Unburnable carbon risk threatens ASX shares more than most

Investors in the Australian share market are exposed, more than most, to the “inevitable” risk of unburnable carbon, and should consider divesting their portfolios of all heavily fossil-fuel exposed companies, a new report has warned.

Released on Wednesday by The Australia Institute in conjunction with 350.org and Market Forces, the report  – Climate Proofing Your Investments: Moving Funds Out of Fossil Fuels – is the latest in a raft of documents warning institutional investors against the risk of “unburnable carbon.”

Unburnable carbon, explains the report, “is the risk to investors who hold shares in companies owning reserves that those reserves will become ‘stranded’, that is, they will lose economic value prior to the end of their useful life.” And the risk to investors in the Australian share market, it says, is “more than most.”

The report warns that the large-scale stranding of billions of dollars worth of fossil fuel investments is inevitable, if governments around the world act on their stated climate objectives of restricting global warming to an increase of 2°C.

Currently, however, the world’s fossil fuel companies are “estimating with 90 per cent certainty that they will be able to extract freely (for subsequent sale and combustion) over three times more carbon than is compatible with the internationally agreed 2 degree limit.”

This constitutes a “fundamental contradiction,” says the report, warning that even action insufficient to prevent runaway climate change will have “a significant negative impact” on fossil fuel asset prices.

“Fossil fuel business valuations involve a fundamental intellectual ‘fallacy of composition’ – analogous to the traditional speculative bubble,” says the report. “Investors’ expectations cannot be met as they have become divorced from the physical reality and committed policy response.”

According to the report, Australia’s stock exchange (the ASX) has significant carbon exposure, although its fossil fuel intensity is lower than many of its peers, both in terms of total carbon and carbon intensity.

“In relation to Australian equities there is a wide range of company-specific exposures to unburnable carbon risk – from pure play coalminers through to oil and gas majors, power generators, diversified miners with some fossil fuel operations, to companies providing services to fossil fuel producers,” says the report.

As the table below shows, TAI recommends investors divest from the ASX 200 companies which it categorises as Tier 1, or “substantially involved in fossil fuel extraction,” including: Origin Energy, Woodside Petroleum, Oil Search, Whitehaven Coal and Horizon.

In Tier 2, more candidates for divestment include AGL Energy, Energy World an Envestra. In Tier 3, where companies have “large absolute direct fossil fuel exposure but less significant relative exposure, you find BHP Billiton, Rio Tinto and Wesfarmers.

The Tier 4 companies – for which the action recommended is engagement, followed by divestment if the outcome of said engagement is not satisfactory – are companies with indirect fossil fuel exposure, including all of the Big Four banks, and big industrial groups like Downer EDI, Leighton Holdings and Toll Holdings.

The move to cut fossil fuel-exposed companies like these – many of them traditionally considered to be “Blue Chip” – from the investment portfolios of super funds and other financial institutions is gaining momentum around the world.

Last July, Norway’s second-largest insurer and leading Scandinavian pension fund, Storebrand, elected to exclude 13 coal and 6 oil sands companies from all of its investment portfolios, after a sustainability analysis of the energy sector.

“The aim of these exclusions is to reduce Storebrand’s exposure to fossil fuels and to secure long term, stable returns for our clients,” said Christine Tørklep Meisingset, the group’s Head of Sustainable Investments.