Green investors need to get their hands dirty

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6 minute read

A worker plants seedlings for reforestation at Huayquecha Biological Station near Paucartambo, Cusco, December 5, 2014. REUTERS/Enrique Castro-Mendivil

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LONDON, June 22 (Reuters Breakingviews) - The energy transition is potentially big business. To have a good chance of limiting global warming to 1.5 degrees Celsius above pre-industrial levels, the globe needs to be spending $5 trillion a year on new power sources and infrastructure by 2030, according to the International Energy Agency. The capital to do so is poorly directed, though. To make a difference, investors will have to get their hands dirty.

There’s no shortage of money managers eager to make a difference. Signatories of the United Nations’ Principles for Responsible Investment, which tries to incorporate environmental, social and governance (ESG) factors into investment decisions, have swelled to 4,375 institutions collectively looking after $121 trillion. A third of these, including influential investors like Harvard University’s $42 billion endowment fund, have publicly committed to remove fossil fuels from their portfolios. This approach, known as divestment, may not be the best strategy.

There’s a seductive logic to washing your hands of polluting companies. If everyone sells the dirtiest assets, their owners will be starved of capital. Even massive oil groups like Exxon Mobil (XOM.N) might then be forced to change their ways. This idea has become ubiquitous among investors using ESG criteria. Metrics like Morningstar’s “globe” ratings reward funds that have fewer “brown” assets. Investors are helping climate activists press companies to ditch their dirtiest businesses.

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This approach can be bad for business and for climate change, though. Take mining giant Anglo American (AAL.L), which last year spun off its thermal coal assets into an outfit called Thungela Resources (TGAJ.J). In the last year, Thungela’s market capitalisation has risen 10-fold to nearly $2 billion, as the energy security crisis sparked by Russia’s invasion of Ukraine prompted governments to reassess coal-fired power. The company’s new management is keen to hike output.

BHP (BHP.AX) boss Mike Henry seems to have noticed. The $150 billion mining giant last week reversed course on a plan to sell its thermal coal assets, saying it would keep them until 2030. Green activists will complain that BHP gets to pocket the proceeds of selling coal, which will account for a tenth of BHP’s free cash flow in 2023, according to Jefferies analysts. However, the miner’s plan to phase out coal by 2030 is in keeping with the path to net zero outlined by the 2016 Paris Agreement. A buyer of the asset might have been willing to extend its life.

BHP’s approach has intellectual backing. ESG academic Alex Edmans accepts divestment makes it harder to finance polluting assets in primary markets. But he counters that an investor who forces a sale also forgoes the share price boost that can be unlocked by persuading a company to change direction.

One example is Orsted (ORSTED.CO). The $40 billion Danish wind farm operator is a favourite of asset managers eager to swap their fossil fuel investments for more sustainable energy providers. But the really smart investors were those who owned DONG Energy, Orsted’s fossil fuel-burning predecessor, when it transitioned from oil and gas to renewable energy. Anyone who invested in DONG at the time of its 2016 listing, before it rebranded and sold its fossil fuel operations, would have made a total return of 200%. By contrast, investors who bought Orsted shares in early 2021, when they were trading at more than 40 times earnings, have lost money.

Backing away from divestment has potential drawbacks. Unscrupulous investors could pocket the cash flows from fossil fuels without doing anything substantial to change polluting business models. Increasingly, however, shareholders require companies to align their assets with a decarbonisation plan. The quality of emissions disclosure is also growing, making it harder for investors to do nothing.

The shift in thinking has spawned a new generation of so-called “transition” funds which focus on tough decarbonisation targets. Take Brookfield’s (BAMa.TO) $15 billion Global Transition Fund, headed by ex-Bank of England Governor Mark Carney, which on Wednesday completed its fundraising. The Canadian asset management giant will invest approximately a third of the vehicle’s capital in renewable energy bets and another third in technology that enables polluters to decarbonise, for example by capturing and storing carbon dioxide. It will deploy the rest funding projects to reduce carbon emissions, for example by helping real estate groups make their buildings more energy efficient.

The risk is that funds like these get shamed for owning polluting assets. But a transition fund is only worthy of the name if its investments have meaningful short-term targets to decarbonise. Brookfield, for example, will require each of its investments to cut carbon at the same rate as the 2016 Paris Agreement assumes for their respective sectors, and submit to independent vetting. Similar endeavours like Aviva’s (AV.L) 1.6 billion pounds of transition funds, Generation Investment Management’s Just Climate fund and BlackRock’s (BLK.N) newly announced strategy for transition investing should face similar scrutiny.

It remains to be seen whether transition funds can generate good returns from helping dirty companies get cleaner. But the scale of the opportunity means firms like Brookfield have the advantage of being first. In time, ESG investors who boast of their pristine portfolios may seem outdated when compared with those that are prepared to get their hands dirty.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

CONTEXT NEWS

Brookfield Global Transition Fund (BGTF) said on June 22 it had increased its assets under management to $15 billion, over twice an initial $7 billion target, making it the world’s largest private fund focused on the global transition to a net-zero carbon economy.

Brookfield said 100 investors including public and private pension plans, sovereign wealth funds, insurance companies, endowments and foundations, financial institutions, and family offices had committed capital. It has previously disclosed that Ontario Teachers’ Pension Plan Board, Temasek, PSP Investments and Investment Management Corporation of Ontario were initial investors in the fund. Brookfield is the largest investor in BGTF, which is co-headed by former Bank of England Governor Mark Carney and Connor Teskey.

Brookfield said BGTF would focus on investments to accelerate the global transition to a net-zero economy while delivering strong risk-adjusted returns for investors. It will invest in the transformation of carbon-intensive industries, as well as the development and accessibility of clean energy sources. Approximately $2.5 billion has been deployed from the fund to date.

BlackRock said on June 16 it would establish an infrastructure strategy to partner with leading infrastructure businesses over the long term to help drive the global energy transition. Over half of the strategy will be allocated to Europe initially, becoming increasingly global over the decades to come.

The scheme will start with “single-digit billions”, the Financial Times reported on June 16.

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Editing by Peter Thal Larsen and Oliver Taslic

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