Energy

Ahead of the Curve ™

ESG Primer – Assessing Climate Change Risk

Feb 14 2019

Report by Cowen Research, Jeffrey Osborne, Vivien Azer, Charles Neivert, Jason Gabelman, Gautam Khanna, Joseph Giordano, CFA, Helane Becker and Chris Krueger

 

This report serves as a Primer on broader ESG trends, with a particular focus on the “E” – Environmental. Notably we have partnered with 8 colleagues in assessing climate change risk on various industries. ESG factors and climate change pose material risks to investors’ investments that we believe are often overlooked today as only 1 in 4 dollars invested in the U.S. utilize ESG screening.


ESG Factors To Affect Investment Decisions Materially In Coming Years (Jeffrey Osborne)
We expect to see a dramatic shift in the investment analysis of ESG factors and climate-related risks. As it stands today, ESG initiatives and the physical risks imposed by climate change are often overlooked by investors. In order to act in the best interest of the client, however, it is becoming increasingly important for investors to consider externalities that support the transition to a lower carbon economy. ESG programs have an importance far greater than just the public appearance of a company. Fortune 500 companies in particular with an established focus on ESG can have a significant influence on reducing emissions and therefore play a large role in combating climate change. Companies like Facebook, AT&T, and Walmart, which are lead corporations with solar and wind offtaker agreements, have power purchase agreements for over 3 GW of renewable energy combined. PG&E’s recent bankruptcy filing may be the first major wake-up call for investors about the exorbitant amount of risk that climate change exposes to an investment. Despite being California’s largest utility, PG&E’s ~$30bn in liabilities for the California wildfires exemplifies the need for climate change to be evaluated in a portfolio. Furthermore, how an investment contributes towards or mitigates this risk must also be considered. In the upcoming years, we expect ESG contribution and the effects of climate change to play a material role in assessing the underlying risks and upside potential of an investment.

Understanding The Risks/Rewards Of Combating Climate Change: Fundamental Impact To Investors
A comprehensive understanding of the risks and rewards associated with climate change is critical for investors to assess their portfolio. The risk-return profile of companies with climate-related exposure may materially shift due to the physical impacts of climate change, climate policy, and new technologies. In an effort to combat these changes, investment opportunities in the energy sector are poised to accelerate. According to a report from the Task Force on Climate Related Financial Disclosures, the transition to a lower-carbon economy is estimated to require an average of around $3.5 trillion in energy sector investments per year for the foreseeable future.
In order to understand the associated risks and opportunities that climate change poses to their portfolio, investors are beginning to ask two simple questions:
1. How does my investment impact climate change?
2. How does climate change impact my investment?

Understanding these two fundamental questions should help investors align environmental returns with financial returns.

How does my investment impact climate change?
This question relates to investors with a proactive focus on environmental returns and has led to the advent of SRI, ESG, and Impact funds, as well as mandates from pensions and sovereign wealth funds. Equities and Debt using this approach has exploded. According to Bloomberg New Energy Finance, green and sustainable debt issuances rose to $230 billion globally in 2018, up from $198 billion in 2017. Investment in clean technology has accelerated in recent years as a number of technologies in renewable energy generation, energy efficiency, and clean transportation have become or are about to become cost effective on their own, without the need for subsidies.

How does climate change impact my investment?
Climate change exposes the financial stability of an investment to physical risks, liability risks, and transitional risks which account for the cost to comply with changes to policy, technology, and asset reassessment. To fully address this question, investors must explore the impact that climate change has on each respective industry. In this report, we aim to provide investors with a helpful framework to begin assessing potential climate risks for an extensive list of industries ranging anywhere from beer to agriculture to chemicals.

Pace Of ESG Portfolio Integration Has Accelerated
Integrating ESG in a portfolio offers a differentiated and alpha-additive complement to fundamental investment analysis and helps attract and retain a growing pool of assets for fund managers. Growth of ESG integration into a portfolio has accelerated in recent years. There has been a strong increase in both the assets under management and the number of registered investment companies incorporating ESG. According to an October 2018 report from the U.S. SIF, sustainable, responsible, and impact investing (SRI) assets have expanded to $12.0 trillion in the United States, up 38% from $8.7 trillion in 2016. New regulations have also increased the relevance of ESG focused investing. For example, failure for automotive OEMs to meet stringent CO2 emission targets in Europe could result in over $1 billion in fines for OEMs. These regulatory targets and the associated fines for non-compliance are driving the need for many OEMs to accelerate their electric vehicle platforms. Other regulations such as the International Marine Organization 2020 rule, which mandates cleaner bunker fuel, has the potential to have a major impact on refiners, tanker operators, and diesel costs globally. We see the two forces of investor demand and regulations leading to increased sustainability initiatives across various industries. For additional information on the impacts of the International Marine Organization 2020 rule click HERE.

This Report Is Geared Toward Both Analysts & PMs To Provide A Broad-Based Understanding Of Growth In ESG Investing As Well As Climate Change’s Impact Across Industries
This Ahead of the Curve report seeks not only to provide investors with a Primer on ESG sector trends from a high level but also to highlight real world examples of climate change on a variety of industries ranging from airlines to cannabis to integrated oil companies. Eight analysts have collaborated on this report and have provided deep insight into how these important issues are manifesting for individual companies and sectors as well as highlighting areas of emphasis to mitigate risks. We believe this report should appeal to both portfolio managers and analysts alike.

 

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