A new report from the Global Research division of Britain’s multinational banking and financial services company, HSBC, has warned of increasing risk of “stranded assets” in the fossil fuel industry.
And though the report doesn’t go so far as to warn investors away from investing in the fossil fuel industry altogether, it does raise certain questions that are going to need to be addressed in the coming years — if not sooner, as the planet’s nations gear up for the United Nations Climate Change Conference to be held in Paris at the end of the year.
Specifically, the report, Stranded assets: what next? asks the question, How investors can manage increasing fossil fuel risk? The report’s authors note that “the risks of fossil fuel asset stranding could come from energy efficiency and advancements in renewables, battery storage and enhanced oil recovery,” and though “the timing of such structural events is difficult to predict,” investors must now determine what is the best strategy for dealing with possible stranded assets “that captures both climate commitment and fiduciary duty.”
Their conclusions are two-fold, and undecided:
Divesting fossil fuel stocks removes assets but dividend yields may suffer and portfolios become more concentrated. Holding onto stocks allows investors to engage with companies and encourage best practice, although there are reputational as well as economic risks to staying invested. Companies can cut capex but risks remain in maintaining exposure.
Fossil fuel divestment is not a new idea, nor is it an unpopular one, as can be seen by the repeated news pieces dealing with new institutions, companies, and persons divesting from fossil fuel investments. Earlier this week we covered a report from the Financial Times which highlighted Prince Charles of England, the Sainsbury family, The National Trust, the Church of England, and SAOS, University of London have all made moves to divest.
HSBC is significantly concerned that “innovation in efficiency and technological advancements” will “resolve in further stranding of high carbon and high cost fossil fuels.” The fossil fuel industry has not been helped by recent developments in oil prices, which according to the authors, “turned the debate from policy to economics, as many unconventional oil sectors, such as oil sands, shale oil, and Arctic drilling, have become loss-making in a relatively short period of time.”
So should investors divest from fossil fuel investments, or hold onto their investments and attempt to engage with the companies in an attempt to encourage best practices?
HSBC isn’t committing to an answer, though its analysis doesn’t shine an attractive light on holding on to fossil fuel investments. “Investors should first analyse what assets will be stranded and so where the risk lies in portfolios,” the authors of the report write, falling back on some safe common-sense advice. They do, however, highlight the increasing risk in coal assets — which “face the greatest regulatory risks, given the high associated emissions and substitution possibilities” — as well as the increased risk in oil reserves.
But HSBC shies away from siding one way or the other, leaving the decision in the hands of investors.
This may not be a completely bad idea for HSBC, however, considering the inherent difficulties faced by divestment. There are numerous challenges faced with divesting from fossil fuels — despite the inherent benefit for forcing change in the fossil fuel industry by “voting with your wallet” as well as the ethical investing benefits. Possibly the biggest concern is what to do with the sudden excess investment cash that is no longer feeding the fossil fuel industry. Understandably, there is a “degree of concentration risk” in divestment, depending “on the scope of an investor’s divestment — whether from all fossil fuel companies or a selection where risks outweigh returns.” Another potential loss in divesting is the loss of dividends, as “many fossil fuel companies are regular dividend payers,” leading the authors to advise investors to “consider lost yield from portfolios when divesting stocks and consider relative yields of investments made with cash released through divesting.”
However, HSBC seems to highlight several benefits, or at least anti-negatives, in divesting, including the possible effect on the carbon budget. As seen in the figure below, “less demand for shares and bonds ultimately increases the cost of capital to companies and limits the ability to finance expensive projects, which is particularly damaging in a sector where projects are inherently long term.”
In the end, HSBC’s lack of commitment to advising either to divest or hold and engage is understandable in dealing with an issue it deems “an immature risk.” Without a doubt, the threat of stranding “intensified this year,” and is likely to continue to increase in the coming years, but the reality is that even a few months is an eternity for an investor’s portfolio, and long-term decision-making may require a more mature understanding of the risk of stranded assets.
Credit to BusinessGreen for providing access to HSBC Research’s report
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