Consensus on divestment of fossil fuel holdings being the last resort is looking shaky.
Perhaps more than any previous iteration, COP26 took place in the full glare of global media attention. This was partly due to the pandemic-induced delay, but it was also a function of a much wider appreciation of the urgency of the climate crisis among politicians and the public.
Suddenly almost everyone had an opinion on how asset owners and managers should do their job. Long-term investors came under intense pressure, before and during COP26, to accelerate the decarbonisation of their portfolios by divesting from firms involved in the extraction and production of fossil fuels.
Investors themselves hold a spectrum of views on the ‘divestment versus engagement’ debate, although their approaches are increasingly driven by the common objective of limiting real-world carbon emissions, rather than just those present in their portfolios.
Many make the case for extended and deepened engagement with carbon-intensive firms, arguing that the pace of their transition will only slow if influence is ceded to shareholders more focused on short-term profits than sustainability.
Exclusion policies are common, with investors increasingly withdrawing from any new exploration, having previously focused on barring specific activities such as tar sands or Antarctic drilling. But apprehension of the steep road to halving global emissions by 2030 is also forcing asset owners to reconsider the most effective tactics to encourage business model transition in firms once considered portfolio stalwarts.
As the 2022 AGM season approaches, the debate will continue to heat up.
For Mark Campanale, Founder of UK think tank Carbon Tracker, the only role for engagement “is to put in place ‘wind down’ strategies for the new green economy”.
COP26 may not have put the global economy firmly on the path to limiting climate change to 1.5 degrees Celsius, but it did signal the intent of governments to support the growth of renewable energy and green technologies. Against this backdrop, continuing to invest in coal, oil and gas, suggests Campanale, is bad for business as well as the environment.
Citing the anecdotal example of a large insurance firm which has seen an 80% decline in the value of its investments in coal-fired power over a six-year period of engagement, he says investors should take a different perspective.
“The insurance firm made the mistake of thinking this is about responsible corporate behaviour, when it’s actually about technology shift,” Campanale explains. “It’s a bit like saying to the people running canals that they need more responsible canals to deal with the rise of railways.”
In the run-up to COP26, Carbon Tracker released a report which estimated that more than a fifth of European gas-fired power plants and nearly a third of US units are lossmaking, predicting also that most gas plants currently planned or under construction will never recover their initial investment.
The report said that more than US$24 billion is at risk in the US and nearly US$3.5 billion in the UK, even if plants run for their full planned lifetime, noting that governments’ existing net zero 2050 commitments would require most gas plants to close early without significant progress in abatement technologies.
Powering past fossil fuels?
Both in terms of the pledges of individual governments and the ambitions of multilateral initiatives, many announcements at COP26 sought to consign fossil fuels to history.
Many of the pledges made by world leaders at the start of the Glasgow summit included commitments to switch energy generation toward renewable sources. India’s plan to reach net zero by 2070, for example, rested partly on an interim target for half of the country’s electricity to be generated by renewable sources by 2030. To this end, India’s renewable energy capacity will need to increase to 500GW from less than 140GW today, with projected CO2 emissions falling by a billion tonnes over the rest of the decade.
India was one of the countries behind the last-minute change to the text of the new Glasgow Climate Pact, signed in ‘overtime’ on 13 November, which committed signatories to ‘phase-down’ unabated coal power, as well as the phasing-out of inefficient fossil fuel subsidies. Between the opening pledges and the final pact, the summit also saw many countries and public and private finance institutions commit to “ending international public support for the unabated fossil fuel energy sector”.
One of the largest collective moves during COP26 was the launch of Beyond Oil and Gas Alliance (BOGA) a group of countries aimed at setting an end date for oil and gas exploration and extraction and curtail new licensing. Members include Costa Rica, Denmark, France, Greenland, Ireland, Quebec, Sweden and Wales as core members, with California, New Zealand and Portugal as associate members. Italy was a ‘friend’. BOGA aims to use COP26’s momentum to create a community that can deliver commitments to a managed phase-out of oil and gas production.
Existing groups also saw renewed vigour in their efforts to wind down use of fossil fuels. The Powering Past Coal Alliance (PPCA) celebrated dozens of new members post-COP26. There were 28 new members, PPCA announced, taking the membership to 165. “We witnessed at COP26 so many accelerating their coal phase-out, cancelling coal pipelines, committing to no new coal, ending coal finance, and the pledge to phase down coal included in the final agreement,” it said. “The end of coal is now in sight, but it is still not fast enough to keep the global temperature increase to 1.5 degrees Celsius.”
Many financial institutions joined the alliance including NatWest, HSBC, Lloyds Bank, Fidelity International, Impax Asset Management, Generation Investment Management, Ethos Foundation, SCOR Global Investments, Vancity, United Church of Canada, and Export Development Canada.
Differences in sentiment
The Principles for Responsible Investment (PRI) said COP26 won an incomplete victory. “COP26 and the Glasgow Climate Pact made progress, creating hooks for accelerating policy in the early 2020s, yet is not a breakthrough in efforts to limit climate change to 1.5 degrees Celsius or well below 2 degrees Celsius.” The PRI added that it was now more vital that nations come back to the negotiating table next year on issues such as Nationally Determined Contributions (NDCs).
“We’ve seen commitment to policy action on countries’ NDCs, reversing deforestation, transitioning away from fossil fuels, curbing methane emissions as well as the financing of increased resilience and clean energy solutions. It’s now vital that we see these commitments lead to decisive action,” said outgoing PRI CEO Fiona Reynolds.
Andy Howard, Schroders’ Global Head of Sustainable Investment, suggested that the first-time reference to coal and fossil fuels in the Pact was less a cause for celebration and more a recognition of the inevitable.
“In reality, getting to net zero or a 1.5-2 degree Celsius pathway meant that at some point fossil fuels were always going to have to be removed from the energy mix. That’s one of the requirements, certainly of unabated fossil fuels, because net zero means removing fossil fuels in their entirety,” he said.
Signs of differences in sentiment among investors were evident before and during COP26.
In the week before delegates gathered in Glasgow, Dutch pension fund ABP said it would sell its €15 billion exposure to fossil fuel companies, noting that engagement was not yielding a sufficiently fast transition toward decarbonisation.
Paris-based NGO Reclaim Finance issued a report which argued that the 60+ members of the UN-backed Net Zero Asset Owners Alliance should take a more proactive approach with fossil fuel firms, setting more ambitious targets.
Chair Günther Thallinger robustly defended the alliance’s stance, asserting, “A simple ‘no investment in fossil energy – especially oil and gas’ would create social and economic inequities, and thus would ultimately slow down the crucial transition into renewable energy.”
Moving the debate
Sustainable Investments Campaigner Lara Cuvelier clarified to ESG Investor that Reclaim Finance and other NGOs did not oppose divestment in principle. “But engagement alone without divestment is not effective,” she said “[Using] divestment is moving the debate. We don’t think engagement is ineffective. We push for both strategies.”
Despite some differences, investors and campaigners alike increasingly recognise the need for tougher sanctions when engagement efforts fail to make meaningful headway. Cuvelier proposes that engagement can be switched to divestment if clear red lines are crossed, for example if certain target dates for transitions are not met, or if new carbon-based projects are undertaken despite promises on green energy.
In a further effort to demonstrate clarity of intent, a group of UK-based asset owners from the charitable and educational sectors launched the COP26 Declaration on 8 December, at a side event held a stone’s throw from the summit. The declaration lists the signatories’ climate-related expectations of asset managers, including active engagement with investee companies to ensure transition plans are aligned with 1.5 degrees Celsius pathways, including 2030 targets. It also calls for escalation policies to be developed and disclosed, providing details on “how and when engagements will be escalated”.
This reflects a consensus that still holds across most institutional investors, that divestment should be the last resort. Caroline le Meaux, Global Head of ESG Research, Engagement and Voting at Amundi, says debate about divestment is healthy, but asserts the value of engagement.
“If you’re divesting, you can’t vote against,” she says. “You don’t have influence over the board. Yes, you might impact the value of the company and its share price at the beginning – but at the end of the day, if only the non-ESG investors are left then who is going to push the agenda?”
How fast is fast enough?
In the aftermath of COP26, insurance giant Zurich announced it would wind down some of its oil and gas investments. In mid-November, the firm said it will no longer insure new greenfield oil exploration projects unless “meaningful transition plans are considered to be in place”. The company also committed to no longer underwrite oil and gas drilling and production in some parts of the Arctic.
Underneath the headlines, the fine print reflects the nuanced and tangled reality. Campaign group Insure Our Future said Zurich’s new policy allowed the insurer to continue “business as usual on oil and gas expansion, and its Arctic and tar sands policy only excludes an estimated 10.4% of short-term oil and gas expansion plans”.
“While we acknowledge Zurich’s announcement as a first baby step in the shift away from oil and gas, it needs to urgently take more meaningful action,” said Insure Our Future, calling on the firm to stop insuring any new oil and gas projects.
Other large financial institutions also made commitments to distance themselves from the fossil fuel sector. France’s La Banque Postale said it is moving toward a total withdrawal from fossil fuels by 2030, while BPCE is decarbonising its portfolios in parallel with directing €21 billion to finance buildings energy efficiency, renewable energy and green mobility.
Caisse des Dépôts said it would exclude oil and gas companies without a credible climate risk strategy from its equity and bond portfolios. A coalition of the six largest French banks will cease all financing of the extraction of oil and gas from shale and tar sands from January.
Beneath the surface of the divestment versus engagement debate lurks the question for investors, ‘how fast is fast enough?’ For Carbon Tracker’s Campanale, the answer lies in the scientific evidence, specifically how to allocate the remaining carbon budget available while limiting climate change to 1.5 degrees Celsius.
“All of us interested in dealing with climate have got to knuckle down. We need to focus on things like a carbon price at the point of production or production permits within a finite carbon budget,” he says.
Such questions go beyond investor engagement with oil and gas majors to the negotiation tables of future COPs, which must handle differences between the countries reliant on the fossil fuel industry and those put at existential risk by it. “We started a couple of decades too late, but as a planet, we have some time to catch up if we can do it in the next decade,” says Campanale.