Pensions heading off climate cliff

Many of the world’s biggest economic institutions are sounding the alarm on the accelerating climate threat barrelling down on the global economy. The systematic failure to put an effective price on climate pollution has created, in the words of Sir Nicolas Stern “the greatest market failure the world has seen.”

Institutional investors representing trillions of dollars in managed assets are joining the call of world institutions, asking for the market certainty that a global price on carbon would create.

Banks are starting to take note. Last week, the financial sector was warned by one of its own about the carbon bubble.

HSBC, the world’s second largest bank, issued a report last week stating that oil and gas multinationals could lose up to 60 percent of their market value if the world cuts its carbon emissions to limit climate change.

Director of the International Monetary Fund (IMF) Christine Lagarde told the World Economic Forum in Davos, Switzerland: “Unless we take action on climate change, future generations will be roasted, toasted, fried and grilled.”

Lagarde stated, “Good ecology is good economics. This is one reason why getting carbon pricing right and removing fossil fuel subsidies are so important.”

The president of the World Bank also called for climate change to be a focal point for the Davos meeting “because global warming imperils all of the development gains we have made.” Other global economic institutions calling for action include PricewaterhouseCoopers, the UN, and the International Energy Agency.

Because government inaction on climate change is creating unnecessary risk in financial markets, a growing number of major institutional investors are starting to act. More often and more loudly, they are asking governments to take actions such as a price on carbon and public funding to unlock private capital for low carbon infrastructure. They are forming networks like the Global Investor Coalition on Climate Change which represents investor networks in Australia/New Zealand, the European Union, Asia and the UN and moves more than $22.5 trillion in assets. Such groups are seeking high-profile roles in climate change discussions.

The mother of all economic bubbles: ”unburnable carbon”

Valuations of fossil fuel companies are based on known reserves, but at least half of those known reserves will need to stay in the ground to prevent unacceptable consequences of climate change. The Potsdam Institute states that 80% of fossil fuel reserves will have to stay in the ground to prevent runaway climate change. Nick Robins of HSBC bank, stated “at least one-half of fossil fuel assets will have to be left in the ground. We’re still pricing [companies in the extractive sector] as if they were all going to be exploited.” According to the International Energy Agency, over two-thirds of today’s proven reserves of fossil fuels need to still be in the ground in 2050 in order to prevent catastrophic levels of climate change.

Consequently unburnable carbon is an asset on the books with a value that can never be realized  (unless we go the roasted, toasted, fried and grilled route). It creates a bubble, like the subprime mortgages bubble and the dot.com bubble, but in a sector that is larger and even more deeply woven through the global economy. No one wants to get caught out when the bubble bursts, and government action is the only way to create a slow deflation, by forcing the fossil fuel industry and its consumers to pay the presently externalized costs of its product through a price on carbon.

Pension funds caught between long and short term duties

Pension funds, which manage about US$30 billion of dollars for their beneficiaries, are among those calling for climate action. They have a duty to treat beneficiaries “even handedly,” regardless of age, but the bias toward short term returns can short shrift younger plan members. For example, if an asset manager makes assumptions about the future that contradict the scientific evidence, the fund may not be able to meet its obligations to a 19 year old plan member who is going to work his full career and then expect to retire and receive a pension cheque. Research anticipates systemic shocks to regional and global economies if governments don’t act, and these will impact his expectations.

On the other hand, asset managers have a fiduciary duty to seek optimal returns on their investments in the near term. Most low carbon investment opportunities will not pass that test until governments put strong, stable climate policies in place. Until then, pension funds can’t meet their duties to both young and old pensioners.

Actions by institutional investors

In addition to banding together for political clout, institutional investors are researching how climate will impact their portfolios, engaging companies to disclose their carbon and reduce emissions, creating funds for exclusively climate friendly stocks, issuing statements to world governments and calling for public funding to unlock private capital.

Example: The Mercer Climate Change Report

International investment institutions representing around $2 trillion in asset management commissioned a global consulting firm to report on how climate change will impact their portfolios. The Mercer Climate Change Report found that traditional methods for determining investment risks don’t account for climate risks because those risks are forward looking and full of uncertainty. It concluded that climate change could add 10% to portfolio risk over the next twenty years and recommended about 40% asset allocation to “climate sensitive” sectors such as infrastructure, real estate, private equity, agricultural land, and timber land.

Many Canadian funds are shifting their investments toward these sectors as a way to manage a variety of risks to the long term needs of plan members. 

Example: Direct engagement

The Carbon Disclosure Project is the biggest funder coalition in the world with $78 trillion under management. It encourages corporations to voluntarily report their carbon emissions and pushes market regulators to raise the standard of disclosure of emissions. It’s utility is limited by the fact that it only reveals operational carbon emissions, not the carbon dioxide that will be emitted when fossil fuel products are burned.

The British investment company CCLA, which specializes in investment management for charities and faith organizations including the Church of England, leads the way. It actively encourages companies to not only disclose their carbon but also to manage their emissions with target setting and energy efficiency. It also rates companies on a scale from A to E based on their actions to mitigate climate change.

Some institutional investors directly ask governments for action. For example, bcIMC called on Canada’s federal government to enact an absolute target reduction in line with the IPCC recommendations and to establish a price on carbon.

Cities, with hundreds of millions invested directly and through their pension funds, are taking action as well. Seattle Mayor Mike McGinn told the city’s pension fund managers to begin divesting from fossil fuel companies.[xiii] This week, Vancouver City Council unanimously passed a motion to align the city’s cash investments and pension plan with the city’s core values. That pension plan is managed by bcIMC which invests in numerous oil sands and oil sands pipeline companies, a story first reported in the Vancouver Observer and eventually picked up by the Vancouver Sun.

Example: call to government action

In 2011, the Institutional Investors Group on Climate Change (consisting of 268 institutional investors) called on governments to shift the risk-reward balance of low carbon investments: 

Private investment will only flow at the scale and pace necessary if it is supported by clear, credible and long-term policy frameworks that shift the risk-reward balance in favour of less carbon-intensive investment.

The statement asks for: 1) domestic policies that will catalyze investment in renewable energy, energy efficiency and other low-carbon infrastructure; 2) international agreement to set the global rules of the road and allow financing to flow; and 3) international finance tools to mitigate the risk of climate-related investments in developing countries.

Carbon Trackers recommends the further step of integrating carbon limits into the accounting treatment of fossil fuel-based reserves to alert investors of unburnable carbon.

Example: call for public funds to unlock private capital

The Institutional Investors Group relied on research that shows public finance tools can leverage between 3 and 15 times the same amount in private investment. A recent report commissioned by the World Economic Forum called for US$34 billion in public funding – less than the $50 billion recently approved by the US Congress to rebuild after Hurricane Sandy – to mobilize private capital of $570 billion.

Hey, let’s go!

Institutional investors have an appetite both for the money to made in climate stabilizing investments and for climate mitigation. Generally, the investment trend is in the right direction. Global investment in renewable energy in 2011 rose to a new record $257 billion, up 17 percent from 2010. The US closed in on China as the leading investor in renewable energy with a 57% increase in outlays to $51 billion. Unfortunately for Canada, it’s investment of $4.1 billion in renewable energy represented a 13% decrease from the year before. But investment is far below what it needs to be to protect the climate and investment in fossil fuel infrastructure still outpaces green investment.

Those demanding action on climate change just don’t fit Minister Oliver’s portrait of radicals with an ideological agenda to sabotage a national interest which has been reduced to development of the oil sands. Environmentalists may be sounding the alarm but they are joined by the world’s most respected organizations and by institutions that control vast amounts of wealth. It’s time for governments to heed the call and move markets out of a high risk carbon bubble, through a period of cost adjustment and into a time of certainty and stability. It’s their job.