Divest or Disregard? IEA’s climate riddle for corporates

Last week we chronicled part of the visit of US environmentalist Bill McKibben, who brought to Australian shores his campaign of “delay” to and divestment of high polluting carbon assets.

It’s a concept that Australian asset managers and corporates, including the Future Fund, are still trying to get their head around, even if most of the mainstream media are completely ignoring it. Do the asset managers sell now for a clean energy future, or hedge their bets for a 3C-5C warmer world? And what will happen to the index?

So, perhaps it would help if an august international body would add its voice to scientists and environmentalists; and the International Energy Agency has done just this.

Deep in its report this week (page 112) on the need to adopt four key options to address the increasingly disturbing impacts of climate change, the IEA includes its 5 “Ds” – key strategies for corporates to deal with a “shift in the nature of opportunities” in a low carbon transition.

The most striking among them was this line: “Divest: Dispose of carbon-intensive assets, particularly those that have higher costs of production, as they are at greater risk of becoming uneconomic.”

It seems that some companies are already taking this advice. The IEA’s recommendation, though, is qualified by the final “D”, which is disregard (see below). That means simply passing on the climate risk to shareholders, which for most of the carbon reserves in the world are taxpayers. Sadly, that’s probably what a lot will do.

Still, this is not an environmental activist speaking, but a conservative grouping with 29-member countries that was established in the 1970s to ensure the developed world has access to plentiful energy sources. It now insists that those energy sources be clean.

Here’s what it writes:

“Corporate strategies that successfully take account of climate policy risk could represent a source of competitive advantage, while failure to do so could result in a company’s business model being undermined,” it writes. “Broad, non-exclusive approaches to mitigating climate policy risk might include:

Decarbonise: Invest in technologies that reduce the carbon reserves associated with an existing asset portfolio. Coal companies could invest in underground coal gasification, coal-to-gas, increased washing of coal (to improve efficiency) or develop coal bed methane assets. Oil companies could focus exploration efforts more towards natural gas or invest in enhanced oil recovery utilising CO2 (or use depleted reservoirs to store CO2). Power companies could invest in CCS and evolve their portfolio of generation assets towards low-carbon options.

Diversify: Invest in new assets to develop a more diversified portfolio diluting the risks associated with those that are carbon intensive. Many coal companies are active in other forms of mining (the largest private sector mining companies generate 10%-30% of their revenues from coal). At times, some oil and gas companies have also owned a portfolio of renewable energy assets, such as wind power and biofuels. Geographic diversification of assets can also mitigate the policy risk of a particular market.

Delegate: Take actions to transfer the risk onto other parties willing to accept it, potentially through price hedging instruments or long-term take-or-pay contracts. Price hedging can ensure a fossil-fuel producer receives a particular price for all or part of its supply. A take-or-pay contract can provide a degree of certainty over the volume of fossil fuels to be sold and the revenues to be received.

Divest: Dispose of carbon-intensive assets, particularly those that have higher costs of production, as they are at greater risk of becoming uneconomic.

Disregard: The alternative to the mitigation options above is to accept the risk as it is, together with the associated impacts should it occur. The financial impact will, ultimately, fall upon shareholders. It is therefore notable that it is estimated that nearly three-quarters of global carbon reserves are held by government-owned companies, i.e. owned by taxpayers.