Asset Management

Fossil Fuels - Lights Turning Amber!

March 2020

Read Time: 5 minutes

2020 is set to be a notable year for investors. A historic transformation which has been underway in the global economy towards cleaner and more resilient economic growth, will see an acceleration led by regulators, creating some momentous implications for investors. A forceful policy response to climate change within the near term is not priced into today's markets. Yet, it is inevitable that governments will be forced to act more decisively than they have so far. We expect the policy responses to gather momentum post the 26th UN conference of Parties (COP26) thus leaving investor portfolios exposed to significant risk. The longer the delay, the more disorderly, disruptive and abrupt the policy will inevitably be1.

 

In November this year, COP26 climate summit will take place in Glasgow, UK. It is being hailed as the most decisive climate change event since the Paris Agreement was signed. The significance of the event is that all countries are to reappraise and upgrade their pledges made at Paris on tackling climate change, and their emission targets through to 2030. Societal consciousness and understanding of climate change today are exponentially higher than where it was in 2015, when the Paris accord was signed. 


In 2015, 196 countries adopted the Paris Agreement with the core objective of keeping the global average temperature rise to below 2°C above pre-industrial levels while pursuing efforts to keep it to below 1.5°C. These countries had also agreed to present revised and more ambitious commitments by 2020 and every five years thereafter. CO2 emissions caused by human activity need to fall by around 45% from 2010 levels by 2030 and reach net zero by 2050.  


Prognosis of action taken on limiting warming and emissions is worrying.


Current trends, relative to the pledges made in Paris are not positive. The average global temperature is now 1.1°C higher compared to pre-industrial times, and there has been a 0.2°C increase in the 2015-2019 period compared to the previous five-year period. Global energy related emissions climbed to a record high in 2018. Even more importantly, according to the Climate Action Tracker, under current pledges, the world will warm by 2.8°C by the end of the century, close to twice the limit agreed in Paris in 20152


Pressure on regulators to embrace climate mitigation and limit emissions will become intense.


The increasing evidence of climate change is expected to intensify the pressure on regulators to achieve carbon neutrality as time seems to be running out to meet 1.5° and 2° Celsius temperature cap scenarios due to rising global carbon emissions.   


We believe that countries will increase their commitments and accelerate this transition at COP26 in 2020. The European Union's new leadership has decided to invest much of its political capital in a plan to position Europe as the global leader in the transition to a carbon-neutral economy. It is likely that in the run up to Glasgow COP26, the EU may announce newer and even more stringent targets on emissions to enforce it is decisively on the path to carbon neutrality.  


What does this mean for investors? 


According to the United Nations Principles of Responsible Investing (UNPRI) the most likely policy levers governments will use to tackle climate change will include bans on coal and a stage by stage ban on internal combustion engine, decarbonization and wider use of carbon pricing. We believe, coal fired power generation, transportation and oil and gas sectors will face high scrutiny. Investors in companies across the fossil fuel value chain must be concerned and be aware of the potential risks.  


Determination to make investor portfolios carbon neutral will pressurize coal, oil and gas companies.  


Investor commitments to carbon neutrality are multiplying fast. Large investors such as Blackrock have openly talked about divesting coal assets.  With rising pressure on moving to net zero emissions by 2050, it is a matter of time before large global investors - signing on to ESG mandates - commit to divesting assets across the fossil fuel value chain. Since its launch by students as a moral call to climate action in 2011, the fossil fuel divestment campaign has become a mainstream financial movement mobilizing trillions of dollars in support of the clean energy transition. Commitments to divest continue to grow rapidly. Today, nearly 1,000 institutional investors with USD 6.24 trillion in assets have committed to divest from fossil fuels, up from USD 52 billion, four years ago. US energy stocks are now underperforming those in the S&P 500 by the biggest margin since December 1941. This trend will reverberate across all markets as ESG mandates increase. 


Transition may be rocky for auto producers.  


Car manufacturers too, particularly in Europe are going through tough times. Growing public angst over climate change is increasing regulatory action and shifting consumer preferences. More governments are setting net zero carbon targets. And, although innovative technologies are appearing at an unprecedented rate, the near-term transition risks for European automobiles appears rocky.  

Author: Abhay Laijawala, MD and Fund Manager, Avendus Capital Public Markets Alternate Strategies LLP

Stay updated with the latest on Avendus