Fossil fuel assets have long played a large role in investment portfolios, and continue do so, albeit amid negative sentiment growing around the sector.
BlackRock, State Street and Vanguard manage $300 billion worth of fossil fuel investment combined, The Guardian reports, while the thermal coal, oil and gas reserve holdings through the companies the managers look after have jumped 34.8% since 2016.
Yet as the concept of responsible investing gains momentum, some investors have gradually phased out their allocations to fossil fuel companies or are looking to do so, and green energy is attracting increasing attention.
The Canada Pension Plan Investment Board, for example, has significantly bolstered its investments in renewable energy in recent years. The amount the big retirement fund had invested in such assets stood at C$3 billion ($2.26 billion) as of June 30, a 100-fold increase from its C$30 million allocation in 2016.
Fossil fuel companies are facing pressure from rising global demands to cut carbon emissions. According to World Bank data, 45 jurisdictions have implemented means to capture emission costs, such as a carbon tax, which could potentially hurt these companies' profits.
But many are sceptical about the potential for big breakthroughs on this front.
Martin Wolf, chief economics commentator at the Financial Times, does not believe that "climate change anxiety" will lead to any "profound shift in the policies of any major nations" in the next five years.
This is perhaps not surprising, given that the world's main superpower is not on board; US President Donald Trump pulled the US out of the Paris Climate Agreement.
So, given rising concerns about climate change and interest in the net impact of ESG factors, what has been the impact on the risk and reward dynamic of fossil fuel assets? Ultimately, should investors be divesting and, if so, how and to what extent?
We put these questions to an insurer's chief investment officer and two fund managers.
The following extracts have been edited for brevity and clarity.
Ian Coulman, chief investment officer
Pool Re (a London-based reinsurer of terrorism risk)
[Divesting from fossil fuels] is the right thing to do. But investors have varying views on what is an ideal approach.
There are some areas that investors would most likely want to exclude – the likes of coal producers. But there are other areas where an engagement approach might be preferable for bringing about change.
[As for Pool Re,] we're not going own the route of excluding companies just yet. We are favouring an engagement approach, but it will continue to evolve over time.
We've had discussions with every one of our investment managers to find out how they incorporate ESG [environmental, social and governance factors] into their investment strategy and philosophy. They do so to varying degrees, but they all are committed to having ESG embedded in their process.
Certainly, the environment has changed significantly in past 12-18 months. There's ever greater pressure from the regulator, campaign groups and government for asset owners to help bring about change. And the pace of that change has accelerated significantly.
[Such a significant change in the market environment means] opportunities emerge to allow investors to capture returns.
That might mean companies seen as not very green are available at relatively cheap valuations. However, if such companies want to survive they will have to change [for the better], and investors can capture that value over the medium- to long-term.
You could even argue that some not-so-green auto manufacturers or oil companies that may be doing very little to diversify from fossil fuels are cheap compared to their peers. But it is likely that industry, shareholders, and potential regulation will force them to change their model and consider the impact their business has on the environment.
By the same token, there will probably be companies that are overvalued because they are seen as very green, yet ... they may not look as attractive from a cashflow or revenue-generation perspective.
Masja Zandbergen, head of sustainability integration
The risk/reward balance for the fossil fuel part of the business is clearly negative, given higher risk profiles, loss in value from stranded assets and potential carbon price implementation for the energy sector hurting profits.
Hence, only those that have a clear game plan to facilitate the energy transition without diluting their return profiles too much, will still have a licence to operate for many years to come.
Using the still-strong cash generation from the conventional fossil fuel business to reinvest in a low carbon economy such as renewable energy, biofuels, biochemicals and carbon sinks, is clearly imperative. We do see, however, that investors struggle to price this transition risk.
Simple screening or exclusion methodologies are not well-suited, we believe, to deal with this complex and long-term issue. It does make engagement with energy companies on crafting a climate strategy more critical to solving global warming.
Paul Milon, ESG specialist for Asia Pacific
BNP Paribas Asset Management
While fossil fuel assets today remain a core part of markets, their relative importance should decrease as we transition to a low-carbon economy aiming to achieve the goals of the Paris Agreement.
For investors, an analysis of material sustainability factors and how they may impact fossil fuel assets demand and valuations is critical to inform investment decisions.
Coal has been at the forefront of investors’ concerns. Indeed, 93% of the total emission reductions required from the energy sector by 2025 to align with the Paris Agreement are from coal-fired generation. This means that the below 2°C target is incompatible with current coal use, prompting an increasing number of countries to commit to an electricity mix without coal and therefore leading to lower demand.
For investors, integrating sustainability insights can help identify the players that are proactively adapting their business models, and which may face the highest risks of stranded assets.
To that end, the fate of German power utilities, which reportedly lost more than 80% of their market capitalisation between 2008 and 2017, is instructive. While conventional generation still represents more than 80% of total capacity, still a far greater proportion than renewables, what drove down those stock prices was not the energy mix, but the incremental growth in demand for renewables.