Oil company values likely to fall within five years, warn asset managers

Over a year which has seen large banks halt funding for fossil fuel projects, major institutions divest from oil, gas and coal holdings, and oil companies snap up power and renewables companies in a bid to diversify their asset base, research published today by the UK Sustainable Investment and Finance Association (UKSIF) and the Climate Change Collaboration suggests nervousness over climate risk has shot up in financial circles.

The share of fund managers that expect oil company valuations to drop within five years as a result of the energy transition has doubled in the last 12 months, according to the survey of 30 influential fund managers.

It found 89 per cent of managers agreed energy transition risks – such as increasing emissions regulations or growing competition from clean tech alternatives – will significantly impact the valuations of the oil companies in the next five years, compared to 46 per cent when the survey was conducted in 2017. More than 62 per cent said the negative impacts will hit their peak for oil companies in the next five years, and start to impact valuations for gas companies within the next decade.

In fact, over half of asset managers reported that reputational risks are already negatively impacting oil company valuations, and a further 25 per cent predicted they will impact value in the next two years.

The results add weight to warnings from analysts that fossil fuel assets are at risk of losing their value and becoming ‘stranded’ as the world transitions to cleaner energy sources. Carbon Tracker, the analyst house which pioneered the stranded asset or ‘carbon bubble’ theory, has warned a quarter of global oil refining capacity could become unviable and be forced to shut down within 20 years due to falling demand. Meanwhile, changing regulations, and shifting public attitudes, pose further threatsto fossil fuel companies’ valuations.

In addition, public awareness of the issue is already prompting a shift in client demands. Some 71 per cent of managers reported an increase in client interest in climate resilient products over the last 12 months, according to the survey.

“This report shows how fund managers, the experts on whom millions of savers rely, see the climate-related risks to share prices,” said UKSIF chief executive Simon Howard. “Over half of the mangers think climate risk is already a factor affecting share prices and they see more risks crystallising in the short term. It is imperative that owners start to act to protect their investments now.”

However, despite growing awareness of the risks engulfing oil companies, the survey revealed a startling lack of preparedness on the part of asset managers. Despite efforts from the likes of Shell, BP and Exxon to reassure investors their business models are compatible with a low-carbon economy, some 71 per cent of fund managers said they have not yet decided whether they think oil companies can make a successful transition to a low carbon economy, and 41 per cent do not have a strategy for engaging with oil companies on the issue.

This lack of planning is translating in to a dearth of climate-resilient products being offered to the market despite rising client interest, the survey found. The report also notes that most low carbon investment offers are active products, where managers actively try to outperform a specific stock market index, as opposed to passive products, where managers create a portfolio that aims to track the returns of a specific market index. The survey found 17 of the 30 managers are offering climate friendly active products, compared to just five offering passive products.

This is bad news for everyday savers, according to the researchers, as millions of pension holders have their funds invested in lower risk passive products. A report in February last year from the Pensions and Lifetime Savings Association suggested default funds for defined contribution (DC) pensions – which 90 per cent of DC savers subscribe to – are vulnerable to a range of environmental, social and governance risks (ESG), including substantial climate risk.

“Climate related risk is one of the biggest trends affecting investors today and will impact the pension pots of millions of workers,” warned Diandra Soobiah, head of responsible investment at NEST Corporation.

She called on fund managers to offer a wider range of climate resilient products. “It’s vital that pension savers have low cost, high quality options for mitigating climate risk in their portfolios,” she said. “That means that trustees need access to passive or systematic indexes that take account of how companies are preparing for a low carbon future and can engage with those that aren’t doing enough to adjust. There are some asset managers leading the way on this. Clearly this research shows that more can be done.”

One of those asset managers “leading the way” is Legal and General Investment Management (LGIM), one of Europe’s biggest investment managers with almost £1tr of assets under management.

The firm said this week it will “name and shame” companies that do not respond to its warnings to address their climate impact, and warned it will be prepared to divest from those firms that fail to reform.

At the same time it is preparing to “name and fame” companies which are most progressive on climate issues, LGIM’s head of personal investing Helena Morrissey told the City Week conference this week. The strategy forms part of the firm’s “climate change pledge”, she said, and will apply initially to its future fund range.

It follows the launch of LGIM’s climate ’tilt’ fund in November 2016, which was designed to incorporate a ’tilt’ to better address the investment risks associated with climate change.

The message that the low carbon transition poses substantial risks for fossil fuel companies – many of whom number among the world’s richest companies – finally seems to be cutting through to the financial sector. It is a trend that is only set to accelerate as policy measures such as the recommendations from the Taskforce for Climate-related Financial Discosures and new green finance rules from the UK and EU start to take effect and require firms to disclose more information on the climate risks they face.

But it seems the market is still not ready to handle the implications of these complex risk, with more work badly needed to develop climate resilient investment products for everyday savers. It is time for asset managers to take their lead from those progressive firms and investors who are embracing the low carbon transition, and prepare themselves for a future of greener investment patterns.

Culled from BusinessGreen