The new war on carbon
US President Donald Trump may have turned his back, but world leaders and money markets are becoming alert to global warming’s “terrifying” risks and are taking action.
Immaculately dressed in a dark dinner suit, Mark Carney took his place at the lectern and began with a warning for his audience. “I’m going to give you a speech without a joke,” said the Canadian-born Governor of the Bank of England. “So charge your glasses and prepare yourselves.” In front of him were 160 titans of London’s financial sector. The location was the magnificent underwriting room – known simply as “The Room” – at Lloyds of London, one of the City’s oldest institutions and a bedrock member of the global insurance industry. Long dining tables were elegantly laid with tall candles and bouquets, and a menu of quails’ eggs, truffle dressing, Atlantic halibut and fine wines from the Loire Valley and Burgundy awaited the guests.
It was September 2015, seven years after the peak of the global financial crisis and two months before the Paris climate talks.
Carney, a former Goldman Sachs financier and governor of Canada’s central bank, was speaking to an audience he understood. After advising them to prepare for a serious subject, he spent 25 minutes hauling the issue of climate change in from the easy-to-ignore margins of corporate social responsibility departments and protesting environmentalists and placing it firmly at the centre of the finance sector’s metaphorical boardroom table.
Climate change – the need to both limit its damage and deal with its impact on people and property – was a matter of enormous financial and business risk, Carney told them. Depending on the global response, the financial system as a whole could once again be thrown into turmoil.
He spoke of “stranded assets” – vast reserves of coal, oil and gas worth trillions of dollars on company balance sheets – which had to stay in the ground if the world was to avoid temperature increase of more than 2°C. Between a third and a fifth of proven fossil-fuel reserves, carried on the books of energy behemoths such as Shell, ExxonMobil and BP, was “literally unburnable”.
THREE TYPES OF RISK
For directors responsible for running companies and for investment managers charged with looking after other people’s retirement savings, the risks fall under three headings. First is “transition risk” – the prospect of sudden huge losses on investments as the market wakes up to the fact that moving to a zero-carbon economy will render oncevaluable fossil-fuel reserves worthless. The companies that either own such reserves or rely heavily on energy from oil, coal or gas – the cement, chemical and construction sectors, for instance – account for a third of global financial assets. Thus, if there is a “wholesale reassessment of prospects”, said Carney, it could “potentially destabilise markets [and] spark a pro-cyclical crystallisation of losses and a persistent tightening of financial conditions”.
Second is “physical risk” – the cost to property, assets and people from increasingly frequent severe storms, droughts and heatwaves. In New York, the cost of Hurricane Sandy in 2012, for instance, is calculated to be 30% higher because a warming
There’s “the prospect of sudden huge losses on investments as the market wakes up to a zero-carbon economy”.
climate had already lifted sea level by 20cm.
Finally, there’s “liability risk”. People who suffer damage or a loss as a result of climate change could come after those they deem responsible and sue for compensation, said Carney. Those likely to be in the line of fire of aggrieved litigants are “carbon extractors and emitters” – oil, coal and gas companies and heavy industrial users of fossil fuels – and their insurers.
In other words, climate change not only poses unfathomable dangers to future generations but also presents an immediate material risk to the wealth and security of people like those sharing the splendour of The Room and to the financial system they inhabit.
Carney’s proposed response was both conventional and radical: to lower the risks of massive investment losses and global finan- cial turmoil, shareholders need information. Companies that pump large volumes of carbon dioxide into the atmosphere need to provide their owners with information about how they are managing climate risk and how they are planning to make the critical transition to a world of zero carbon emissions.
Carney’s message drew both rousing support and affronted criticism. Some accused him of “overreach” and “opining” on a topic about which he had no qualifications. Others suggested he should stick to the central bankers’ core business of fighting inflation and fixing interest rates.
But his meticulously calibrated speech was neither a statement of opinion nor an appeal to morality. Instead, it was firmly anchored in years of groundwork by shareholder groups, leading scientists and innovative financial analysts who have translated the physics of greenhouse gases into the mathematics of money.
By crystallising all this into a single message that identifies climate risk as a matter of naked financial self-interest, Carney unleashed a potent lever to help shift the global economy away from fossil fuels and towards a zero-carbon future.
“A DIRECT MESSAGE TO THE WHITE HOUSE”
Twenty months on from that elite London dinner, compelling evidence came from the other side of the Atlantic that the smart money is waking up to the risks of owning fossil-fuel companies and to the need for information on how those companies plan to function in a carbon-constrained world. The day before US President Donald Trump announced he was pulling America out of the Paris climate accord, the board of the world’s biggest oil company, ExxonMobil, lost a battle with well-organised shareholder groups demanding the company come up with a strategy for adapting to the global target of limiting warming to 2°C.
The Exxon vote was “a direct message to the White House”, says Abigail Heron, head of responsible investment at Londonbased Aviva Investors, which is responsible for managing £380 billion in insurance, pension and institutional funds. The significance of the vote was not that it was backed by investors such as Aviva, which has a long track record in climate issues and responsible investment, but that massive global fund managers BlackRock and Vanguard – which had opposed a similar resolution just a year earlier – also voted for the change in the face of opposition from the Exxon hierarchy.
The vote was a sign that action on climate risk has become “socialised in the more mainstream actions of a number of investors”, says Adam Matthews, head of engagement for the Church of England Pensions Board and the Church Commissioners, which manages £7.9 billion on behalf of the church.
“The Exxon vote was the first time you had a large group of investors going against a totemic company. That I think is significant.”
Chris Fox, director of international
investor engagement at Ceres, a powerful Boston-based network of investors who collectively manage US$17 trillion in assets, says the Exxon vote marks a tipping point in putting climate risk centre stage for investors. No longer was it just those shareholder groups with a history of involvement in sustainability issues backing the vote but also funds that “are just completely focused on financial risk and economic opportunity”, says Fox. “We haven’t seen that before.”
In his speech at Lloyds, Carney envisaged the development of “a market in the transition to a 2° world” based on transparent information from companies about their climate-change footprint and how they are preparing for a zero-carbon world.
That “market” came a significant step closer last weekend when the G20 – or, as many dubbed it, the G19, given the isolation of Trump over his rejection of the Paris accord – included the Task Force on Climate-related Financial Disclosures in its new climate and energy action plan. Set up by the global Financial Stability Board – chaired by Carney – and led by former New York Mayor Michael Bloomberg, the task force published its final recommendations in late June. Aiming at shining a light on the carbon buried in company accounts, they mean boards of directors will be expected to show how they are dealing with climate issues, how their companies are preparing for a world that must rapidly replace fossil fuels with renewable energy and how directors are incorporating climate-related risk management into their core duties.
In other words, climate risk will have to be dealt with alongside all the other risks that boards are responsible for managing, such as revenue, borrowings, health and safety, and regulatory compliance.
For now, the regime will be voluntary, but already pressure is building from some shareholder groups to make it mandatory.
Will it drive down carbon emissions? Not instantly, but allowing the “sunlight” of disclosure to shine on companies’ climate risk will ultimately drive up the cost of capital for those firms that are failing to adapt to the new world order, says Adrian Orr, chief executive of the New Zealand Superannuation Fund.
“When you allow investors to make decisions on better information, then it means those who are not behaving as best they could will pay a higher price for their capital and their businesses will struggle, and those with good behaviour will get access to the capital. Pricing [gives] the best distribution of demand that you can get.”
THE TOTAL CARBON “BUDGET”
It has been a long time coming and is not a moment too soon, given that the transition to a low-carbon economy is expected to require about US$1 trillion in investment every year for the foreseeable future. To achieve the Paris goal of net-zero emissions by 2050, global investors have to replace “trillions of dollars of high-emitting assets with low-emitting assets”, according to the Asset Owners Disclosure Project, an Australian-based initiative that for the past decade has been monitoring “climate-change capability” among investors such as pension funds, insurance companies and sovereign wealth funds.
In the US, Ceres has been trying to use shareholder power to pressure companies into more sustainable business models since 1989. Fox says climate change was seen as an “obscure” issue back then, although that started to change during the 2000s when Ceres and other investor groups, with the backing of the United Nations, began reframing climate risk as a matter of
People who suffer a loss as a result of climate change could come after those they deem responsible and sue.
corporate governance, which pension fund trustees and directors had a fiduciary duty to respond to.
A further breakthrough came in 2009, when two groups of scientists simultaneously worked out how many tonnes of carbon could accumulate in the atmosphere before the temperature increase went beyond 2°C. The research, published in Nature, firmly quantified a total carbon “budget” – a finite amount of carbon that humanity could emit, above which warming would go beyond the disastrous 2°C threshold.
That budget was roughly a thousand gigatonnes of carbon, of which mankind had already emitted about half.
This powerful new information was then picked up by a tiny group of financial analysts in London who translated it
“Those not behaving as best they could will pay a higher price.” “It’s utter madness for markets to be carrying this kind of risk.”
into a calculation of financial risk. Carbon Tracker Initiative, a think tank founded by long-time market analyst Mark Campanale, had been trying for years to make investors understand the financial implications of breaching ecological limits, including in such areas as the financing of tropical rainforest logging and overfishing.
When it came to climate change and the potential global supply of fossil fuels, “nobody had done the maths”, Campanale tells the Listener. But the new research on the total carbon budget made it possible to run the calculations. With financial backing from philanthropists, Carbon Tracker was able to hire the analytical brainpower needed to go through the published reserves of the world’s biggest publicly listed oil, coal and gas companies and figure out how much of those reserves could be burnt while remaining within the global carbon budget.
The conclusion was stunning: the world’s fossil-fuel companies owned reserves which, if burnt, would dump 2795 gigatonnes of CO into the atmosphere, but the carbon budget showed there was room for only a further 565 gigatonnes.
In other words, only 20% of the reserves owned by those companies could be dug up, sold and used as energy for transport, electricity and industry.
UNBURNABLE CARBON
Suddenly, there was a new reason to be worried about carbon emissions, articulated in compelling language designed to capture the attention of the financial markets. Carbon Tracker’s report was titled “Unburnable Carbon”, and the 80% of reserves that cannot be used is a “carbon bubble” and will become stranded assets. Continued investment in fossil-fuel reserves is therefore pushing “climate risk onto the pension funds of ordinary citizens”.
Campanale says Carbon Tracker wrote the 2011 report as “a letter to the Bank of England”. The 2008 global financial crisis had proved that the financial markets were not self-managing and revealed the disastrous consequences of regulators failing to monitor stability risks. “We said that to control this [carbon risk], we need financial regulators to step in and say that it’s utter madness for markets to be carrying this kind of risk.”
Initially, few took the report seriously, and some were horrified. Campanale says the think tank printed only 100 copies and organised a modest launch at a London law firm. “The night before, a senior partner rang me and said, ‘I can’t believe we have allowed you to launch this report in our office. None of us will be able to turn up because what you have written undermines the core business of our biggest clients,’” he recalls.
One commentator in the Financial Times waved off the notion of a carbon bubble and stranded assets as “bollocks”. Even some activist investor groups found the report too radical.
But gradually the logic of Carbon Tracker’s numbers spread. American author and climate activist Bill McKibben, the founder of 350.org, read the report and rebranded its message in a long essay in Rolling Stone as “global warming’s terrifying new math”. This became the springboard for the global divestment movement, which lobbies investors to dump their holdings in oil, coal and gas companies and which now has the backing of shareholders and institutional investors worth US$5 trillion.
And big mainstream finance houses started running their own numbers, producing reports that backed up the case that climate risk was a here-and-now concern for investors and the financial markets. Citibank put the value of potentially stranded fossil-fuel assets at US$100 trillion; the Economist Intelligence Unit figured out how much damage global warming would knock off asset values (US$4.2 trillion in 2015 terms); Mercer predicted a collapse in values in the coal and oil sectors and came up with a guide to investing in a time of climate change.
Carbon Tracker, meanwhile, recruited an expanded team of ex-Wall Street and City of London financial analysts into its
crammed London Bridge office and continued pumping out carefully researched reports that pushed the reality of climate risk under the noses of investors and regulators. Soon after the inaugural “carbon bubble” report, it calculated that almost US$700 billion was spent in 2013 by fossil-fuel companies on finding new reserves, even though 80% of what they already had on the books could never be exploited. Continuing to invest on the assumption of unrestrained carbon emissions in a world that was compelled to decarbonise was akin to the “emperor’s new clothes”, argued Carbon Tracker’s chief analyst, James Leaton, a former PricewaterhouseCoopers consultant.
Gradually, the Bank of England under Carney, the marathon-running financier who took over as governor in 2013, started taking notice, culminating in his seminal speech at Lloyds in the late British summer of 2015 and his establishment of the climate-related financial disclosures task force.
“HUGE PROGRESS” IN AWARENESS
Agitating at company annual meetings for action on climate change was by then becoming an increasingly popular activity for shareholder groups. Stephanie Pfeifer, chief executive of the International Investors Group on Climate Change, says her London-based group has gone from representing 25 European institutional investors managing €1 trillion in assets 10 years ago to 140 and €18 trillion now. At the annual meetings of BP and Shell in 2015, shareholder resolutions demanding disclosure on climate risk and plans for adapting to a zero-carbon world passed with overwhelming majorities and the backing of the companies’ management.
She believes there has been “huge progress” in shareholder awareness that climate risk equates to investment risk.
At Ceres, Fox says the landmark Exxon vote in May this year will be a springboard for heightened investor pressure, particularly between now and 2020 when global leaders agree that carbon emissions must peak and then fall steadily towards net zero.
“We can apply the lessons of Exxon to other large emitters … in a way that makes it impossible for [fossil-fuel] companies to continue business as usual and which we hope will lead to decisions, as have already been taken by some large energy companies, to start purchasing renewable energy businesses and really change their portfolios. We think there will be a shift away from high-carbon assets to low-carbon assets and we are trying to accelerate that shift …
“It is a risk issue, but the smartest companies are seeing it as an opportunity in the transition to low carbon.”
By fortunate coincidence, the momentum among shareholder groups has started to build just as the cost of investment in solar and wind energy has plummeted, making them increasingly competitive with fossil fuels.
Although Trump’s decision to pull the US out of the climate accord is disappointing, Fox says, companies are holding firm
Continued investment in fossil-fuel reserves is pushing “climate risk onto the pension funds of ordinary citizens”.
on the Paris goals. “Major companies are holding together now about how we can continue to implement the Paris commitment despite Trump’s failure to lead.”
GREENWASH OR PROGRESS?
But backslapping among shareholder groups is premature, warns Catherine Howarth of ShareAction, a London non-profit group that tries to influence company behaviour through shareholder voting and that recently took over the Asset Owners Disclosure Project.
Despite the overwhelming shareholder backing for climate disclosure at the BP and Shell annual meetings in 2015 and the vote against the Exxon board by 62% of shareholders, Howarth says these achievements are merely a first step towards meaningful change. She says behind the bravado sits a continued “business as usual” strategy among the fossil-fuel companies which, if left unchallenged, would take the world to 3-4°C of warming. Two years on, neither BP nor Shell has yet proposed a “convincing strategy for commercial resilience in a low-carbon global economy”, she says.
She points out that at this year’s BP and Shell annual meetings, shareholders were asked to vote for executive pay policies