Companies in the mining, oil and gas sectors are ignoring a big risk to their valuations and predictions of future revenue.
This is the risk that assets will become stranded, unexpectedly losing all or most of their value due to external events. Given increasing consensus that as much as 80 per cent of proved fossil fuel reserves will have to be left in the ground to avoid catastrophic climate change, this risk should not be dismissed lightly.
This is why F&C Investments, the UK fund house, has put stranded assets high on its agenda, according to its annual responsible investment report. Over the past year, F&C has been working to make sure senior executives in the oil and gas, mining and utility sectors are aware of the concept.
“Many companies continue to focus on short-term risk management in response to the current weak oil price, rather than a robust long-term risk management approach that considers climate change policy risks,” says the report.
Although individual analysts at companies may be aware of the issue, frequently the awareness stops there, rather than rising to the board.
“It needs to be a strategic board-level discussion,” says Vicki Bakhshi, head of F&C’s governance and sustainable investment team. “It is a risk management question, it is a stress-testing question.”
The issue of stranded assets may not yet be at the forefront of the corporate board’s mind, but its profile is growing quickly in the investment community.
When FTfm covered this topic four years ago, with specific reference to fossil fuels, it was easy to find commentators to scoff at the idea. It was seen as an ideological proposition driven by climate-change campaigners.
By contrast, in 2015, mainstream outfits such as MSCI, the stock market indices provider, and Towers Watson, the consultancy, have put out discussion documents on the topic, while Oxford university’s Smith School of Enterprise and the Environment has a programme dedicated to systematic analysis of the subject.
The director of this programme, Ben Caldecott, says investment managers are slowly coming to terms with the new landscape: “There are some real leaders, but there are lots of investment managers who do not really know what they are doing. There is lots of research showing this stuff is financially material [but they have not yet integrated it into investment processes],” he says.
An understandable preference for looking for opportunities instead of mitigating risks may be to blame for investment managers finding it tricky to engage with the issue, Mr Caldecott suggests.
“With climate change, there is a risk/opportunity division. A lot of attention has been on the opportunities. But on the other side, [stranded assets] throws up a whole range of issues about how to preserve value in sectors undergoing major change.”
The leaders named by Mr Caldecott are Wheb, Impax Asset Management and Generation Investment Management, all asset managers set up with environmental, social and governance issues at the forefront of their investment philosophies. To truly enter the mainstream, the idea of stranded assets needs to be taken on board by investment consultants.
“You also have to look at the role of investment consultants,” says Mr Caldecott. “And you have to ask whether they have the understanding needed.”
The preliminary findings of a Smith School report due out shortly imply that investment consultants “need to man up on this issue”, he says.
Towers Watson would disagree, having put out a 14-page report on the topic in January. The report looked only at probable restrictions on carbon emissions (other drivers of asset stranding might include water scarcity, pollution limits and policy changes such as abandoning nuclear fuel). It attempted to consider a range of scenarios and assess the potential impact on the entire value chain, down to residential electricity use.
The time horizons of investment as well as risk are significant — there may be a high risk of asset stranding within 10 years, but if an investment horizon is two years, it is immaterial.
Likewise, if the payback time on an asset is short (shale gas investments, for example, are expected to pay back within a couple of years), you might not care about a problem likely to arise by 2020.
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