Climate change: now risk, not uncertainty

Is climate change likely to destroy value in the energy sector, and how can investors respond to mitigate this risk?

Climate change is now considered a risk not a possibility. For as long as I can remember the utilities have been considered safe havens to create income from a portfolio. Not anymore.

Whether because of the move by major investors away from the sector, or because of the fear of huge compensation payments due to accidents (remember BP) or just because my clients and many thousands of others care about the environment.

Investments in utilities are no longer a reliable income stream.

As we learned from the recent financial crisis, systemic issues can emerge unexpectedly and wreak havoc on portfolios.

For many investors, climate change is emerging as a major systemic issue: economic damage from extreme weather and shifting climatic belts is likely to get worse, and governments will need to take action. Investors should now be developing a coherent, flexible strategy to manage the risk of governmental intervention.

The “unburnable carbon” issue has become polarised.  Those advocating full divestment are seen by some extreme, particularly as divestment entails the wilful avoidance of dividend streams and a risk of under-performance if energy prices rise.

However, recent statements from fossil fuel E&P companies to challenge the analysis behind stranded asset risk and/or downplay its significance have been less than persuasive.

Asset owners may be increasingly frustrated, particularly if faced with rising stakeholder pressure to reduce exposure to fossil fuels. Although there are a growing a number of high profile announcements of wholesale divestment, for the vast majority, the default response is to wait for further developments.

Doing nothing is irrational for two reasons.

First, recent developments in science and policy have had a major impact on the climate change issue, recasting it as a risk rather than an uncertainty, thereby facilitating the use of traditional investment management tools, particularly asset allocation.

And second, developments in energy efficiency markets have created options for investors to mitigate some of the risks implied by divestment.

Is your investment decision-making sound in today’s market?

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