Agenda item

Carbon Tracker

Simon Perham - Head of Investor Outreach – Europe  and Joel Benjamin  Press & Communications Manager  will present on Pension fund carbon divestment and energy transition .

Minutes:

The chair welcomed the Simon Perham, Head of Investor Outreach, Europe, and Joel Benjamin Press & Communications Manager to present and take questions on Pension Fund carbon divestment and energy transition.

Joel Benjamin gave a presentation, uploaded with the agenda.  Below is an edited transcript of his talk:

Carbon Tracker is an independent, non-profit financial Think Tank, with offices in London and New York. Carbon Tracker is funded by US, UK and EU foundations with an interest in all things climate. Our vision is to enable a secure global market, aligning capital markets with the reality of climate change. And our mission is mapping the transition from the fossil fuel industry to stay well below two degrees, Paris compliant trajectory.

 Carbon Tracker supports investors, such as pension funds, utilising the tactics of both engagement and divestment; a diversity of approaches is supported.

The presentation will be mainly about the impacts of the energy transition on the financial sector and investments, and in how investors like pension funds should reposition themselves for that.

It will explore pension fund objectives for investors who are on a divestment journey once the low hanging fruit has been exhausted, such as ending direct investment in fossil fuel companies, as covered in the previous presentation by Southwark Pension Fund. 

The priorities for any Pension Fund are to bring in stable, long term returns for members and keeping the contribution rate stable.

A fossil fuel based economy is usually going up and down, which provides major complexity in managing share prices and return. It is very hard to manage a pension fund when your assets from returns are fluctuating on that basis.

The objectives around stable returns are being delivered by council’s in the context of the climate emergency. So what can local authorities, and the people who manage pension funds, do to align our financial investments with the need to tackle climate change? 

Allied to decisions about pension fund divestment are the wider aims of council’s to address the Climate Emergency in their locality and the costs associated with this. One example is Cannock Chase District Council who set a district wide climate target, and then had to reconsider the near zero climate targets because of the gap between the costs it would take to actually decarbonize the entire borough and the available funds. Here this includes not just what the council is directly responsible for managing but also the wider district infrastructure, private housing etc. There is a far greater capital requirement to do those sort of things then the council has at its disposal, particularly after a decade of austerity.

This speaks to the tension between where we need to get to in terms of decarbonizing our society and what resources we have at our disposal currently, and thinking about how to use those resources strategically. This an interesting dilemma for the pension fund, because as many of us will know there is often a lot of pressure from Central Government for Local Government to come in and use assets like pension funds, to fill a gap in part caused by the withdrawal of Central Government funding from Local Government.  There is often pushback on this from scheme members and managers because of potential risks around the primary objective of paying for people's retirement.

London CIV pension fund slide shows various different kinds of asset classes and allocations.  A large number of London boroughs now pool their assets to input into this larger portfolio, and this has increased in the past decade. The investment graphic illustrates the globalisation and financialization that happened, particularly in post war period.  Historically about 50% - 60% of holdings immediately post war were in British companies. Now that figure is something like 20% to 30% of UK companies, with the vast majority in global investment, US, Europe, and emerging markets. This applies to asset managers too, with Bailey Gifford and Aviva as one of the few UK based managers; the majority are a US - European international funds. As the financial sector globalises we have got more and more remote from where our pension funds are invested.  The counterpoise to this is what is happening in places like Preston, who have worked to maximise inward investment and increase the money retained within the borough, because of the economic benefits this brings. There is an interesting tension here between financial assets, which are global in nature, and the goals of local authority, which are basically how to achieve the best result for a locality. Exploring that tension and thinking about how to retain more of this kind of money, both within the borough and within the UK, is quite an interesting project, prehaps for a later date.

The next slide shows the fossil fuel exposure of global major financial exchanges. The London Stock Exchange has some of the largest investments, alongside, the likes of USA, Russia, China, Saudi Arabia, as well as other emerging major markets with a significant carbon exposure. This is  significant for index linked passive funds, as those funds and investments will essentially track these exchanges and these markets, so if you're invested in an exchange in these localities you are going to have significant exposure to  carbon and fossil fuels. 

The Strategic Director of Finance in his presentation rightly identified the next phase for Southwark Pension Funds is to examine the investments in markets around the world with large amounts of carbon, and develop mechanisms to screen them out. Otherwise the carbon in these are going to pollute our pension funds. This the next phase of pension fund decarbonisation foot printing.

Southwark pension fund is showing strong initial progress with a carbon footprint  down 40 50%, so the next phase is green tilting the passive funds.  In doing this I will flag up some of our experience in Carbon Tracker on the pitfalls around ESG, and the risks of regulatory scrutiny in some cases greenwashing a sector. Different people mean different things by ESG, and an awareness of this is important.

A further avenue Carbon Tracker would recommend to explore is in the Corporate Bond sector. Here this is not only talking about fossil fuel supply and production, and companies such as Chevron and BP, but also addressing companies and sectors that use fossil fuels. This means industries such as transportation companies, which produce internal combustion engines that burn fossil fuels, and the extent to which they are likely to be disrupted and vulnerable to deployment risk in the future. And therefore the risk that investors in those companies could lose money.

Here Carbon Tracker is really thinking about the future, and how we align our portfolio, our pension fund, for energy transition, which is currently taking place across the world.  The next slide show shows how much land would be required to produce all of our energy from solar. In large parts of the world it is actually less than 0.1% of available land, which is significantly less than what we currently use for fossil fuels. So the good news is we are moving to a cheaper, healthier, less pollution, more efficient energy system based on low carbon. And one of the benefits of that is currently, nine out of 10 people live in a country which currently imports fossil fuels. Only one and ten live in a country which produces fossil fuel, Saudi Arabia, or Russia and the like. This means we are moving towards more distributed renewable based energy system where there is not going to be this major imbalance between importers and exporters. This means that wealth, and opportunity, will be much more distributed globally. This will be a much fairer system where a small number of countries do not actually control global resources that we have now.

When we talk about energy transition Carbon Tracker are first focusing in on four particular technologies, which we think are essential to the global transition to low carbon energy. These are manufactured technologies: combination of onshore and offshore wind, solar and batteries.

Batteries are being used for products like electric vehicles. If we look at the cost of these technologies over the previous decade, they are down substantially across the board. For onshore and offshore wind there is a 60% reductions over the last ten years period, and for solar an impressive 90% and for batteries it is 83%. So the cost of deploying these technologies is on S curves that keeps coming down year on year, and that's meaning it's becoming increasingly more affordable to deploy them.

When we look at actually deploying these renewable technologies there is associated growth in these technologies. For annual solar and wind, you're talking about between 20 and 40%, combined annual growth rate for every sales, approaching 70% for battery sales, and  again tracking Electric Vehicles (EV)  it is at 68%.

As the cost of renewable energy is falling so rapidly, it is now becoming much cheaper to deploy these technologies, increasingly without subsidies. As a result of that this is increasing causing disruption to incumbent technologies based on fossil fuels. This translates to something Al Gore talks about: ‘in economics things like longer to happen than you think the will, then they happen far faster than you thought they could’. This is a good example with Southwark Council Pension Fund, seven, eight years ago, when we first started talking about divestment and getting these funds out of fossil fuels, to a large extent the first phase is complete in less than a decade. Things happen slowly, then may happen overnight. And investors who fail to see the writing on the wall stand to lose a lot of money.

The next slide just looks at the what happens when we have peaking of demand in a particular sector delivering new technology, mirroring  reduction in demand in old technology . The example shown on the right of the chart is for Electric Vehicles (EV) sold in the UK. If we go back to around 2016, only 1 in a 100 new vehicles sold and UK market was EV. Fast forward to 2023 and we think by the end of this year that one in three cars sold in the UK market will be an EV – sales are increasing exponentially.  Then it is possible to see in the left chart what is happening to the reducing market share of incumbent internal combustion engine fossil fuel cars. As EVs are scaling up, demand for internal combustion engine cars is declining. The demand for fossil fuel cars peaked in 2017 is now rapidly declining as EVs scale up. Companies like Tesla are taking an increasing market share. And within three years it is predicted that EV sales will match internal combustion engine cars. A similar thing happened with Netflix and Blockbuster sales of video / CDS.  By the time Netflix sales approached Blockbusters the company was bankrupt. So as investors in these companies funds ought to be aware that changes have been happening extraordinarily quickly, and the risk of stranded assets. Unless you’re paying attention, you risk getting caught out.  For a big pension fund who pay people's retirements this is of course of important and we need to be cognizant of how rapidly these changes are occurring and align our investments accordingly.

We have spoken a little about EVs. I think one of the one of the points to note about the decarbonisation journey is that transport is one of the more difficult and capital intensive sectors to decarbonize. This slide looks at fossil fuel usage infrastructure – a transport industry largely based on fossil fuels. Using fossil fuels and burning fossil fuels to power transport is by far the biggest component currently. There are also nearly 12 trillion global assets invested in the ‘road infrastructure’ category, out of a total of 22 trillion invested in fossil fuel infrastructure.

This speaks to the challenge of how we might go about rewiring these technologies for the future beyond fossil fuels. So while that is a relatively achievable task in the lights for the passenger car market with the rise of battery and electric vehicles. In the heavy transportation market then we are talking about things like hydrogen, other technologies coming through. This might be a little bit slower and harder to abate, but certainly in the passenger car market the changes can to be extraordinarily rapid, and there's a lot of assets out there which are exposed to disruption, as we decarbonize.

When we are speaking of demand, generally what happens is the incumbents suffer a major precipitous fall in the stock price, and in many cases, they go bust. So when we look at previous demand peaks, there's a few on the slide chart (Fig 23)  like coal which hit peak demand in  in 2013, and saw big coal company going bankrupt in the US . In the case of fossil fuel turbines, when demand for those peaked in 2011, General Electric (GE), the big US manufacturer restructured the entire division and retooled for growth in demand which never came in. So the lesson here is that when incumbents see a future of growth this may not materialise. They are going to struggle as they lose market share, see precipitous drops in stock price, and a large percentage of them will go bankrupt, unless they adapt. So in future we are talking about peaks in heavy vehicle transportation and trucks, and shipping. In the longer term future we will get to harder to abate sectors like aviation, where solutions for short haul flights are already emerging on the table. And then we will get into industries such as plastic and steel manufacturing as we find solutions for fossil fuel feedstock’s as inputs for those processes. In each of those examples there is going to be winners and losers and incumbents are likely to struggle. So for the pension fund, the lesson here is this change is going to happen quickly with the 2020s as the decade of disruption, where change is going to be coming becoming much more rapidly and harder to ignore. In making sure the pension fund is positioned for low carbon growth stocks the future, being cognizant of which companies are likely to lose out when the product peaks and alternative products, lower carbon, come to market will be important.

The 2020s will be the decade of disruption as S curves increasingly disrupt the fossil fuel linked incumbents who fail to adapt or perish, just like the Blockbuster example. Investment risks are far broader than just equities of fossil fuel producers; we need to think about the usage of fossil fuels, so industries such as plastics and transportation.

Investors must also assess Corporate Bond holdings and the Passive Index Funds, which we are speaking about here. This is about moving from the low hanging fruit progress the pension funds has already made into thinking about the longer term decarbonisation journey.  The question then becomes how do we rewire our Passive Funds for this journey and where should we be investing to avoid pollution of fossil fuels. There are obviously huge opportunities for the clean tech investors as the world electrifies. We will need to build out an entirely new system based around low carbon technologies and the technologies of solar, wind and batteries.  This will mean exploring opportunities in those spaces to profit from the upside.

In conclusion:

  1. 2020s will be the decade of disruption
  2. Disruptive tech on s-curves outcompetes fossil incumbents
  3. Incumbents who fail to adapt perish
  4. Investment risks far broader than equities of fossil producers
  5. Investors must also assess fossil use infrastructure, corporate

bond holdings & passive index linked funds

  1. Huge opportunities for clean tech investors as the world electrifies

 

Some suggestions for further reading are provided.

 

The chair then invited questions on both Pension Fund divestment progress and Carbon Tracker, and the following points were made:

 

·  The definition used for decarbonisation of the Pension Fund is scope 1 & 2 carbon emissions, rather than scope 3. There is some work looking at scope 3 but these are harder tracker. Members suggested that clarity is provided about what is in scope.

 

·  In a response to a question on using corporate engagement to improve sustainability officers said that this was done through the LPFA scheme. 

 

 

·  The Strategic Director responded to a question on tracking carbon divestment, by explaining that there is currently not an agreed single measurement, and as measurements improve there are fluctuations in the performance, which the Pension Fund has seen that over the last five years.  There is now a more towards carbon disclosure and next year the fund will be using TFCFD (Task Force on Climate-related Financial Disclosures) to measure carbon exposure. He explained that one of the issues is that the financial sector is global, but regulation on the whole was still done at the nation state level. In each jurisdiction ESG and carbon measurement use slightly different definitions. The other issue is that ESG has not been extensively regulated. There has been a lot of greenwashing. Now the Financial Conduct Authority is looking at companies marketing materials, to see if they are making claims they can back up.  We do need more clarity and regulation.

 

·  Ryan Jude, Programme Director, Green Taxonomy, GFI, added to the discussion by explaining his main role at the Green Finance Institute (GFI) is defining sustainable economic activity for every sector, on behalf of the UK government. Once this is completed, alongside a Regulation called the Sustainability Disclosure Requirements, this will mean the funds in question will have to report on taxonomy alignment.  This will enable scrutineers to see what percentage is green using a government endorsed regulation, with a science backed dictionary. In the meantime it is actually due diligence, a lot of research, which can be frustrating, and difficult to find the time and capacity to deliver.  Once the UK has complete this work,  later next year , the UK  will join the EU, which is more advanced on this already and also China, which is also a bit more advanced.

 

 

·  A member referred to the broad coalition of investors such as Climate Action 100+, which brings together multiple large investors much bigger than Southwark, such as Aviva and BlackRock.  They asked if there was opportunity to use their benchmarks and standards to assess the transition risk and transition strategies, and also referred to the science based target initiative.  They asked if Southwark could increase capacity by utilising those standards or inject ourselves into these bigger coalitions.

 

·  In response to a question on the proportion of the fund directly invested in energy Carbon Tracker and Southwark Pension Fund officers explained the energy weighting of a traditional portfolio is around 4-7 % whereas Southwark Pension Fund is now at fractions of these percentage. However, Southwark Pension Fund is aiming to decarbonise the fund and be zero carbon by 2030, which is a broader, more ambitions target.

 

 

·  The Strategic Director referred to investment funds that the Pension Fund considered including creation of solar panels, battery storage, solar panel and wind farms in Norway, as well as greening airports and railway stations.  The Pension Advisory Panel recommended wind, solar and batteries, which was accepted by him as the decision maker for the Fund. He noted there was resistance to the products reducing fossil fuel exposure in these existing dirty assets and speculated that it may be good to revisit this over the next few years because in terms of carbon impact cleaning industries that are dirty may actually be our best way to get to carbon neutrality.  He added that Southwark Pension Fund engage in retrofitting a property portfolio and see this investment as bringing good value, with 15% of the fund in Managed Property.  Here Southwark Pension Fund managers buy buildings, and then they make them green. Because good green buildings are the buildings that are attracting higher rents and better customers this is a strong part of the portfolio.

 

·  There was a discussion on the complexity and potential unintended consequences of moving to renewable technology, for example buried plastic wind farms and the energy involved in solar production and shipping. In response Carbon Tracker said that that a huge amount of resources are going into maintaining the current fossil system. One example is that 40% of the shipping in the world is simply moving fossil fuels from one continent to another. There are also large amounts of minerals involved in  involved in building the enormous shipping tankers crossing the ocean, as well as  the fossil fuels they burn doing it, so the focus on the smaller amount of materials and fuels in the production of renewables misses this larger consumption.  Carbon Tracker said that perfection is the enemy of good in the move towards sustainability, and referred to the Edison dilemma.  Edison designed electric light but he used candles and gaslight to do it. Similarly the railways used the canals to transport the goods to build the track. It is always the case that new technologies coming in use the old technologies to build the future. Carbon Tracker also cautioned against using concerns about electricity generation, and intermittency, to delay transitioning as intermittency only becomes a problem at about 80%. But at the moment, the global proportion of electricity generated by renewables on an average is somewhere in the region 10 to 15%. In the present scenario it makes no sense to worrying about intermittency when the gap is so huge.

 

·  There was a discussion on other aspects of responsible  investment and how mindful Southwark Pension Fund was of the Governance and Social aspects of ESG, alongside the Environment, particularly given companies such as Tesla might be weaker on the Governance compared with the Environmental aspect. The Strategic Director said that while the fund always practice responsible investment and is mindful of this, there is a single minded focus is on carbon reduction. He added that they also always hone in on diversity of personal.

 

 

·  Members questioned if weight also ought to be given to social aspects of ESG to ensure that transition is equitable. Carbon Tracker contributed to the discussion by outlining how energy transition provides for a more equal world, and can be defended for social and environmental reasons. In a world powered by fossil fuels 90% of the global energy is from 10% of countries (Saudi Arabia, Russia etc.). The energy is highly concentrated in small pockets of the world leading to supernormal profits.  In transition to renewables there is fundamental shift in the way that energy is distributed. This impacts on both the business model as well as on human beings, with every country having the ability to supply its own energy, to manufacture its own energy. In this scenario there are not supernormal profits, but you bring opportunities to people that do not have energy. Currently large parts of the globe do not have any energy, mostly because they are in remote places where the grid dose work. However, a solar panel in the middle of nowhere generates electricity, and then connectivity. Once you get connectivity, you generate wealth.  The new business model is also a challenge for investors because the new system is more like a mobile phone or internet network provider business making steady profits. Previously there was a pay for play mode, but now it’s a case of all you need for £30 a month, which is analogous to the new energy system, with steady sustainable profits. The transition will lead to a more equitable distribution of both energy and wealth bringing benefits to the environment and humanity, which why he suggested this singular focus right now is justified. 

 

 

 

Supporting documents: