Investors should quiz companies on shadow carbon price – Al Gore

Launch of major new paper from Generation on stranded assets

Institutional investors should be asking the companies they invest in about whether they have an internal, hypothetical ‘shadow’ carbon price, says former US Vice President and Generation Investment Management co-founder Al Gore.

“Investors should ask companies if they have a shadow price for carbon and, if not, why not,” Gore said on a call with reporters to discuss a new report from Generation on stranded carbon assets.

Gore likened the situation to the sub-prime lending fiasco, where investors made misinformed decisions about the market. “We believe something similar is happening in sub-prime carbon assets,” he said, adding investors are confusing risk with uncertainty, i.e. “if it can’t be measured, ignore it”.

The report urges investors to adopt a four-point framework on stranded assets ahead of a likely “fire sale” of carbon intensive assets. Gore and his Generation co-founder David Blood suggest asset owners “identify, engage, diversify and divest” stranded assets.

That involves firstly identifying how much carbon risk is embedded in current and future investments across all asset classes, then engaging companies on their plans to mitigate and disclose carbon risks. Next would be diversifying into opportunities positioned to succeed in a low carbon economy. Then comes divestment of fuel-intensive assets to mitigate or eliminate carbon risks.

“Investors have a choice – begin re-pricing fossil fuel assets today, or absorb the cost of inaction by suffering the widespread stranding across industries and asset classes in the future,” they say in the report.

Generation, the sustainable investment boutique they founded in 2004, now has around $10bn in assets under management, Blood said.“From the perspective of risk management, it is no longer prudent for investors and asset owners to treat climate change as a peripheral issue,” the pair argue in Stranded Carbon Assets: Why and How Carbon Risks Should be Incorporated in investment Analysis.

Blood said on the call: “This is a conversation with mainstream investors. This is about fiduciary duty and risk management.”

The report follows Gore and Blood’s Manifesto for Sustainable Capitalism in late 2011.

But they realise investors can’t achieve the transition to a low-carbon economy in a vacuum: “Standard setters, regulators, and rating agencies must take concurrent actions to unwind carbon asset risks.” And more work was needed to develop analytical tools to enable investors to quantify financial market carbon risk.

The report acknowledges that many asset owners question the notion of divesting fossil fuel assets, largely due to the industry’s benchmarking practices.

“These indices include fossil fuel assets, which, in the excessively short time horizon typically used to evaluate the funds’ performance, remain highly profitable. As a result, the returns from carbon-free portfolios sometimes appear less competitive than they truly are for long-term investors.

“To encourage asset owners with long term liabilities to divest their carbon assets, adjustments must be made to both the benchmarks selected, and the time horizon used to judge the returns generated by fossil fuel free portfolios.”

The report also recommends that asset owners should broaden the criteria used to evaluate asset managers to include the integration of carbon risk into the investment process.