This is the second article in a two-part art analysis. The first article (available here) concluded that a “labyrinth of scenario analysis could collapse under its own weight or be manipulated by companies that wish to produce their own self-serving results”.
This is why investors need to develop their own ‘house view’ on scenarios. Whether or not they embrace the TCFD in whole cloth, they should define a set of investment beliefs around climate change and craft some plot lines to help guide their engagement with companies and related scenario outcomes. Here is a short list of first-order, big-picture questions that investors may wish to ask themselves as a litmus test in preparation for company disclosures that come through the TCFD process:
1. Is the 2°C scenario (or scenarios) attainable? If so, what is a reasonable glide slope for carbon emissions – how fast will they peak and then start to decline? When might physical manifestations of climate change start to crimp long-term economic growth and the ‘beta’ of market performance? What are the legal, ethical and/or fiduciary consequences of failing to achieve the 2°C limit adopted under the Paris Climate Accord?
2. Will a global price be set on carbon emissions? The Paris agreement has no such requirement. But for those who believe it will come about eventually, what is its expected price trajectory? Should there be an implicit carbon price used in evaluating future capital allocation decisions?
3. Is carbon capture and sequestration (CCS) a plausible mitigation option? CCS could serve as a meaningful offset to ongoing emissions from carbon energy sources, but very little commercial deployment has taken place so far. At what carbon price does this option become economically viable and at what scale might it grow?
4. Setting aside carbon pricing, what is the future price trajectory for oil? In a ‘stress test’ where oil demand peaks in the next five to 10 years and fails to increase in price, what are the implications for capital expenditures and carbon stranded assets?*
5. Related to the above, at what pace will electric and autonomous vehicles be introduced? A half-dozen major auto makers already have announced plans to convert their fleets in coming years. How will this alter demand for oil, driving patterns and transportation infrastructure?6. At what pace will solar and wind power continue to grow? They are now poised to become the lowest-cost sources of electricity, free of subsidies. How much room will this leave for future investments in coal, natural gas and nuclear power?
7. How will the Digital Revolution influence future energy demand? As electrons replace molecules, at what pace will product and industrial operating efficiencies continue to improve? And how will Internet connectivity transform workflows, workspaces, shopping patterns and delivery systems?
8. Finally, what will be the next game-changer in global economic development? Looking back, coal ushered in the Industrial Revolution, and the automobile transformed the 20th century landscape. Now the Internet is changing how we work, play, shop and communicate. What lies beyond the Digital Revolution, with the advent of artificial intelligence, machine learning and virtual reality devices?
Admittedly, these are broad, futuristic questions in their own right – some more pressing than others. But the answers, speculative as they may be, lay a necessary foundation under the TCFD and offer essential guide posts for scenario planning. Without such direction, the process of evaluating company disclosures risks becoming so unwieldy and open-ended as to defeat the underlying objective of the TCFD exercise. While many institutional investors are increasingly passive in their investment strategies, this is an instance where they must place pro-active bets on certain scenarios and preferred courses of action which they believe will secure the wealth of beneficiaries and future generations.
Climate change won’t wait for this to happen. Now is the time for patient capital to address these urgent needs – and make meaningful progress in arresting this growing existential threat to our planet.
*See, for example, Carbon Tracker, “2 degrees of separation: Transition risk for oil & gas in a low carbon world,” June 2017. At prices below $60 per barrel, this analysis finds the net present value of most new oil and gas projects (assuming a 10% discount rate) is negative.
Doug Cogan, formerly with MSCI, is the author of ‘The Greenhouse Gambit: Business and Investment Responses to Climate Change’. He now runs his own climate consulting firm. He is available via email.