently: “We’re burned in any which way you want to think of it if we don’t kill fossil fuels by then.”

Investors don’t think Cop26 will fix the stranded asset problem, however, even with the IPCC report’s severe warnings. Instead, they believe the best that can be achieved is some closer alignment on what a green investment actually means, putting a squeeze on vague definitions which amount to very little impact, branded “greenwashing”.

“The lowest hanging fruit would be the standards”, says Mr Wade, so a green investment in Europe, the US or Asia has “some degree of comparability”.

Keeping fossil fuels in the ground will only happen at a quick enough pace to avoid catastrophic global warming if that’s achieved, investors say. That’s because, according to the same US money manager quoted above, there will be “a carrot for transition, as well as getting stranded with the s*** sticks”.