Asset owners grappling with the challenges of climate change would hope that Winston Churchill’s famous ‘this is not the end’ speech about the phases of war is indeed coming true for the low carbon economy.
It pays these long-term investors to consider the phase we are in as they consider their base case for managing the risks.
We know that all industries have lifecycles. They start with an introduction phase which is heavy in innovation, then move through a growth phase where capital acceleration is experienced before market maturity, commoditisation and eventually consolidation and sometimes ultimate decline.
So if the low carbon era is maybe a decade or so old, where are we compared to the end game? The data is mixed – Bloomberg’s market graphs imply good growth in recent years whilst displaying the volatility of the initial phase, shown by a net reduction in the renewables supply market in 2012 due to supply side cost pressures.
But what is bad news for the supply side is good news for installers…not everyone wins at the same time in infant markets. In pure lifecycle terms, an investment bill of around $10-12trn to solve climate change would imply we are about 10% of the way there and thus, indeed, approaching the end of the beginning.
But there are some other more subjective signs that shifts into the next phase are occurring.
The flood of reports and media around the unburnable carbon and associated stranded assets hypothesis has dragged the climate risk debate firmly into the materiality zone for asset owners, so much so that their fund managers, not known for consideration of risk outside the commission window, have also started to raise eyebrows.We now have data on company value destruction scenarios, HSBC and Citi producing qualified research on stranded assets, Jeremy Grantham suggesting GMO isn’t far from shorting coal and now CERES President Mindy Lubber calling for their investor members to reduce their emissions intensity in a way that is “commensurate and equal to what science tells us we need to do”.
Whilst even many climate advocates would not necessarily suggest the radical path of assuming a 2-degree shift as a base case for asset owners’ climate hedging strategies, the CERES message to its asset owner members is positive and clear – inaction is not an option.
Whether you take your leadership potion from Machiavelli or Schwarzkopf, leaders tend to have the skills of a meerkat in smelling the air to anticipate change. CalPERS’ public endorsement of the AODP climate index to drive competition and differentiation has been followed by significant private endorsement and it is clear that the fundamental driver of an efficient market – data – is not far from becoming embedded in the sector.
The data has a new customer base too – civil society and their huge memberships ready to use it to identify the good from the bad from the ugly.
The 350.org fossil fuel divestment campaign may not be steeped in hard-nosed investment logic (the unintended consequences law is strong when you try to divest from the likes of BHP because of its coal operations and accidentally divest from a large chunk of the metals market).
However its impact on the psyche of the industry is immense and the ‘D’ word is here to stay, even if in more accurate terms it implies underweighting, thematic hedging and all the other tricks of the portfolio trade.
The increasing role of civil society is becoming well understood by the leaders – they realise that pension beneficiaries will not be educated by civil society in portfolio theory or risk analysis and they will not be able to argue one-on-one with the CIOs of their pension funds.
But they will have the fundamentals translated into language they understand and they will be shown how to apply pressure for change. It’s not enough to simply tell members that they do not understand institutional investing and the reason why asset owners allow their fund managers to continue to inflate the carbon bubble is because ‘that’s the way the system works’.
The pressure from civil society will be excellent news for those that have refused to hide in an industry defined by its herd mentality and addiction to the index.
The leaders secretly want this, as many of them have moved early and instinctively.They want and need members to understand that a kind of climate insurance policy, call it what you want for the layman, is common sense.
If the leadership group can continue to accelerate its bravery as CERES did recently, civil society continues to move, gurus underweight coal and so on – then even a market full of unsavoury high discount rates to favour the short-term may not stop the march of the blindingly obvious way to protect long term returns and minimise risk.
It may be seven years since Lord Stern first showed that delayed action would cost more than early action. But recent events would suggest that while it isn’t the end, not even the beginning of the end, it is perhaps the end of the beginning…
Julian Poulter is Executive Director of the Asset Owner Disclosure Project