Is my pension fund’s asset management strategy still on track, taking along climate risks?
Starting at a party with good chops and bad news
The good news about climate change is that we have a lot more of the long summer evenings. So in our neighbourhoods we have more garden parties with good food and barbecues. My neighbour Heinz had a good reason for a party: he celebrated the successful removal of the dent in his car. There I met Oliver. His polo was a little older and less clean than I would have guessed from an investment banker, but that might be due to the very nice pork chops that Heinz makes. His yellow gold Rolex Daytona did match nicely with Heinz’s gooseberry crumble pie.
As I am open to learning more, especially from specialists in the field, I decided to broach the subject with him. Heinz was very positive about him, and he really seemed a likable fellow.
“Hi Oliver. Are you all done this week keeping an eye on the money mountain they call our pension fund? Is everything behaving well?”
“Well, mostly. The oil funds and airlines have taken a big hit with all these lockdowns going on, far more than any other sectors. Royal Dutch Shell even slashed their dividend for the first time since the Dutch were at war! But at least the airlines are flying again. Back to business, is what we all need. And some of these chops. Do you know Heinz’ recipe? This alone is already worth marrying into the family for…” he said with a charming smile.
I had to admit that Heinz never disclosed the recipe to anybody. I only had heard that it was really simple, like a standard rule set. That got us talking about rules and how convenient, or not they can be. Oliver excused himself for a moment, the favorite sausages of his fiancée where ready on the barbecue. She could not get up, she had sprained her ankle when they were walking in the cobblestoned center yesterday. And he really wanted her to eat well tonight, now the pain had subsided.
This gave me some time to recover. When Oliver saw his beloved was eating fine, he looked to me and invited me over. I was happy to continue our conversation, because I wanted to get another worry off my chest.
“Oliver, I understand a lot more of the difficulties of investing now. Thanks. Just to ease my mind a little: if a company gets extra rules from a government or the EU, for environmental benefit for instance, does that means those companies will have trouble?”
“Any company will say they are good with official rules. But off the record: why do you think Shell invests more money into lobbying than into those hobby climate projects they have? Climate is not a serious thing, I tell you. And if that climate change thingie exists, we don’t have any numbers on it. And if we have no rating, we cannot do any accounting, period. So there is no way we can
There he lost me a bit, because he went on about hedging, swap, derivatives, alpha’s. My head whirled. But that might have been the Schneeeule beer Heinz just gave me. That is very good beer, did you know?
I caught on again at: “…and those rules make running a business impossible. Why all the fuss? I mean: they have filters on their installations and the sky is so big, it swallows it all up and good. We don’t have filters on our barbecues here either, don’t we?”
So I tried to keep it on a level where I could still grasp it. “And how do those rules matter to you, when you decide where to invest? Whether you invest in BP or windfarms or GlaxoSmithKline?”
“Well, they are a thing, sometimes: Those oil companies had to borrow heavily the last couple of years, with all the current market troubles. They are at the end of their financial rope. If they have to find money to innovate and change, they don’t have any borrowing space left. And you know innovation doesn’t always work out. We call that Transition Risk.” It sounded very important and very dreadful. But then again, he was right: new products don’t always work for a company.
“Uhuh, a logical term. How is the risk called that Climate Change poses for a company?”
“Uh? Are there risks involved there? Climate Change, if there is something to it, I say, that will happen sometime in the future, isn’t it?”
“Well, yes, Shell and BP indeed once had films that it would happen in the future. Those came out 30 years ago, around the time the wall fell in Berlin. Their predictions were pretty good, those companies have good scientists! Just look around on our lovely warm evening, the future in those films is now all around is. Happening already, and I am sometimes afraid how much it will get worse. The world is going to be so hot, a person simply cannot live in the outside air in countries like India, by 2100. I don’t want to continue on droughts and floods, this evening is too nice for these real horror stories. Our nice European barbecue summers are a piece of that pie, of course. We only will have more of them, and hotter ones, more heat waves.“
“Ah heat waves do not bother me, I made sure my new home was not only insulated, but also has air conditioning everywhere… So no problem!”
“But for the people without air conditioning, like pensioners, or people who cannot pay the rising energy costs of it, it is not going to be a nice life in that future. How do you take that into account when investing?”
Oliver shifted his weight uncomfortably, did a deep pull from his glass and wobbled his feet. I admit, I was carried away. Too much Schneeeule beer, I could tell in my defense. He surely heard such horror visions from his fiancée Emma, Heinz’ daughter, who sometimes came to my terrace for a coffee and there debated with Hannah and her friends, whereby her climate concern was limited to talking. Not so with Hannah. To this day, I have not been able to decide which I preferred. Hannah sometimes really overdid it!
Oliver had quickly recovered his composure. He now talked about accounting standards and strict policies, and the complicated computer programs there are nowadays and I didn’t even know where he had started.
So I ended the evening focusing on the chops and sausages, and the gooseberry crumble pie.
Thinking it over: Finance really works with a blindfold on!
I couldn’t sleep very well. My mind kept going round in circles: How could it be that such a capable and likable fellow like Oliver didn’t know or didn’t really care about the link between the climate crises and his pension fund’s investment policy? Well, his investments impact the climate, and climate impacts his investments, don’t they?
Obviously it is not Oliver’s job to deal with climate change risks. He’s busy enough to invest or reallocate his billions to earn a return. So for him it’s strictly a math exercise. His complicated programs apparently do not even give him the opportunity to take into account the risks that the big companies in the energy industry now represent.
In the past, oil companies were the reliable, somewhat boring sources of good returns. Now their business model is
a) increasingly noncompetitive. Electricity can be generated more cheaply with wind and solar power (1). There is still a lack of infrastructure, decentralized networks, storage facilities, but many places in Europe are fixing that as we read this.
b) on the verge of ruining our planet. Coal etc. has been burned for 200 years. The community of nations agreed to stop this, to limit heat rise to well below 2 degrees. But heat is going up faster than expected (2), 2015-2019 saw 1,1 Degrees. 15 years of rapidly rising methane pollution will have contributed a lot. (3)
Large oil companies in Europe hoped to extend their old business model as long as possible by embarking on a gas strategy, ramping up infrastructure, doing lobby efforts and PR to promote “clean” natural gas (4).
I smell a bad ending
This cannot go well! With increasing heat waves and heavy rainfall and therefor growing public pressure, the prospect of a rapid easing of the climate crisis, albeit temporarily, by stopping natural gas production and fracking is too tempting. Sooner rather than later, Europe will resolutely push for a consistent switch to renewable energy supply. Away from methane/natural gas. Away from this dangerous energy source. In the end, the investments in new pipelines, in LNG terminals, and in the newly developed gas fields e.g. in the Mediterranean will be a total loss.
This trend is clearly noticeable in the EU, which is currently reforming its financial system to make it climate-proof. (5)
In short, the oil and gas company’s business model is being phased out. It is becoming riskier every day. The ground for save investment is shaking. It looks that my Pension Fund is building a mountain of risks, and is now on a slippery slope.
(1) According to the EU’s latest energy statistical datasheets, renewables are currently the leading source of electricity generation in the EU. https://ec.europa.eu/info/news/focus-renewable-energy-europe-2020-mar-18_en
(2) World Meteorological Organization (2019) Global Climate in 2015-2019: Climate change accelerates https://public.wmo.int/en/media/press-release/global-climate-2015-2019-climate-change-accelerates
(3) There is a time lag between greenhouse gas emission and climate heating. Maybe the full impact of the methane rise will only be felt in the next few years. However, the methane concentration was already far too high before 2007.
(4) Gas transport companies (also known as Transport System Operators, TSOs) continue to be a driver of gas expansion in Europe. One of them is the Italian Company Snam, a “Leading energy infrastructure operator” (self description).
Thanks to ten lobby groups, Snam is well represented in Brussels. One of them, GasNaturally, is chaired by Snam CEO Marco Alverà.
Snam is also on the board of the European Network of Transmission System Operators for Gas (ENTSOG), a body created in 2009 by the EU. its task include providing projections of future gas demand in Europe. Until now, ENTSOG has consistently over-estimated the demand.
(5) Technical expert group on sustainable finance (TEG) https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance_en#teg