Houston, we have a problem. Man Made releases of greenhouse gases are heating up the planet and shifting the climate. It is causing so much damage, this has led to many people branding it as one of the greatest problems of our age - climate change. While there is broad agreement, even scientific consensus, that greenhouse gas emissions produced by burning fossil fuels are driving climate change. A 2018 Intergovernmental Panel on Climate Change report quantified 89% of global GHG emissions from fossil fuels. In a bid to tackle global warming, 193 countries have signed the landmark Paris agreement, pledging joint action to lower greenhouse gas emissions to net zero by 2050.
Australia, a net exporter of coal, oil and gas, is one of the world's worst carbon polluters on a per-capita basis, the 2019 report from Climate Analytics found. They argue that if you accounted for the emissions we sell to other countries, Australia’s carbon footprint would be nine times bigger than China’s, four times bigger than the US’s and thirty-seven times bigger than India’s on a per-person basis. When you consider stats like this, it is no wonder low carbon strategies and tools to limit your treatment to fossil fuel are quickly becoming an essential part for the Australian sustainability focused investor, and they are accessing strategies that have become necessary in an economy that is moving towards a low carbon future.
Investors are increasingly backing strategies that aid climate solutions and research globally found global assets in climate funds have doubled in 12 months. Outside of Europe, China and the U.S., all other countries are referred to as "the rest of the world". Australia retains its top spot for AUM in the rest of the world category with $2.45bn invested across 18 funds, so clearly local investors are putting their money where their mouths are when it comes to climate solutions.
With that background, can any rationalizations justify an environmentally responsible investment that would contain any fossil fuels in the portfolio? Yes, for now If on the likely controversial. If you’re in the transition process from decarbonisation, there are plenty of reasons a sustainable fund could still have exposure to fossil fuels. Some examples are:
Pledge to transition to net-zero. There are companies that still have fossil fuel exposure, but they have identified a clear pathway to transition or are already moving to net zero. This may involve the sale of fossil fuel assets, investment in renewable energy sources and the retirement of fossil fuel assets or a mix of the three. Contact Energy (NZE: CEN) also, although majority deriving its electricity from renewable hydro and geothermal stations, continues to have some residual exposures to fossil fuel assets.
Engagement. A case for differentiating across fossil fuel companies would be that ownership is a mechanism through which investors can influence company actions by being active owners – the example of AGL (ASX: AGL) that is discussed more in [here in] this report.
Alpha potential. It could be that you will get more alpha generating opportunities from the companies just making the transition to net zero, than from the ones who have already done so I think. The danger here is that companies do not make the change, and the investor is left holding a company that does not perform well or stranded assets. An instance is BHP (ASX: BHP) that reduced its fossil fuel exposure when it sold its petroleum and gas to Woodside (ASX:WDS) but decided to keep its Mt Arthur coal with a plan to close down the asset early – by 2030, as well as making a provision for a land rehabilitation amounting to $700 million.
Investment style. Certain types of investors are likely to be biased towards holding certain companies. Value investors, for instance, look for unloved, inexpensive stocks. For these investors, until very recently, the most beaten-up and hated sector has been the energy sector. Index investors are governed by a benchmark, so if the stocks don’t alter this relative to the given index, the index investors will hold those same stocks at close to benchmark weight.
Strategy objectives. There is a spectrum of sustainability initiatives aimed at different things. Not all sustainable funds are focused on achieving a low-carbon result. From those that seek to remove environmental, social and governance risk through basic exclusions like tobacco or addressing S and G risks such as gender diversification, enhanced workers’ rights or supporting more equitable executive remuneration.
Managing market risk. Additionally, investors looking to diversify could consider having some of the equity of the energy sector, an industry comprising 5.9% of the broad market (ASX 300 as at 30 June 2022). The usual fall-back here is to invest in the best of a sector – but that is certainly going to mean exposure to the stock of fossil fuel assets. Other sectors too have fossil fuel exposure, such as materials which accounts for 23.6 per cent (ASX 300 as at 30 June 2022) and includes companies like BHP, Rio Tinto and Fortescue Metals.
