Investing for the energy transition

While these major shifts in energy markets are playing out, it is disturbing that most KiwiSaver and investment funds are still investing predominantly in the oil and gas companies that continue to be part of the climate problem, rather than investing in the climate solutions.

This is most starkly seen in high levels of investment in those fossil fuel producers that are still using most of their capital expenditure to expand their production and develop new oil fields, rather than transitioning to renewable energy. They are adding fuel to the fire of climate change that is killing millions of people, destroying communities and devastating the natural environment.

Mindful Money’s analysis shows that $3.4 billion of KiwiSaver and retail investment funds are being invested in these companies. This is two thirds of overall investment in fossil fuel production and far exceeds investment in renewable energy or the fossil fuel companies on a credible transition path to net zero.

This pattern of investment does not reflect the preferences of most KiwiSaver and retail investment clients. Annual surveys show that Kiwis want to know where their savings are invested and three quarters of them want to avoid investments in fossil fuel companies.

This is also not good financial management.

The world already has plenty of oil and gas. Expert predictions are for demand to peak in the next few years and then decline rapidly. When it does so, investors will be left with stranded assets – the unusable reserves and production infrastructure left over from a declining industry. As with the demise of the coal industry, there will be massive bankruptcies and financial losses.

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How are fossil fuel investments being justified?

Chasing short term profits

Oil prices spiked after Russia invaded Ukraine and many of the fund managers that had been reducing their investments in oil and gas companies quietly shelved their climate commitments and instead increased their investment in fossil fuels to chase short term profits.

Their promises about investing ethically or responsibly or using ESG (Environment, Social and Governance) approaches have been shown to be greenwash. They are pursuing a ‘sugar hit’ from short term profits above all else.

This is a risky approach. The demise of the oil and gas industry is not just a prediction – it is already underway.

The graph below shows there was a pivotal change in 2014. The value of oil and gas companies started to decline at the time that the Governor of the Bank of England Mark Carney and other experts warned about business decline and stranded assets.

The funds that have divested in that period have generally benefited financially from doing so. In 2020, the NZ Super Fund announced that its partial divestment from fossil fuels had resulted in increased returns of $800 million. The price hikes after the Russian invasion of Ukraine are rapidly petering out, but many New Zealand KiwiSaver and investment funds are still invested in the riskiest fossil fuel companies.

Industry declines are not new. The demise of coal has been the first stage - more than half of the coal companies in the US have gone into bankruptcy since 2012.

As Sheikh Ahmad Zaki Yamani, former Saudi Oil Minister predicted:

“The Stone Age did not end for lack of stone, and the oil age will end long before the world runs out of oil.”

Many fund managers think they can time the market and get out before share prices collapse. But financial experts know how risky that is. New Zealand fund managers found out to their cost when the value of Russian companies collapsed after Russia invaded Ukraine and when the Global Financial Crisis wiped out billions of dollars from investment portfolios in 2007.

Memories are short. The price of oil went negative during the early days of COVID, showing how sensitive price is to a change in demand. Those investing in oil and gas companies are taking huge risks with their clients’ hard-earned savings.

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Saying that divestment doesn’t make a difference

The argument put forward is that there isn’t an impact on the company if an investor sells their shares – they will just be bought by someone else.

That is true for an individual investor but not when that divestment happens at a large scale.

There is now over US$40 trillion of global assets under management that have divested from fossil fuel companies. Many of the leading global investment funds have divested, as well as institutions like churches, universities, trusts and foundations, charities and local government.

This scale of divestment is certainly sufficient to reduce the share prices of fossil fuel companies, making it more expensive for them to raise capital. It should not be a surprise that share prices are influenced by the level of demand for the shares. The economic laws of supply and demand work in the finance industry, as in any other part of the economy.

It is not just the direct effect that is important. As the Financial Times reported, a 2023 study by academics from Stockholm, Brussels, and Harvard showed that divestment has an impact through changing social preferences. It plays a role through de-legitimising fossil fuel companies, wiping billions off their market value.

These effects have been important in the successful divestment campaigns on apartheid in South Africa and investment in tobacco, as well as for fossil fuels.

Companies recognise this effect.

When Peabody Coal went bankrupt it listed divestment as a big reason, and Shell had to tell its shareholders in its annual report that the campaign had become a “material risk” to its business. In New Zealand, Genesis said that one of the reasons for their announcement to stop burning coal at Huntly was that the continued use of fossil fuels reduced their share price by 20-30% compared to their competitors.

The opposite effect is seen with renewable energy companies. In 2021, Meridian’s share price soared by 40% when it was included in a BlackRock clean energy fund. The higher share prices enable renewable energy companies to issue capital at a lower cost and support expansion of their businesses.

Divestment matters and so do the positive impacts of investing in companies that provide climate solutions.

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Claiming fund managers can persuade fossil fuel companies to change

When funds purchase equities of companies in their portfolios, they become part owners of the company. Many ignore their governance role, but it is good practice for fund managers to use their influence to promote ethical practices. This is easier when the companies are local and the shareholdings are relatively large. New Zealand fund managers can have an influence over the policies and practices of New Zealand companies, but it is far more difficult for them to influence global companies when their shareholdings are tiny.

While engagement is important, it should not be an excuse for continuing to invest in harmful companies that are not making meaningful improvements.

Fund managers should report back to their investors how their engagement with the companies has actually reduced harm, backed up by credible evidence. Where they are not making significant progress, they should divest.

A shareholder action against Exxon-Mobil three years ago is frequently cited as an example of the power of engagement. Exxon Mobil was once the world’s largest company in the world, but as with other major fossil fuel companies, its share price has fallen significantly compared to the US market average. Exxon has suffered from repeated scandals, such as from oil spills, and has long been synonymous with the fossil fuel sector’s resistance to climate action.

Despite clear internal evidence of the dangers from climate change, the company has funnelled vast sums into climate denial campaigns and lobbying efforts against climate regulations. They have also failed to make the transition to renewable energy. Between 2010 and 2018, ExxonMobil reportedly spent just 0.2% of its capital expenditure on sources of low-carbon energy like wind and solar.

In May 2021, a small activist investor, Engine No.1, persuaded BlackRock, Vanguard and other institutional investors to support them in removing three directors and replacing them with new directors standing on a climate transition platform. This was heralded as a new era of shareholding power by fund managers.

However, little has changed subsequently.

Exxon is still spending the vast majority of its capital expenditure on oil and gas, developing new production fields and exploring for more reserves. They have continued to spread misinformation on climate change and lobby against government action. Exxon meets none of the benchmarks set by the collaborative engagement forum, Climate Action 100.

Real change needs to be about more than promises and token policies.

The role of the world’s largest asset managers was crucial in the Exxon case. However, both of the largest, Vanguard and BlackRock, have reported steep declines in support for ESG-related shareholder proposals. BlackRock supported 7% of ESG-related proposals in the year to June 2023, down from 22% in the previous cycle and 47% in the one before that.

The claims that engagement is a rationale for continuing to hold harmful companies is under increasing scrutiny. In October 2023, the Australian Securities and Investment Commission warned that, if fund providers are making claims about the effect of their engagement strategy, they need evidence to back them up. While the FMA has not yet taken a case, greenwashing is not solely a regulatory issue. In November 2023, civil proceedings were filed against Z Energy alleging greenwashing.

In the face of inaction by major oil and gas companies, many international investors are giving up. Last year, after more than a decade of engagement, the Church of England Pensions Board announced it would divest from fossil fuels, citing that no fossil fuels company had met their targets for progress on a transition to renewable energy.

Further, as noted by the fund manager, BetaShares, divestment is not a barrier to engagement. They have fund that companies excluded from their portfolios frequently wish to engage to understand what actions they need to take to end that exclusion.

While engagement is an important mechanism to support and accelerate change with the companies that have a credible transition pathway, it should not be used as a justification for investing in companies that are continuing to cause harm, such as the fossil fuel expanders.

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So what can investors do?

Investment into renewable energy is taking off, despite the fossil fuel industry.

The pace of change has far exceeded all the predictions by the International Energy Agency. The hope for our future is that the exponential growth in renewable energy and electrification will be faster than then exponential growth in impacts from climate change.

Investors should understand where your money is being invested. Claims about ethical investment or ESG or sustainability are easy for fund managers to make. But the objective truth is in the companies they invest in.

Look it up on Mindful Money. It is quick, easy and free. You can see which are the worst fossil fuel companies, those expanding their production, as well as those that are transitioning on a credible pathway to net zero.

You may want to talk to your fund manager about your preferences. Many will say that their investments in global companies are beyond their control because they use an external fund manager for global investment or use an index.

That’s no longer a valid excuse.

There has been huge rise in the availability of funds that screen out fossil fuels and low carbon funds that provide good financial returns.

Then if you’re not satisfied, divest and find a fund that fits your values. Find a climate friendly fund or look for a fund that invests in clean energy. Switching funds is far easier than most people think and it’s free. We can all play our part in accelerating the energy transition.