By Marshall Geck in Washington DC (@MarshallGeck), Manager, Climate Action 100+, the PRI
Energy companies recognize that the world will eventually shift towards a low-carbon economy, but just how fast it will happen is where the agreement ends.
This sentiment was on display earlier this month in Houston, Texas, where representatives from across the energy industry gathered for IHS Markit’s massive CERAWeek conference. The event made headlines for the fact that many energy executives openly acknowledged their need to play a constructive role in solving climate change and helping the world transition to low-carbon energy forms. At the same time, however, they were quick to express confidence that demand for fossil fuels would remain stable for decades to come.
While it is encouraging to see these companies speak about being part of the solution to climate change, investors should be mindful of the fact that the transition to a low-carbon economy may not necessarily be gradual and orderly. History tells us that economic transitions can sometimes be rapid and disorderly.
Nowhere is this more apparent than in the US coal industry, which has become a case study of this. Less than 10 years ago, things were looking pretty rosy for the industry, with both coal prices and US coal company stock values flying high. Fast forward to today, and the outlook for US coal is about as bleak as it comes. The share of US electricity generated from coal was just 27% in 2018, down from 45-50% in 2010 and the lowest it has ever been in the post WWII era. Many coal companies that were overly-optimistic about the future of US coal at the beginning of the decade are now facing bankruptcy, and the four largest US coal producers have seen their combined stock market value tumble to a shadow of their former selves—from US$33 billion in 2011 to US$6.3 billion in October 2018. A number of factors have contributed to the demise of US coal during these years, including competition from cheap natural gas and renewables, falling energy demand, and new environmental regulations.
The rapid pace of change has also been hard on the industry’s workforce. A confluence of automation, shifting energy markets, and other factors has left many US coal workers unemployed, causing economic distress in coal-producing regions of the country. Despite promises from US President Donald Trump to the contrary, most energy analysts don’t see the US coal industry or US coal employment bouncing back any time soon. In fact, coal plant retirements have continued apace during his time in office, with over 6 GW of coal capacity retired in 2017 and another 13 GW in 2018, the second most in US history.
In just one decade, the US electricity sector and the US energy workforce has been completely transformed. And the transition has been anything but gradual and orderly.
While there are many explanations for why companies could reasonably expect stable demand for carbon-intensive products in the future, there are also ample reasons to believe that a transition to a low-carbon economy may be less gradual and more like the experience of the US coal industry. Improved economics and technological innovations have already led to exponential increases in renewable energy installations around the world that few would have predicted a decade ago. Young people, many of whom are just coming of voting age and tend to see climate change as a bigger problem than the generations they will be replacing, are already calling for big solutions, and are likely to continue doing so well into the future. And governments will come under ever-increasing pressure to set stronger emissions reduction targets as the gap between the level of action needed to keep global warming to safe levels becomes more and more apparent, which the PRI has outlined in its work on the Inevitable Policy Response.
Fortunately, investors who have come to recognize climate change as a systemic risk to the economy are now engaging companies to ensure that they are prepared for a low-carbon transition. For example, more than 300 investors with over US$32 trillion in assets collectively under management are participating in Climate Action 100+, an initiative to engage the world’s highest-emitting companies on improving their governance, curbing emissions, and strengthening climate-related financial disclosures.
Investors who have come to recognize climate change as a systemic risk to the economy are now engaging companies to ensure that they are prepared for a low-carbon transition
However, while these are all very good steps, investors also need to be asking not only if companies are prepared for a gradual transition to a low-carbon economy, but also if they are prepared for a potentially abrupt, disorderly one. This might include, for example, encouraging companies to stress test their business plans under a range of future scenarios, including under a rapid low-carbon transition. It might also include setting emission reduction targets aligned with the Paris Agreement today so companies are well-positioned in the future even if world governments aim to keep global warming to 1.5 degrees Celsius, an ambitious goal that the IPCC recently outlined as necessary to avoid many damaging impacts of climate change.
Sustained and strategic engagement from investors like those participating in Climate Action 100+ could be the difference between a portfolio that weathers the storm of economic transition and one that finds itself at the mercy of it.
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