Why asset owners should take heed of the transition to a low-carbon economy

Addressing the energy transition is a necessary long-term strategy, but it may throw up risks in the shorter-term as well.

Not a day goes by without commentary on the global energy transition which is now well underway. Even if climate change was not the clear and present danger that it represents, it is likely that human ingenuity and other factors (air quality and health; energy savings) would have been responsible for developing ways of energy generation from renewable sources and new, clean technologies. But the climate imperative has driven things further and faster, so that the transition now seems inevitable.

If this is an unstoppable transformation, the question then arises about how quick the transition will be. This is a key point that should matter to all investors: those who have exposure to large fossil fuel stocks in their portfolios; and those who are seeking to generate returns from a future that is set accelerating towards the present. For those investors trying to make sense of all the noise and speculation in the media, this paper explains what is driving the transition, and suggests reasons why it is important to consider acting in the shorter-term as well as changing their overall strategy for the longer-term.

The conclusion of climate scientists on global warming is inescapable: 2016 was the hottest year on record, following 2015 as the previous hottest year. What holds for 2017? The principal greenhouse gas, carbon dioxide, has risen past a concentration of 400 parts per million[1] (PPM) – probably the first time this has happened in human history – and this year, CO2 levels at the Mauna Loa observatory in Hawaii breached 410 ppm for the first time. The International Panel on Climate Change (IPCC) forecasts that if current trends continue, global concentrations of CO2 are anticipated to reach 450 ppm in the 2030-2040 timeframe. It was these alarming trends in warming that persuaded global leaders to reach the landmark Paris Agreement on climate change in December 2015. The International Energy Agency and other expert institutions leave no doubt about the critical linkage between climate change and the energy landscape.

Drivers of the transition to a sustainable energy future

Governments are responsible for policy decisions, and it is clear that policy is one of the main drivers behind the energy transition. Paris was unprecedented because it was the first time that basically every country on the planet agreed that it needs to implement national measures to tackle the impacts of global warming. Since December 2015, if anything, the pace of policy action has increased. Both China and India are introducing increasingly more ambitious climate policy measures. Europe is demonstrating that cutting emissions can sit alongside economic growth; and this same scenario goes for the US who, despite the seeming insistence of the Trump administration in turning their back on the realities of climate change, has in recent years likewise decoupled emissions reductions from GDP growth.

In terms of financial markets policy, it is only a matter of time before financial regulators will require by law greater transparency and disclosure by market participants in managing the investment risks created by climate change. We are already seeing the effects of Article 173, under their “Energy Transition Law” in France when it became the first country to introduce mandatory climate change-related reporting for institutional investors.

But policy measures are not enough in themselves to drive the transition. Increasingly, it is the dramatic cost reductions in renewable energy that is accelerating the transformation. Bloomberg New Energy Finance (BNEF), which has a better record of forecasting in this sector than practically any other organization, estimates that solar power, already cheaper than fossil fuels in some parts of the world, will in less than a decade be the lowest-cost option almost everywhere. In the UK, the largest offshore wind market globally, wind farm costs have fallen by almost a third in four years. Moreover, the transportation sector may be on the cusp of its greatest revolution in a century, if BNEF’s forecast of an electronic vehicles tipping-point in the 2020s is proven correct.

Economic and technology forecasts – albeit ones which are based on established trends – are important. But perhaps stronger evidence of the transition and its implications for investor strategies can be provided by four key developments that have recently taken place:

  • first, the recognition by G20 Finance Ministers, first voiced in 2015, that climate-related risks should be addressed by the financial sector. This was confirmed by the establishment of the Taskforce on Climate-related Financial Disclosure (TCFD), whose recommendations at the end of last year are gaining traction with policymakers and business alike. In July this year, the TCFD will submit its final recommendations to the G20 leaders in Hamburg; this report can be one of the catalysts for accelerating the global transition to a low carbon economy;
  • second, recognition by the energy and utilities sector that there is a need to change their business model, in the face of the risk that fossil fuel energy reserves and power generation resources may become uneconomic or “stranded”. E.ON and RWE have already been compelled to undertake fundamental restructurings of their companies in response to the energy transition in Germany. The Energy Transitions Commission (there’s a hint in the title!), whose members include a spectrum of corporations and financial institutions from Shell to HSBC to Blackrock, published a report in March 2017, whose core conclusion was that clean electrification and decarbonisation beyond the power sector should be accelerated. To reinforce this point about business change, a coalition of investor groups has just published a study showing that institutional investors are now, in respect of the issue of climate risk, having a major influence on the decision-making of oil and gas majors;
  • third, even Actuaries are sitting up to take notice. On 16 May 2017, the UK Institute and Faculty of Actuaries (IFoA) issued a “Risk Alert” to inform actuaries that they “should ensure they understand, and are clear in communicating, the extent to which they have taken account of climate-related risks in any relevant decisions, calculations, or advice”. This initiative takes the lead from the leading international think-tank of the insurance industry, The Geneva Association, whose membership comprises a statutory maximum of 90 chief executive officers from the world’s top insurance and reinsurance companies. The Geneva Association lists climate risk, financial regulation and stability (and global ageing) as the three critical pillars with significant implications on the global insurance sector.
  • lastly, the landmark decision by a majority of shareholders to compel the oil and gas giant ExxonMobil, at its AGM on 30 May, to disclose how climate change will affect its business. Coming in the week that Trump pulled the US out of Paris, this decision at the Exxon AGM was a reminder that, no matter what Trump does, investors and corporates are moving in the opposite direction.

A recent annual ranking produced by the Asset Owners Disclosure Project, an independent non-profit organization, showed that there has been a 19% increase in the number of pension funds, insurance companies and sovereign wealth funds taking action in response to climate change. According to a survey by BNP Paribas Securities Services, asset managers are planning a significant step up in selling their funds under ESG or responsible investment labels in the next two years, to meet growing demand from asset owners.

Despite this encouraging backdrop, a significant number of investors still remain far behind the curve. The accumulating weight of evidence really ought to convince investors that they need to consider pushing the climate and energy issue higher up their agenda; and to question whether they should be re-aligning their approach, at least over the medium-term.

Short-term pressures: where does this road lead to for coal related assets? 

An emerging question is whether coal is on the run, especially in OECD countries. France, the UK and Canada have all announced their intention to phase out coal-fired power stations by 2030 or earlier. The future of coal power in Europe will be further affected by a decision just taken by EU member states to impose stricter pollution limits on coal-fired stations.  And, despite President Trump’s pledge to revive the US coal industry, the intensive cost competition imposed by shale gas and renewables is making US coal companies gloomy about the future. Perhaps more worryingly still for the sector, there is growing evidence that demand for coal has peaked in the two most important developing markets, China and India, where air quality is a major domestic issue and who are both accelerating plans to diversify into renewables. In short, coal is becoming more and more of a market driven by policy decisions, not supply and demand economics.

China and India are taking action

The changing attitudes in the major developing countries cannot be ignored. India, whose government has been ramping up its plans for solar power and scaling back previous plans to build new coal power plants, is likewise now scheduled to exceed its Paris target.  China, has made clear that it – despite (or even because) the fact that the Trump administration may choose to opt out of the hard-fought leadership position on climate that President Obama had secured – sees climate action as essential to its national interests and is therefore happy to take a global leadership role on the issue. This trend is supported by the fact that China is now on track to exceed its 2030 emissions reduction target under the Paris Agreement. As part of China’s clean energy transition plan, led by China’s National Energy Administration, the Chinese government is expected to invest 2.5 trillion yuan (around $72 billion per year) in renewable energy projects to support the energy transition up to 2020. The green bond market has already exceeded the $200 billion mark in 2017 and Chinese issuers have been dominant. In April, we saw the Bank of Beijing issue a green bond for RMB15 billion ($2.2 billion), the largest by a Chinese issuer this year.

And renewables are continuing to fall in price

This narrative of declining enthusiasm for coal, even in the developing world, and tougher policies to tackle climate change are backed up by the other trend which seems to be further accelerating – that of the continuing fall in the costs of renewable technologies. As BNEF consistently emphasizes, renewables have now achieved, on a levelized cost of electricity (LCOE) basis, achieved the long-awaited goal of grid competitiveness. In many countries, it is now undercutting every other source of new generating capacity, and further reductions in the costs of equipment are expected. As Professor Dieter Helm argues in his recent book, “Burn Out – The endgame for Fossil Fuels”, the future is electric.

What this means for asset owners

The evidence seems to point to a global transition where there is no going back. A combination of policy measures on a global scale, and a revolution in low-carbon technologies and electricity generation, is accelerating this transition and turning it into a transformation of industry models and ownership. Asset owners and institutional investors, if they are not already thinking about the implications, would be advised to:

  • Educate themselves about the implications of climate change and the global energy transition
  • Undertake an internal debate with all stakeholders and establish their institutional position on the topic
  • Establish a plan to keep up with developments and develop a road map for action

June 2017

This paper is written by Richard Folland and Shuen Chan of Sustineri.

Sustineri is a boutique advisory firm that provides insights and solutions to institutional investors in a world that is advancing towards a low-carbon future.


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[1] Atmospheric CO2 levels are expressed in parts per million by volume (ppm). 1 part per million of atmospheric CO2 is equivalent to 2.13 Gigatonnes Carbon.