For some, the massive write downs of oil & gas assets recently are just the start of what looks set to be a painful death for the fossil fuel industry. If we’re to take the predictions of the renowned think tank Carbon Tracker at face value, increasing climate action and the rise of cleantech is likely to slash the value of fossil fuel assets by nearly two thirds. In such a case, the investors who’ve been attempting to usher oil & gas giants down the path marked “transition” will be doomed to take a hit too.
But what is the flipside here? Just this week, we’ve seen Tesla’s market value surpassing Exxon’s – a sign investors are increasingly betting on the transition. Where will further disruption to the fossil fuel sector come from, and is it investible? Can investment in green be the other side of the coin to fossil fuel divestment?
Fossils out, green in?
Kingsmill Bond from Carbon Tracker says you can’t just replace A with B. “Oil & gas extraction is an extremely rent-intensive industry and generates a lot of super-profits, while renewables don’t, because there’s so much more competition. Fossil fuel extraction is also four or five times as inefficient as renewables, so you need a lot more of it,” he explains. “It means by definition, with renewables, there’s a lot less to invest in.”
Meanwhile, Lee Clements, Head of Sustainable Investing Solutions, ISD at London Stock Exchange Group, says the total size of the green economy is estimated at around 6% – around the same size as the fossil fuel sector. But he has some caveats: “Given the rollback we’ve seen in the energy sector, you are changing your risk profile if you go into these green opportunities. In terms of size and geography, the opportunities are quite broad, but they do tend to be focused in certain sectors – technology, utilities and so on.”
“You want to take out from one area and put into another area, but you want to do that without necessarily significantly changing the risk profile. So for us, it's become a combination of trying to understand these things, trying to have the data or generate the data to do it, and then have methodologies to translate that data into choices for index weighting.”
What is green anyway?
Brenda Kramer, Senior Advisor Responsible Investment at Dutch asset manager PGGM, says the challenge in finding “dark green companies” is not only that there has been no common definition of green (although the EU taxonomy is attempting to change this) – it’s that a company, especially in listed equities, can undertake both green and not green activities.
So, for example, a wind turbine manufacturer might make 100% of its revenues from “green” capital goods, but control less of the market than the wind power arm of a big diversified utility that also has significant fossil-based operations, making it complex to decide which company is greener in absolute terms.
She says PGGM has been working with revenue-related data with a view to helping achieve its impact targets. Where data is unavailable, the Dutch pension giant has used estimates. “That originates in the era where we didn’t have any data at all. Now with all the new regulations, like the EU Taxonomy and Non-Financial Reporting Directive, I think the amount of, and quality of, revenue data will increase quickly, so it will enable you to be more precise in your final judgments of how green a company is – and how green your portfolio is.”
Not all disruption is created equal
Even if you’ve got a bonafide green company on your hands, it doesn’t mean it’s necessarily a wise investment. Clements says in his former position as a fund manager, he saw a lot of green companies come and go – and lots of “disruption” done without profits.
He gives the example of solar, back in the mid-2000s: “Back then, a lot of the German companies were doing very well – disrupting coal and other areas and benefiting from subsidies. Then they themselves were disrupted by the Chinese manufacturers. A lot of the German listed companies like Q-Cells ended up going bust. So there are some areas where you see it working at different points in the cycle, but not forever.”
He says, for investors, making predictions at a granular, decision-useful level is a big challenge. “It’s very, very difficult to predict [disruption] with a huge amount of specificity,” he says. It could be because of unforeseen policy shifts, he adds, “like when China suddenly decided to put a 50% subsidy on LED manufacturing units”. Equally, it could be coming from intangibles: “With electric vehicles and batteries, we saw a lot of companies come and go until Tesla came along. Elon Musk has created a huge brand awareness that has really lit up that market, while there’s a whole closet full of failed electric vehicle companies which, arguably, from a technology point of view, are no better or worse than the others.”
What’s an investor to do?
PGGM’s Kramer says one way financial institutions can contribute to the transition is by investing venture capital in small companies that are making a difference. The problem is, that’s not something pension funds and other fiduciary investors often feel comfortable, or allowed, to do. “We don’t necessarily have the expertise and risk appetite to do that. We have to be able to pay pensions all the time, so there’s not much space to take that kind of risk on a large scale,” she says.
She adds that use-of-proceeds bonds are often a more feasible way of financing disruption. “Earmarked bonds and debt is a very good way to speed up this change. There’s a reason the green bond space has been growing so quickly – it’s because investors are interested in knowing what their money is used for and are looking for positive impact.”
Meanwhile, Bond says only reallocating to green misses the point Carbon Tracker is making: it’s a financial argument, not a moral one.
“Our argument is that investors should underweight the [fossil fuel] sector as it is likely to continue to underperform. The second argument is that they should reallocate that capital to the sectors of the future. That doesn’t all have to be in energy – you’d struggle to do so anyway. There’s just not enough opportunities. So you might want to relocate across your portfolio or to other sectors as well as reallocating some of these new attractive growth sectors. That’s the strategic view.”
The passive route
Clements has a different approach. “It's quite easy to throw the utility, heavy industrial and oil & gas players out of an index to replace them with Amazon or a software company, or more banks or something, and on a total portfolio level you look great. But does that necessarily have a benefit from an environmental point of view?”
He says FTSE’s green revenues data is being used to address this issue within broader indices.
“With our Global Climate, Transition Pathway Initiative, and Smart Sustainability index series, we reduce weighting of companies with high carbon intensity or exposure to the oil & gas sector, and then put the weighting back into areas like green revenues, which are quite broad – from renewables to water.”
He says, in times of rapid change like these, long-term investors should stay informed and diversified.