Assessing carbon risk within a portfolio

Properly understanding a portfolio’s carbon footprint can help financial advisers avoid the financial impact of carbon risk for their clients.

Australia lags the world in renewable energy, generating just 17% of its energy from renewable sources, compared with 24% globally. So how much of your clients’ money is invested in fossil fuels? And what are the financial risks of being carbon-ambivalent in a changing investment environment?

There’s compelling evidence that unless the entire globe acts now, we’re heading for catastrophic levels of climate change. Yet Australia’s economy and energy production still relies largely on fossil fuels – and both individual and institutional investors continue to invest heavily in coal and oil.

But the tide is turning. At the time of writing, the 23-year-old university graduate Mark McVeigh is suing his super fund, REST, for failing to give him information about their management of climate-related risks in their investment strategy. If he wins his case, this could compel investment managers – in particular super funds – to review the way they invest when it comes to climate change forever.

Our fossil fuel obsession

Australia is a signatory to the 2015 Paris Agreement and has agreed to take action to help limit warming to below 2 degrees Celsius. To meet our obligations under this Agreement, the Climate Council estimates we’ll need to leave 90% of our coal reserves unmined.

Yet despite the climate risks of coal and oil and Australia’s abundance of renewable energy sources, the country remains fixated on fossil fuels. At home, fossil fuels generated 83% of the nation’s energy needs in 2017 – compared to the global average of 76%. Meanwhile, overseas reliance on coal is continuing to fall, with plants rapidly closing in the UK, Germany, the US and China.

The switch to renewables is a global megatrend. Ignoring it is not only dangerous to the future of the planet – by continuing to put their money into fossil fuels, investors are missing out on the opportunities offered by the fast-growing renewables sector. What’s more, ignoring climate risk leaves them open to future legal liabilities.

The environmental risks of climate change are well documented. Extreme weather events, like the recent drought and winter bushfires, are exacerbated by climate change – and long term we can expect rising sea levels, more climate refugees and food security risks. What’s perhaps less well understood are the financial risks of taking a business as usual approach. And it’s not only individual investors like McVeigh who are taking a stand.

Already, the Australian Prudential Regulation Authority (APRA) is pushing financial companies to run climate-risk tests on potential investments. And in a recent speech, Australian Security and Investments Commission (ASIC) Commissioner, John Price, confirmed the regulator would be treating climate risk as a key priority from a governance and a disclosure perspective. A mechanism to price carbon seems inevitable – and when it becomes a reality, fossil fuels could become stranded assets.

The move towards renewables

So will transitioning from our dependency on fossil fuels to renewables spell financial ruin for Australia?

The short answer is no. Renewables have huge financial potential – even more so now that their costs have fallen dramatically. Globally, onshore wind schemes and solar photovoltaics are cheaper or comparable to the electricity generated by fossil fuels. And rapid developments in technology are making renewables more reliable and cost-effective than ever.

In Australia, old coal stations are still marginally cheaper, but they will all need to be replaced in the coming years – making renewables more economical in the long run. What’s especially exciting is that Australia can potentially produce almost unlimited energy from solar and wind alone. And already, the renewable sector is creating thousands of jobs for Australians – and will continue to grow with more investment.

Beyond green bans and boycotts

Deep green funds – those that invest ethically – have long considered climate change as a financial risk. But ethical investing goes much further than ruling out harmful investments. It’s also about actively seeking investments that do good.

At Australian Ethical, we do not invest in coal or oil. Instead, we actively work to create a renewable future for Australia, investing in solar, wind, tidal, geothermal, and hydro renewable energy companies. We’re also invested in companies like world-leading Danish wind power company Vestas – the largest wind turbine equipment and service provider in Australia.

We understand that tackling climate change goes way beyond fossil fuels. That’s why we invest in companies and sectors that help decarbonise our economy – from food production and transport, to recycling and waste management.

Our financial results speak for themselves. We’re the country’s fastest growing super fund by members over the last 5 years. In the 2016-2017 financial year, our super fund grew by 43% to $1,491 billion while our managed funds rose by 27% to $654 million. We’ve achieved this without any investment in fossil fuel companies. This means we exclude all companies whose main business is fossil fuels, as well as diversified companies that earn some fossil fuel revenue and aren’t creating positive impact with their other activities.

Australian Ethical also recognises the value of measuring the impact of investments and being transparent about the results. In 2017, analysis by the European 2° Investing Initiative (‘2ii’) found our renewable investments are well above what is needed to limit warming to 2 degrees Celsius. Overall, our investments produced 66% less carbon dioxide than the benchmark emissions intensity.

The role of advisers

Australians are rightly concerned about climate change. A huge four out of five of us would consider changing to a fund that invests in line with our values – and 56% believe there’s not enough information to help make an informed choice about investing ethically.

As an adviser, you play a key role in helping your clients invest in line with their values, while protecting their wealth from climate risk. What’s more, by ensuring your clients understand and make informed decisions about renewable investments, you can be part of the solution to avoid climate risk and financial instability.

You might like to try our carbon footprint calculator with your clients.

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