In October 2014, Mark Carney, the Governor of the Bank of England, made an unusual pronouncement: he said that we could not afford to burn all of the fossil fuel resources that we know exist. To do so would be to invite disaster, from runaway climate change. It was the first time a bank governor has made any such intervention, and marked a turning point in the year.
He said it several times, in private and in public. He refused to spell it out in greater detail, but his words and his concerns clearly imply that companies holding those fossil fuel reserves – of coal, oil and gas – may be left with stranded assets. Their valuations, in other words, are false. Their share prices are based on a presumption that they have assets in the form of vast untapped reserves, but this fails to take account of what will happen what if these unburnable fossil fuels turn into liabilities.
Carney’s opinions have not yet been translated into action by the Bank of England – for instance, by forcing companies to set a value on their potential stranded assets, and warn shareholders of them. But the Bank will be instigating inquiries into whether fossil fuels pose a risk to financial stability.
That will take some time. In the shorter term, some investor activists have been taking matters further. In 2014, the first large-scale campaigns began to encourage individual and institutional shareholders to divest fossil fuel stocks from their portfolios.
Under stock exchange listing rules, shareholders are entitled to know, and companies must report, any “material risks” to a corporation. These risks often include pending lawsuits, patent disputes and unstable regimes in certain countries where the company operates. Within the last decade, there has been a move to include climate change and other environmental factors among the list of issues under “materiality reporting”, thereby forcing companies first to assess and then address their exposure to global warming.
The divestment campaigners have taken this one step further, by arguing that in a carbon-constrained future, fossil fuel companies will have a large stock of stranded assets, in the form of coal mines, oil wells, coal-fired power stations and the like. They may also, at some point, face damage claims on the basis that they knew their emissions were causing climate change, much as happened with tobacco companies that tried to bury warnings on cancer.
The divestment campaigns are driving a new way of looking at financial reporting and shareholder value, argues Stephanie Pfeifer, Chief Executive of the Institutional Investors Group on Climate Change. “Investor engagement on carbon asset risk with the fossil fuel sector is being stepped up. Boards are being asked questions about how their strategies will fare in a range of future energy and climate scenarios and how climate risk is factored into final investment decisions, and into the setting of KPIs and remuneration. There is certainly a growing sense that climate should be central to overall business strategies, not a peripheral concern.”
The motives driving investors are not just to do with ethical concerns, moreover. “Some mainstream investors are choosing [to divest from fossil fuels] on the basis of underlying market dynamics. Other investors are choosing to tilt their portfolios away from high carbon assets towards lower carbon assets, and others are monitoring company carbon emissions and setting targets which trigger engagement and exclusion.”
Dimitri Zenghelis, co-head of climate policy at the Grantham Institute, agrees: “The divestment campaign is certainly raising concerns among institutional investors and sovereign wealth funds. If you look at tar sands and coal stocks, they have long underperformed the S&P 500. Indeed, WWF has a swap instrument that monetises returns from hedging against these stocks, and it has performed very strongly. So markets are pricing in stranded assets risks.”
He adds: “To the extent that prices have not shifted as far as the climate science, and the necessary response to meet 2°C would suggest, that is because markets are not pricing climate risk directly. They are pricing the intermediary of policy risk, and here many are betting that there may be another decade of short returns to be had before ambitious action is taken.”
If these campaigns can force companies to evaluate, declare and – crucially – do something about their stranded asset risk, it would be a massive win for materiality reporting.
The divestment campaigns are part of a wider move to encourage, or in some cases force, companies to take greater account of externalities, which are not currently accounted for within their share prices or business plans. Financial measures are poor proxies for social or environmental goods, and a company can merrily destroy the environment it depends on – air, water, soil, climate – while fulfilling its definition of answering to its owners in terms of pure, short-term, financial gain. This movement has been operating for the past decade, with initiatives such as the Carbon Disclosure Project, which asks large publicly listed companies to assess their greenhouse gas emissions and declare them. From a mere handful of companies doing so in its initial stages, the project has grown to include the vast majority of companies on the UK and US exchanges, and many more in other countries.
Some economists now also favour moving beyond standard measures such as share price and GDP, which they say do not reflect the environmental and social aspects of our economies. Tim Jackson, professor at the University of Surrey, set out the arguments in his book Prosperity Without Growth, saying that current ways of evaluating companies and economic growth were inadequate and failed to take into account externalities such as the effects on the environment. These ideas are now gaining a broader purchase.
One effect has been the beginnings of a move against quarterly reporting, which encourages a short-term point of view and discourages longer term investment, for instance in energy efficiency, which requires an upfront investment that dents profits in the initial quarters but pays for itself only after many quarters have passed. Unilever, for instance, has publicly moved away from quarterly reporting, and Nestle provides only limited reports at the first and third quarter, with fuller half-yearly reports.
Mindy Lubber, President of Ceres, a US-based non-profit sustainability advocacy group, welcomes these moves: “Our capital market’s obsession with short-term returns continues to be a big obstacle. We’re still seeing too many CEOs, investors and analysts focusing on quarterly returns instead of long-term value creation that can be achieved with sustainable business practices and product innovation.”
With these moves, on divestment, materiality reporting and quarterly reporting, campaigners for companies to take a more ethical and sustainable stance are targeting the heart of what makes modern listed companies tick: their share prices. There could be no more compelling reason for businesses to take note.
Fiona Harvey is an environmental journalist.
Image Credit: Light Bridaging / Flickr