At the end of 2012, the largest two hundred listed fossil fuel companies had a market value of around $4 trillion. However, Impax, in its white paper The Investment Case for Fossil Fuel Divestment, argues there are strong reasons to believe the market prices of these companies are overvalued.
“[The] valuations do not take into account how credible action to address climate change might slash the value of their fossil fuel reserves,” Impax stated.
According to the Carbon Tracker Initiative - which Impax draws heavily on in its report - 80 per cent of the world’s proven fossil fuel reserves cannot be consumed without exceeding the international target to keep global warming within two degrees Celsius above pre-industrial levels.
Impax believes that if action is forthcoming, this could significantly reduce the market value of fossil energy companies.
“This implies that the world’s listed fossil fuel companies, whose share prices are partly based on their proven reserves, are grossly overvalued,” the report stated.
The firm also compared the historical performance of the MSCI World Index to fossil-free portfolios.
“For the five years to the end of April 2013, which excludes the dramatic run up in energy prices ahead of the 2008 financial crash, excluding the fossil energy sector would have improved returns by almost 0.5 percentage points annually,” Impax pointed out.
The company also believes, through a more “activist” portfolio strategy, one can enhance ones returns in the non-carbon sector.
“The picture is further improved if Impax’s actively managed portfolio of renewable energy and energy efficiency stocks is used in place of the passive FTSE’s Environmental Opportunities Energy universe,” Impax stated.
The asset management group argues evidence like this, coupled with stronger ethical and environmental concerns, is only likely to increase the pressure for investors to divest from oil, gas and coal companies.
However, they do concede that immediate divestment is not a viable option for many investors. In this case, Impax argues managers should pursue a ‘carbon-tilting’ strategy, where investors overweight less carbon-intensive companies and underweight those with the greatest carbon exposure.
Impax believes investors could also pursue thematic strategies by offering hedges to fossil fuel exposure. They could do this, for example, by investing in portfolios of ‘climate solutions’ providers, or in forestry assets.
The firm believes these strategies could be developed progressively to slowly build up a low carbon portfolio funded by incremental allocations from their fossil fuel holdings.
Although Impax admits its “forward-looking analysis is speculative”, it says there is enough evidence to support a compelling case for a re-orientation of investors' portfolios away from fossil fuel.
“These more environmentally attractive alternatives can [also] mitigate the large and growing financial risks of fossil fuel energy, which is the compelling win-win most investors seek in discharging their fiduciary duties,” Impax said.
