By Valerie Gardner
Since our founding in 2002, we have seen it as our job to help our clients invest prudently in the market, in order to participate in the overall market growth and returns generated by business. We have always known that our clients will do best if we reduce their unnecessary costs and uncompensated risks, while providing them with well diversified access to all sectors of the market.
As long term investors, we keep watch on developing market trends and stay attuned to the burning issues which can have significant impact on the market and on market returns. Accordingly, for quite some time, we have been concerned about the increasingly urgent issue of climate change, and have been studying ways to respond to it.
American scientists became seriously alarmed about the prospect of global warming as early as the 1970s and 80s. Dr. James Hansen, then a NASA Senior Scientist, famously testified to Congress in 1988 and predicted with great certainty how the climate was going to warm. As a result, the UN established the Intergovernmental Panel on Climate Change (IPCC) in 1988, with a mandate to study the issue and report back. The IPCC recruited the help of the world’s most renowned scientists to study the body of peer-reviewed scientific literature, assess if climate change was really happening and, if so, what its causes were.
In the three decades since 1988, the planet’s heating has gone almost exactly according to Hansen’s prediction. Thousands of scientist volunteers around the globe have dutifully labored on behalf of the IPCC to engage in comprehensive scientific reviews. They have issued hundreds of reports. It did not take all that long for what were strong suspicions to evolve into an overwhelming consensus: The IPCC’s findings have confirmed what Dr. Hansen said thirty years ago: that climate change was definitely under way and that it was being caused by man’s emissions. As the evidence has accumulated, many of the individual IPCC scientists, including Dr. Michael Mann, who co-authored a 1998 report producing the famous “hockey stick” graph of CO2 concentrations documenting man’s role in the crisis, have been targeted by interests opposed to action on climate change.
Since the IPCC’s founding, the world’s political representatives have gathered in what’s been called a “conference of the parties (COP)” to review and discuss the IPCC’s findings. We refer to these newsworthy conferences by names of the cities where they are held, starting with the third COP held in Kyoto in 1997. The Kyoto Protocol was the first global agreement that challenged the world to begin to reduce its emissions. The US refused to sign the Kyoto Protocol. This leadership failure resulted in Kyoto remaining a non-binding agreement. That set back global commitment to the process.
Most countries and many US cities nevertheless proceeded to work towards meeting the goal of the Kyoto Protocol, which was to reduce emissions down to 1990 levels by 2020. This goal was the basis for AB32, California’s landmark Global Warming Solutions Act of 2006, signed by Governor Arnold Schwarzenegger, which effectively bound California to meeting Kyoto’s goals. Over 1000 US mayors also committed their cities to meeting Kyoto through a campaign called the Mayors’ Climate Protection Agreement.
By the time of the 21st COP in Paris in 2015, the question facing global decision-makers was not whether there was action that could prevent climate change: because the planet had already heated up almost a full degree and climate change was already in process. Rather, they faced a choice of selecting a pathway, determining how much hotter we would allow the planet to get. Remarkably, this conference produced the Paris Agreement, under which every nation on the planet committed to working towards their own voluntary emissions reductions plans to try to limit warming to merely 2 degrees Celsius. Even this goal was a compromise, as all understood that a 2 degree Celsius warming would still result in significant climate impacts. The informal consensus was that, it would be vastly better if the world could muster the will to limit heating to no more than 1.5 degrees C (equal to 2.7 degrees F). In a hopeful development, global emissions appeared to level off and did not grow in either 2015 or 2016, though they remained at their height.
Although the United States was party to the original Paris Accord, the current Administration has chosen to withdraw the US from the agreement and, in an even worse development, CO2 emissions rose again by more than 2% in 2017. As with the Kyoto Protocol, when the US announced its withdrawal from the Paris Accord, nearly 400 more mayors committed their cities to its goals.
Extreme weather events in the past several years have also highlighted some of the costs we face from climate change. In the US, the bill for extreme weather events for 2015 was $23.4 billion and there were 155 associated deaths. In 2016, climate’s toll amounted $48.2 billion and 138 lost lives. But, in 2017, extreme weather took a significant turn for the worse, and it cost US taxpayers $306 billion and 362 people lost their lives to floods, fires, tornadoes and hurricanes, which does not count the new estimates of nearly 3,000 deaths that resulted from Hurricane Maria, a category 5 storm that hit Puerto Rico, from which devastation, the island has still today not fully recovered. As for 2018, we are still in the midst of Hurricane season but already the ferociousness of some recent storms (Hurricanes Florence and Michael) has broken records.
This past week, on October 8, 2018 the IPCC issued a very special report: our world is already nearly 1 degree C warmer and climate change is already underway, wreaking havoc on natural systems. In no uncertain terms, the IPCC warns that we either get our carbon emissions substantially under control by 2030 and limit temperature rise to 1.5 degrees Celsius, or we will lose the very ability to limit the irreversible consequences of this climate catastrophe, and it will spiral entirely out of our control. Among the effects the IPCC highlights for temperature rise greater than 1.5 degrees C are major and devastating loss of animal species, destruction of 99% of coral reefs, and sea level rise will inundate a number of major global cities. Adding to those losses, the IPCC predicts that heat spikes will make huge swaths of the earth uninhabitable, starting with the Middle East, and much more.
While the specific extent and effects of climate change remain uncertain, we find the contours of the IPCC’s report credible — and alarming. From a long-term investor’s point of view, climate change poses an enormous risk to future returns. Our current path is as unwise economically as it is environmentally. Hence, while we are mindful that corporate profitability remains a central tenant of our analysis, we recognize that we also need to consider the effect of climate change and global policy in our analysis. Since the principal cause of climate change is emissions of greenhouse gases, particularly CO2, this means securing our future by investing in the low-carbon options that will enable the transformation that the world needs.
We are encouraged in this thinking by others who are responding similarly. TIAA Nuveen writes:
“Climate change has arisen as a leading health and economic challenge of our time. For investors, climate change poses a range of risks, spanning asset classes and geographies, and intensifying the timeless tension between the desire for short-term gains and the responsibility to preserve long-term value. At Nuveen, we continue to give voice to the long-term perspective, not at the expense of near-term performance, but as an added emphasis on preparing carefully for tomorrow’s performance in tomorrow’s world.”
The recent IPCC report has investment implications too stark to ignore. Most importantly, we anticipate that public awareness, and ultimately policy responses, to climate risks will increase dramatically in the coming years. The recent awarding of the Nobel Prize in Economics to William D. Nordhaus for his research into the implications of climate change for macroeconomic analysis reinforces this view. While not every company is directly responsible for or has control over this crisis, every company’s fortunes will, in the long term, depend in part on how they manage potential contribution to climate change.
The investment implications of the policy and market response to climate change will naturally be most acute in the coal, oil and gas sector. For some time, we have been reducing our holdings in fossil fuel companies and those developing fossil resources. For the most part, the response of these firms to findings like those of the IPCC report has been to push back, in an effort to justify their continued investment in developing fossil fuel resources. We believe that these firms will find themselves on the wrong side of public opinion, public policy, and economics. The unfortunate fact is that only a few fossil fuel companies have demonstrated any meaningful effort to accept climate facts or seek remedies to the emissions caused by their products, which may well require a complete shift in their business models. It was only a few weeks ago, at the end of September, in what Reuters described as a “U-turn,” that ExxonMobil and Chevron joined the Oil and Gas Climate Initiative (OGCI), a group of major international oil and gas companies in an initiative launched in 2014 that seeks to address the risks of climate change by curbing emissions coming from the Oil and Gas sector.
While the global economy continues to rely on increasing quantities of energy, we believe the viability of fossil fuels as a component of the global energy mix will necessarily decline. Successful investors will be those that recognize these trends and begin to shift their energy holdings focus onto those companies with the technologies to meet humanity’s growing needs for energy in ways that do not exacerbate the climate risks. This means basing investment decisions not on hype, such as “green-washing” messages which proclaim climate conscientiousness even while continuing to develop high CO2 energy sources, or even popularity. Of all energies technologies ever devised, fossil fuel extraction, refinement and use—which releases more than its original weight as emissions waste into the atmosphere—pose the most risks and cause the most damage to health and well-being on the planet. Thus, it is impossible not to observe that investors in coal, oil and gas firms, and especially exploration and production companies, face the substantial risk that fossil fuel reserves will become stranded assets. For many investors, this already poses an insupportable risk as, increasingly, basing valuations upon the future exploitation of those fossil reserves comes starkly at the expense of the natural systems on which we all depend.
For those reasons, institutional investors controlling more than $6 trillion in funds have committed to divest from fossil fuels, and we believe that number will only grow. There are many other trends—within the business community overall and within the institutional investment community in particular—which reveal much more widespread efforts to elevate and reward those companies that are working to eliminate carbon emissions and otherwise conform their operations in furtherance of the global Sustainable Development Goals, as enumerated in conjunction with the Paris Agreement. These efforts serve to increase the pressure on fossil fuel companies to reconcile their business activity in light of impacts on climate change and the global community and the efforts of the OGCI—to develop carbon capture technologies among other things—is a step in the right direction.
We are encouraged to see the trend towards increasing levels of investment into all types of low-carbon technologies. We believe the rapid development and deployment of the available carbon-reducing options could enable the world to make some progress against increasing emissions. Where we part ways with many traditional clean-energy investors, however, is in our willingness to support and invest in all types of low-carbon energy. While we invest, like others, in renewable sources of energy, we also believe strongly in the importance of nuclear power in meeting our world’s increasing need for non-CO2 emitting energy.
Nuclear power, long seen as the most dangerous type of energy, is actually the safest—based upon the data. This is the only low-carbon method of generating energy from a fuel which, in contrast to fossil fuels (whose emissions are causing our climate to shift as well causing harmful air pollution), safely stores all of its waste and releases nothing but water vapor into the air and warmer water into the environment. Despite the vitriolic opposition that this industry has borne, ironically from environmentalists, we have grown increasingly bullish on nuclear energy due largely to its potential to provide reliable and ample energy to a climate-stressed world. We have delved more deeply into the nuclear energy industry’s beleaguered history, with its record-shattering safety performance badly smeared by a few exceptionally frightening reactor meltdown accidents. Sensationalized news coverage has produced widespread public concerns about nuclear safety even as the actual, surprisingly minimal mortality and health impacts of these meltdowns has largely gone unreported and under-appreciated, especially when compared to the continuously eggregious health risks posed by fossil fuels. The fact is that all energy technologies pose risks, which must be considered, but the largest risk of all, dwarfing every other risk humanity has ever faced, is that of failing to address our carbon emissions challenge. Globally, nuclear power has proven to be the most reliable and most promising competitor to fossil fuels and we believe it will increasingly prove itself and its value to society, especially as the increasing costs of climate change become untenable.
We have implemented a portfolio design approach that anticipates that moment, when CO2 emissions are fully valued, which we call the “Future Generations” portfolio. For clients who have requested it, we have applied this cost of carbon filter into our approach to equities investing. Even without applying this specific filter, our day-to-day analysis of climate change risk has shifted our long term investment perspective such that it tends to focus more on sources of carbon-free generation than not. We believe that companies which meet market needs in ways that prevent carbon emissions will have the potential to outperform competing companies, especially those continuing to profit from and defend business activity which is reliant on “free” carbon-emissions.
As investors, we remain committed to critically evaluating and often resisting the pressure of whatever the market hype du jour is, while basing our investment decisions on quantitative assessments. No one knows what the future holds and, while we cannot predict with any certainty what will happen, we can choose to make informed decisions based upon solid science and known data. We find the science upon which the IPCC’s latest report is based completely credible and entirely frightening. The global trends are unmistakable. Increasingly frequent catastrophic weather events and their tolls are forcing the governments of the world to come to terms with the enormous costs and dreadful implications of failing to make a complete commitment to the elimination of mankind’s emissions. As investors, we see it as purely irresponsible not to respond to these unprecedented risks with the courage of conviction that direct our future choices to those companies that best help us eliminate emissions however we can.