Investors should strike while the planet is not too hot

In 2007, when the Intergovernmental Panel on Climate Change published its  last reports detailing the causes and effects of climate change, the topic was  on everyone’s lips, boosted by the success of Al Gore’s film An Inconvenient  Truth and the recent publication of the UK government’s Stern Report.

But the issue slipped from the headlines after disastrous 2009 UN climate  talks in Copenhagen failed to deliver on expectations, and the financial crisis  and Arab spring took centre stage.

Progress was blocked because the world’s second-biggest emitter of the  greenhouse gases that cause climate change, the US, refused to commit to cutting  emissions unless the biggest emitter, China, also did so. However, China and  other developing countries said it was the responsibility of the industrialised  world to cut emissions and allow emerging markets to develop.

This impasse allowed asset owners and the investment industry to lessen their  focus on the issue, and to continue valuing fossil fuel companies on a “business  as usual” basis.

However, as the IPCC prepares to release its next set of  reports, starting in September, the impact of man-made greenhouse gas emissions  is edging back up the agenda. It has been helped by a number of recent extreme  weather events, such as last year’s drought in the US Midwest, huge  floods in Pakistan and severe winters in Europe. Furthermore, there are  signs that the deadlock in global policy talks may be easing.

President Barack Obama recently announced plans to limit emissions from power  plants, to stop financing coal-fired power stations abroad and ensure that the  US “uses less dirty energy, uses more clean energy and wastes less energy  throughout our economy”.

Meanwhile, commentators in China have started to hint that the country may  accept binding international targets on its emissions, although analysts warn  that this is by no means certain.

As governments start to grasp the implications of runaway climate change,  there are signs of real change in the actions countries are taking domestically,  says Bob Ward, policy and communications director at the Grantham Research  Institute on climate change and the environment at the London School of  Economics.

China  is moving in the right direction and it is clear that in the US Obama would  like to do more. All around the world, countries have been acting through  domestic measures to move to a low-carbon economy,” he adds.

This is partly because the consequences of exceeding average temperature  rises of 2C – the benchmark for the UN’s climate talks – are becoming clearer.

“The IPCC reports [one on climate science, one on impacts, adaptation and  vulnerability and one on how to mitigate climate change] will remind people of  what is at stake and spell out very clearly the consequences of a rise of more  than 2C,” says Mr Ward.

“The impacts of climate change have been happening even faster than  anticipated – the extent of Arctic sea ice last summer was about half the level  in the 1980s, for example, which is an unexpectedly quick change.”

Climate change will also cause more extreme and more frequent droughts,  floods and heatwaves, higher sea levels, lower crop yields, lower water  availability and increased desertification.

There is a much clearer sense, both in the scientific community and  popularly, that climate impacts are going to be more serious than previously  thought, says Nick Robins, head of the climate change centre at HSBC. “Political  and public opinion has clearly been shifting, which gave Obama the political  space to make his recent speech,” he says.

This is not just an industrialised-world phenomenon. “Governments in Asia  have also begun to shift, driven largely by the very apparent environmental  crises and degradation, and the horrifying impacts on Asia’s population,” says  Jessica Robinson, chief executive of the Association for Sustainable and  Responsible Investment in Asia.

This shift has significant implications for investors, according to Chris  Davis, director of investment programmes at Ceres, a US-based sustainable  investment coalition. “We are seeing a sea-change in the investor landscape, not  least because we are starting to see an alignment of interests on climate  between China and the US, which will be crucial for a global agreement in  2015.”

Governments attending last year’s climate talks in Doha agreed to sign a  global agreement that binds all economies to cut emissions by that date. If it  happens, says Mr Ward, “a global emissions path will be defined that will  effectively create a global carbon budget”.

Analysis by the International Energy Agency and others suggests that to meet  the 2C limit, two-thirds of current fossil fuel reserves “are unburnable and a  lot of companies are sitting on assets that are not worth as much as the market  says they are now”, he continues.

With the world’s asset owners estimated to have 50-60 per cent of their  portfolios invested in high-carbon assets, (defined as oil and gas producers,  miners, utilities, the banks that finance this activity and the manufacturers  that rely on its output) investors may need to re-evaluate the value of their  holdings in fossil fuel companies if that target becomes codified in  international law. If they all decide to sell at the same time, it could lead to  a very nasty market event, Mr Ward warns.

Investors need to change the way they think and behave, argues Mr Robins.  “The primary duty of investors is to build capital discipline. They need to  think about how their capital stewardship will generate good long-term returns  in a carbon-constrained world.”

At the same time, tackling  climate change provides a fantastic opportunity, Mr Davis says. But “the  market really lacks the capacity to channel the hundreds of billions of dollars  of institutional money that are needed into low-carbon investments right now,”  he adds.

“The market has to offer alternatives that are pretty much substitutable,”  says James Cameron, chairman of Climate Change Capital, a London-based  investment manager. Bodies such as the Climate Bonds Initiative are working on  this, but progress is slow.

One quick way to create alternative investment opportunities in the US would  be to make master limited partnerships available to renewable energy and energy  efficiency projects as well as to oil and gas infrastructure, argues Mr Davis.

Ms Robinson says that “in China, the shadow banking issue illustrates that  there is massive demand for attractive products for retail investors that are  relevant to China’s growth. In response to this issue, who is going to provide  the green investment products for these retail investors?”

She also highlighted the urgent need for “stable, consistent and long-term  government policies and incentives that would have a positive impact on  investment flows and lead to better resource allocation – for example, away from  subsidies that favour fossil fuels in place of renewables”.

Mr Robins says that creating a low-carbon economy is about more than just  climate change.

“In the run-up to Copenhagen, the view was that we needed to take action to  deal with the long-term risks. That is an argument that is hard for people to  understand.

“Low carbon also means more innovation, lower healthcare costs because there  is less air pollution, and less water stress because renewable energy uses less  water than fossil fuel plants, while energy efficiency reduces the need for  capital expenditure on new power stations. These things have very attractive  macro implications.”