Download Technical annex to the position paper

Climate change and
energy investments
Technical annex to the position paper
Dialogue with participants and other stakeholders is an important part of the new
responsible investment policy that we adopted late 2015. As part of this dialogue,
we will give more insight into investments that raise questions with (some of) our
participants and into certain themes that have an impact on our investments.
We do this via position papers that will be published twice a year. This first position
paper deals with the topic that generated the most questions during 2015: climate
change and investments in energy. The technical annex to the position paper goes
into the different aspects of this topic in greater detail. The paper and the annex are
both published in Dutch and in English.
December 2015
1. Summary
Climate change is one of the biggest challenges
for the world to overcome in the 21st century.
In the Paris Climate Accord of December 2015,
195 countries have committed to restricting the
global temperature rise to well below 2 °C at
the end of this century. This will necessitate a
transition to cleaner forms of energy. ABP is well
aware of the changes in the energy sector that
this demands. As part of the new responsible
investment policy we have formulated a number of
ambitious targets for arriving at a cleaner portfolio,
with more room for investments in sustainable
energy.
The transition to a sustainable energy economy
allowing the climate goals to be achieved
represents a risk to companies and to investors
in them, but simultaneously creates opportunities
as well. Global energy demand will continue to
rise in the years ahead – even in a 2 °C scenario
– and fossil fuels will continue to be needed for
the foreseeable future in order to meet the energy
requirement. We regularly screen our investments
in light of various scenarios and in this paper
consider a scenario of 2 °C. Companies in the
energy sector will continue to play a part in our
investment portfolio because they can offer
returns, diversification, and a hedge against
inflation. Moreover they have a key role to play in
bringing about the transition.
Companies in our portfolio are expected to
anticipate and adapt to these developments
in a timely fashion. They will be required to
satisfy our sustainability criteria and we will use
our position to engage with them and express
our expectations. At the same time we will
urge governments and regulators to pursue a
consistent policy in order to create a level playing
field for investments in sustainable technologies.
2. Scope of this technical annex
This annex looks at ABP’s position regarding
climate change and energy sector investments.
We consider the contribution that ABP can
make to the energy transition along with ABP’s
ambitions. We also take a look at the role of our
investments in the energy sector, at companies
with reserves of fossil fuels in particular, and at
the necessary changes in policy required of other
parties such as governments and regulators.
This includes a more in-depth look at climate
change, future global energy demand, and
the ways in which that demand can be met.
Next, we consider the role of investments in
energy companies in the portfolio and the
valuations of companies with fossil fuel reserves.
Finally, we provide a brief summary of our current
investments in the energy sector.
ABP Climate change Technical Annex 2
3. Position of ABP
ABP fully supports the goal of the international
community to reduce greenhouse gas emissions
and to restrict global warming to well below
2 °C and to attempt to limit the rise to 1.5 °C
o
ABP aims to use its position as one of the
largest pension funds in the world to contribute
to the energy transition necessary to achieve
this goal
o
ABP attaches great importance to improving
efficiency in order to save energy and thus to
limit the growth in energy demand
o
ABP has set itself ambitious targets for
contributing to the transition to a cleaner energy
supply but also realises that fossil fuels will
continue to be needed in the foreseeable future
o
ABP continues to see added value in
investments in the energy sector, not least
because of the diversification benefit and
inflation hedge they can offer
o
ABP realises that the energy transition involves
risks, but it also creates opportunities. ABP has
high expectations of energy companies in
the portfolio and actively engages with these
companies
o
ABP realises that not all of the world’s fossil
fuel reserves can be exploited but is of the
opinion that the risk this represents to share
prices is manageable in most cases
o
ABP continues to engage with governments
and regulators with the aim of bringing about
the effective government policy that is essential
in order to facilitate a rapid but orderly transition
o
Climate change and global warming
There is broad consensus among scientists
that the climate is changing as a consequence
of greenhouse gas emissions. These greenhouse
gases are responsible for climate change largely
because they cause the earth to warm up.
The United Nations Framework Convention on
Climate Change (UNFCCC) has as its objective to
limit the global temperature increase to well below
2 °C above pre-industrial levels. This is considered
necessary in order to prevent dangerous human
interference with the climate system. In the climate
agreement reached in Paris in December 2015,
195 countries have committed to this target and
to pursuing efforts to further limit the temperature
increase to 1.5 °C by the end of the century.
ABP supports these goals. As part of the new
responsible investment policy (October 2015) we
have set ourselves a number of ambitious targets.
The carbon footprint of our listed equities portfolio,
for instance, has to be cut by 25% by 2020.
Energy transition
Two-thirds of the greenhouse gas emissions
attributable to human activity comes from burning
fossil fuels to meet our energy requirements.
In order to limit climate change and its negative
consequences, the world therefore needs
to transition to cleaner sources of energy.
This transformation to cleaner energy will not
be achieved overnight however, so it is vitally
important that we use energy more efficiently.
ABP is equally aware of both the transition
needed in energy supply and the need for greater
efficiency in our use of energy. We aim to use our
position as one of the largest pension funds in
the world to help in bringing about the required
transformation. We are convinced that the best
way for us to contribute to that transition is by
continuing to engage with the companies that
will have the greatest amount of work to do and
which are essential to accomplishing the transition
itself. Our new responsible investment policy
for the period 2016–2020 accordingly includes
contributing to a more sustainable energy sector
as one of the key objectives.
ABP Climate change Technical Annex 3
Demand for energy
Increasing global population, coupled with growing
prosperity, means that demand for energy will
continue to rise. According to estimates made
by the International Energy Agency (IEA), this
will be the case even in scenarios in which global
warming is limited to 2 °C. In these scenarios
however, growth in energy demand will be much
less rapid than if no action is taken. This is not
because of lower demand growth for the actual
benefit that we derive from energy (transport,
heating, use of electrical equipment etc.), but
because in these transition scenarios we will
use energy much more efficiently. ABP therefore
also attaches great importance to the further
promotion of energy efficiency. Reducing the
carbon footprint therefore applies to the entire
listed equities portfolio and not only to the energy
sector itself. Additionally, we will continue to
invest in sustainable real estate and we shall
double the ‘high sustainability investments’ that
will help to bring about a better and cleaner
future, from €29 billion currently to €58 billion in
2020. This category includes investments with
the potential of contributing to efficiency as well
as those in cleaner energy supply.
Energy supply
On the supply side, low-carbon technologies
like solar, wind and hydro power and also carbon
capture and storage will be an important part
of the transition. ABP has accordingly set itself
the target of achieving a fivefold increase in its
investments in renewable energy from €1 billion
to €5 billion in 2020. Given the limited availability
of investment opportunities in renewable energy,
that will present challenges. On top of that, the
energy supply side is an important element in the
doubling of the high-sustainability investments.
Despite the transition to cleaner sources of
energy, a substantial proportion of the growing
demand for energy even in transition scenarios
will still have to be met by fossil fuels. The required
investment in the supply of oil, gas and coal, and
in power generation capacity based on fossil fuels
is considerable, and the new technologies cannot
replace that requirement.
Added value of energy sector investments
On the one hand, the transition represents a risk
for companies, particularly those in the fossil fuels
value chain. On the other hand, the transition
creates opportunities for energy companies,
because substantial investments in energy supply
and in energy efficiency are required over the next
few decades. Although there will be far-reaching
changes in the energy markets in a transition
scenario, we believe that the traditional energy
companies will continue to have an important role
in the future as well. This will be partly as suppliers
of fossil fuels (particularly natural gas, for which
demand still shows an upward trend), which we
cannot do without at this stage. They will also
be able to play a key part in achieving the high
level of investment in low-carbon alternatives
that will be required. Despite the fact that there
is competition (especially for funding these new
technologies) from new non-traditional players,
the traditional utilities are the main developers and
operators of, for example, wind farms, hydropower
plants, and also storage facilities. Traditional oil &
gas companies have an important role especially
in developing the infrastructure for gas as a bridge
fuel and in the long term for biofuels and carbon
capture and storage. Companies in this sector can
therefore form an important part of our portfolio,
not only because of the expected returns but also
because of the benefits of diversification and the
hedge against inflation which investments relating
to natural resources are specifically able to offer.
ABP Climate change Technical Annex 4
Energy companies’ expectations
We actively engage with management of energy
companies and this allows us to assess to what
extent they are prepared for different low-carbon
transition scenarios that might unfold. We question
management on large capital projects, especially
those with long lead times (such as offshore
Arctic oil & gas exploration and development)
and projects that will take a long time to break
even and become profitable even when they go
into production (such as tar sands). We also expect
companies to set targets for bringing down their
greenhouse gas emissions and increasing their
efficiency and we ask that they take account
of transition scenarios and possible increases
in financial penalties for emitting CO2 in their
investment decisions. Additionally, we expect
companies to be transparent in reporting their
emissions. At shareholders’ meetings we
have accordingly generally voted in favour of
resolutions making this possible or stipulating
reporting transparency. We expect companies that
cannot realistically play a role in the transition to
return a large share of their cash flows back to
shareholders. We do not invest in companies that
are unwilling or unable to meet our expectations
on managing climate risk. When we engage with
companies, we expect to see visible progress
within two years. In the absence of such progress
we shall divest our position.
Fossil fuel reserves
When it comes to the valuation of energy
companies, we have to take into account the risk
that not all of the world’s coal, oil, or gas reserves
can be produced and burned in a transition
scenario. There will be winners and losers and
the outcome will be different for each company,
but we believe that the effect this will have on share
prices is manageable in most cases. In the case of
coal companies, which represent by far the greater
part of the reserves, the fact that the reserves are
not going to be fully produced and burned already
appears to be reflected in the valuations. Western
oil and gas company valuations on the other hand
appear to imply that all proven reserves will be
produced and burned, however given the current
rate of production, the reserves will probably have
long been depleted before demand disappears.
This is partly explained by the fact that the marginal
production costs for these oil and gas fields, which
are mostly already in production, are very low.
Engagement with governments and regulators
Finally, ABP realises that effective and carefully
considered government policy is essential in
order to facilitate the transition. We accordingly
urge governments and regulators to pursue a
consistent and predictable policy that will create
a level playing field for investments in sustainable
technology. An example would be a price on
emissions that is high enough to be an incentive
for developing low carbon technologies. At the
same time, it is also crucial that governments
around the world gradually reduce subsidies for
fossil fuels. Subsidies for renewable technologies
can be an effective tool in order to advance
promising technologies along the learning curve.
Overreliance on unsustainable subsidies can pose
risks, as we have seen in a number of countries
over the past years.
ABP Climate change Technical Annex 5
4. Background: Climate change and energy supply & demand
Climate change and energy supply
Climate change is one of the biggest challenges
for the world to overcome in the 21st century.
In 2010 in Cancún during the 16th Conference
of the Parties (COP), the 196 Signatories to
the UN Framework Convention on Climate
Change (UNFCCC) agreed that urgent action
should be taken in order to keep the global rise
in temperature below 2 °C compared with preindustrial levels. This is deemed necessary in order
to prevent dangerous human interference with the
climate system. Serious reductions in greenhouse
gas emissions are required in order to meet that
target. At the 21st COP in Paris in December 2015,
it was agreed that the global average temperature
increase should be kept well below 2 °C, while
efforts will be pursued to limit the increase to
1.5 °C. Since the energy sector accounts for about
two-thirds of all anthropogenic greenhouse gas
emissions today1 , a major transformation of this
sector is required. In a world of growing energy
demand and increasing importance of security of
supply, this is particularly challenging.
What does this mean for fossil fuel reserves?
The Intergovernmental Panel on Climate Change
(IPCC) estimates that in order to have a 50%
chance of meeting the 2 °C target, the world can
support a maximum so-called ‘carbon budget’
of 2,900 to 3,200 Gt of anthropogenic CO2
emissions, of which 1,970 Gt had already been
emitted before 2014. The International Energy
Agency (IEA) reckons that this leaves a budget
of about 980 Gt of emissions from the energy
sector (including supply, transformation, and
consumption). Estimates made by the Carbon
Tracker Initiative (CTI)2 show that global proven
fossil fuel reserves have the potential to emit close
to 3,000 Gt if burned without carbon capture
and storage technology, hence far surpassing
the budget. The latest estimates also show that
the top 100 exchange-listed coal companies and
the top 100 exchange-listed oil & gas companies
combined had reserves with an emissions
potential of 555Gt as of the end of October 2014,
of which 72% is in the form of coal, 14% in the
form of oil, and 14% in the form of gas3. The
CTI study concluded that a large proportion of
the reserves could not be exploited and that the
potentially ‘stranded’ reserves might adversely
affect the valuation of the listed companies
concerned. In assessing the risks for companies,
it is important to consider the expected energy
supply and demand developments and the
valuations of companies with fossil reserves.
Future energy supply and demand
In its annual World Energy Outlook, the IEA
forecasts energy demand for the next decades
under several scenarios. The New Policies
Scenario (NPS) serves as a base case, while the
main alternative scenario (‘450ppm scenario’)
is consistent with limiting global warming to
2 °C. The Paris climate agreement has now
tightened up the requirement by setting a target
of holding global warming well below 2 °C, while
pursuing efforts to limit rising temperatures to
1.5 °C. Compared with the 450ppm scenario,
this probably means that greater energy savings
will be needed and that the transition to cleaner
alternatives will have to be accomplished more
rapidly. We will assess the precise implications
of a 1.5 °C scenario in the course of the coming
year but the trends outlined below provide a
good insight into the challenges facing the energy
sector.
In the base case scenario, total global energy
demand will increase by 1.0% per year between
2013 and 20404. In the 450ppm scenario, energy
demand growth is lower, although it is still
expected to grow by 0.4% per year from 2013
onwards (see Figure 1).
World Energy Outlook Special Report on Climate Change, IEA,
June 2015.
1
2
Unburnable Carbon, Carbon Tracker, 2012.
The original CTI list is currently maintained by Free Fossil Indexes
under the name Carbon Underground 200TM. In this report we use
the 2015 version of this list.
3
4
IEA World Energy Outlook 2015, pages 584 and 585.
ABP Climate change Technical Annex 6
Global energy demand projections in various scenarios
Primary Energy Demand
Share in the mix
Jaarlijkse groei
Actual
NPS
450ppm
Actual
NPS
450ppm
NPS
450ppm
2013
2040
2040
2013
2040
2040
2040
2040
mln toe
mln toe
mln toe
%
%
%
%
%
Coal
3.929
4.414
2.495
29%
25%
16%
0,4%
-1,6%
Oil
4.219
4.735
3.351
31%
26%
22%
0,4%
-0,8%
Gas
2.901
4.239
3.335
21%
24%
22%
1,4%
0,5%
11.049
13.388
9.181
81%
75%
60%
0,7%
-0,7%
326
531
588
2%
3%
4%
1,8%
2,1%
1.376
1.878
2.331
10%
10%
15%
1,1%
1,9%
Other renewables
161
937
1.470
1%
5%
10%
6,5%
8,2%
Total renewables
1.863
3.346
4.389
14%
19%
29%
2,1%
3,1%
646
1.201
1.627
5%
7%
11%
2,2%
3,4%
13.558
17.935
15.197
100%
100%
100%
1,0%
0,4%
Total fossil fuels
Hydro
Bioenergy
Nuclear
Total
Figure 1. Global energy demand projections in various scenarios. Based on IEA data from the World Energy
Outlook © OECD/IEA 2015, IEA Publishing and adjusted by ABP.
Licence: www.iea.org/t&c/termsandconditions.
The magnitude of the transition becomes clear
especially when comparing the share of the
different fuels in the mix in the base case to the
450ppm scenario. Where fossil fuels are currently
supplying 81% of the total primary energy demand
and would drop to 75% (2040) in the base case,
their share would fall substantially to 60% (2040)
in the 450ppm scenario. Despite the fact that even
in the 450ppm scenario fossil fuels remain the
largest source of energy, absolute demand for coal
and oil is expected to drop. Demand for gas, the
least harmful of the three major fossil fuels, is still
expected to increase though. On the other hand,
the 450ppm scenario foresees a strong increase
in the supply of renewables such as bioenergy,
wind and solar. Also worth noting is that this
scenario envisages a strong growth in the amount
of nuclear energy. Total nuclear energy supply is
expected to rise to levels of more than 2.5 times
the current output.
5
IEA World Energy Investment Outlook 2014, page 162.
Nuclear energy does not emit CO2 and for a
number of countries it is therefore an important
option for reducing greenhouse gas emissions.
We recognise these advantages of nuclear
energy but we are equally aware of the risks such
as safety, costs of dismantling and the issues
surrounding final storage of radioactive waste.
In the process of increasing the sustainability of
our portfolio we shall focus on investments in
renewables.
Need for investment in energy supply
The investment implications of the transition
become apparent by looking at IEA’s World
Energy Investment Outlook5 published in 2014,
which estimates total investments required in the
energy sector (across the value chain: upstream,
transport, and processing). This is summarised
in Figure 2.
ABP Climate change Technical Annex 7
Required investment in the energy sector in various scenarios
Annual investments
Cumulative
Actual
NPS
450ppm
NPS
450ppm
'00-'13
'14-'35
'14-'35
'14-'35
'14-'35
$ bln
$ bln
$ bln
$ bln
$ bln
Oil Supply
427
621
503
13.671
11.062
Gas Supply
252
399
339
8.771
7.457
Coal Supply
61
47
31
1.034
690
106
120
131
2.635
2.877
8
48
78
1.061
1.722
Renewable power generation
153
266
400
5.857
8.809
Power transmission & distribution
212
310
266
6.817
5.851
Power supply total
479
744
875
16.370
19.259
10
15
42
320
920
1.229
1.826
1.790
40.166
39.388
21
34
62
739
1.371
Transport efficiency
115
224
369
4.928
8.120
Buildings efficiency
77
106
184
2.334
4.040
213
364
615
8.001
13.531
1.442
2.189
2.405
48.167
52.919
Power generation from fossil fuels
Nuclear power generation
Biofuel supply
Total supply
Industry efficiency
Total efficiency
Total energy investments
Figure 2. Required investment in the energy sector in various scenarios. Based on IEA data from the
World Energy Outlook © OECD/IEA 2014, IEA Publishing and adjusted by ABP.
Licence: www.iea.org/t&c/termsandconditions.
Investment requirements in the energy sector are
higher under the 450ppm scenario than in the
base case, since the transformation would be
more disruptive, however the difference is only
10%. More interesting is the radical shift in the
mix. Although investments in energy supply are
roughly the same in both scenarios ($40 trillion
cumulative), the required investments in efficiency
are much higher in the 450ppm scenario.
In absolute amounts, transport efficiency requires
the most investment, at over $8 trillion cumulative.
Apart from transport, investment requirements in
real estate efficiency are also substantial.
In energy supply, the difference between the
base case and the 450ppm scenario is particularly
apparent from the investment requirements
in renewable power generation. These are
expected to reach $8.8 trillion cumulatively or
$400 billion per year, compared with $153 billion
per year historically. Large increases in wind
and solar generation capacity also require more
investment in power storage and flexible backup.
Investment requirements in coal supply will be
only $31 billion per year or half the historical
level. Despite the transition away from fossil fuels
though, investments in oil and gas supply are still
expected to be higher than historical levels on an
annual basis in the 450ppm scenario.
ABP Climate change Technical Annex 8
For oil this is mostly because of the decline of the
production from existing conventional fields, which
needs to be compensated partially by higher-cost
sources such as deepwater fields. Altogether in
the 450ppm scenario between 2014 and 2035,
a total of $22 trillion will need to be invested in
oil, gas, and coal supply, and in fossil-fuel fired
power generation. This equates to 56% of the total
investment requirement in energy supply.
Electrification of the transport sector
A better understanding of the magnitude of the
transformation in the transportation sector can
be gained by looking at IEA’s Energy Technology
Perspectives6. Its 2DS scenario (2 °C) is broadly
consistent with the 450ppm scenario while the
2DS-ET scenario (Electrifying Transport) shows
what the impact could be of an even more
ambitious electrification of the transport sector.
4DS (4 °C) is the base case. Figure 3 gives an
analysis of the penetration of electric technology
in transport. The most ambitious scenario foresees
a 4% penetration rate of electric vehicles for
passenger cars by 2030. However, by 2050
that will have gone up substantially to 17%.
Bigger steps are to be made for instance by urban
buses/minibuses, and especially for 2-wheelers
which are expected to be 50% electric by 2030
and 70% by 2050 in the 2DS-ET scenario.
Electrification of road freight is also substantial
in this scenario, with 5% penetration for light
commercial vehicles and medium freight trucks
and 2% for heavy trucks in 2030. In 2050 in this
scenario, these numbers are expected to increase
to close to 30% for the light and medium freight
and 15% for heavy trucks.
Key assumptions for vehicles technology penetration rate
Stock share in the fleet (%)
Dominant electric
powertrain type
2DS-ET
2030
2DS
4DS
2DS-ET
2050
2DS
4DS
Passenger
2-wheelers
BEV
50
40
28
70
50
27
Cars
BEV
4
4
<1
17
17
2
Urban minibus
BEV
8
<1
<1
30
<1
<1
Urban bus
Trolley electric
7
<1
<1
27
<1
<1
Intercity bus
Diesel hybrid with pantograph
1
0
0
8
0
0
LCVs
BEV
5
1
<1
26
1
<1
MFTs
BEV
5
1
<1
27
1
<1
HFTs
Diesel hybrid with pantograph
2
0
0
15
0
0
Rail
Electric with pantograph
55
51
45
71
61
50
Freight
Figure 3. Electric transport penetration in various scenarios. © OECD/IEA 2014 Energy Technology
Perspectives, IEA Publishing. Licence: www.iea.org/t&c/termsandconditions.
6
Energy Technology Perspectives, IEA, 2014.
ABP Climate change Technical Annex 9
Figure 4 shows the impact that such an ambitious electrification of the transport sector would have on the
fuel mix. Diesel and gasoline’s share in the mix would be reduced to about two-thirds in 2030 and to below
50% in 2050. The role of biofuels in these scenarios is also significant.
Other fossil
Hydrogen
Biofuels
Electricity
Diesel
Gasoline
180
160
140
120
Exajoule
100
80
60
40
20
0
2011
6DS
2030
4DS
2DS
2DS-ET
6DS
2050
4DS
2DS
2DS-ET
Figure 4. Breakdown of final energy use for transport by fuel type. © OECD/IEA 2014 Energy Technology
Perspectives, IEA Publishing. Licence: www.iea.org/t&c/termsandconditions.
Conclusion
All the developments and scenarios presented
show us that the demand for energy, in the 2 °C
scenario, will continue to grow, and that in a
transition scenario the mix will shift to relatively
more renewables and nuclear energy and less
fossil energy.
It also shows that investments in the energy sector
will be significant, even higher in a low-carbon
scenario than in the base case, and that even in
a low-carbon scenario investments in oil and gas
in the next 20 years will have to be higher than
they have been previously. Finally, it shows us that
investments in efficiency will become increasingly
important going forward.
ABP Climate change Technical Annex 10
5. Background: Role of the
energy sector in our portfolio
We discuss the characteristics of investments
in listed shares of companies owning fossil fuel
reserves and their role in our portfolio. A proper
assessment of their role in our portfolio requires
a long-term horizon. Only a long-term horizon
can provide a view that is not blurred by naturally
occurring cycles of supply and demand.
Diversification
Besides returns, diversification is an important
reason for investing across sectors, including the
energy sector. Sectors are not perfectly correlated
and therefore the risk of a diversified portfolio is
lower than the weighted average of the individual
risk of the sector portfolios. In our ex-ante
analysis, the MSCI AC World Index has an annual
risk of 15.5%, while the weighted average of the
individual sector risks adds up to 18.3%. In other
words, sector diversification caused by imperfect
correlation reduces risk by 2.8 percentage points.
The fossil fuel companies have a relatively low
correlation, which makes them a relatively valuable
sector in terms of diversification. Using a utilitybased approach we estimate that the economic
value added by sector diversification is equivalent
to a 0.6% outperformance per annum7.
Inflation hedge
Another advantage of investments exposed to
commodities, for example in the energy sector,
is that they can serve as a hedge against inflation.
Commodity prices have a big impact on consumer
price indexes, both directly and indirectly. ABP has
exposure to commodity prices, not only through
investments in energy companies, but also
more directly through our investments in listed
commodity futures and unlisted commodityexposed investments. Most energy infrastructure
investments can also provide a certain inflation
hedge, since tariffs are generally linked to inflation
through a regulatory formula.
Returns
Fossil fuels have on average generated higher
long-term returns than the MSCI AC World Index.
These companies have outperformed the global
market by close to 0.8% annually for the past
20 years based on geometric means8. We should
mention however, that although this represents an
outperformance of economic importance, it is not
statistically significant.
7
If the return were actually 0.6% per annum lower, the level of
pension contributions needed to produce the same level of benefit
payments – based on analysis of historical results – would have to
be approximately 20% higher.
8
We define fossil fuel companies as a separate sector here by taking
MSCI’s “Oil, Gas, and Consumable Fuels” industry within the Energy
sector and the “Metals & Mining” industry within the Basic Materials
sector since MSCI’s ‘ex fossil-fuels’ index has only 5 years of history
available. The MSCI ‘ex fossil-fuels’ index excludes any company that
owns any oil, gas, or coal reserves.
ABP Climate change Technical Annex 11
On the left hand axis:
On the right hand axis:
Brent Oil
7
160
6
140
120
5
100
4
80
3
60
2
40
1
20
0
Dec-95
Oil Price ($/barrel)
Cumuulative Performance
‘Fossil Fuel’ Companies
World
0
Dec-97
Dec-99
Dec-01
Dec-03
Dec-05
Dec-07
Dec-09
Dec-11
Dec-13
Dec-15
Figure 5. Cumulative total return of the fossil fuels sector and the MSCI AC World Index.
As can be seen from Figure 5, the performance of
the fossil fuels companies has been volatile. In the
second half of the 1990s for instance, they were
roughly keeping pace with the MSCI AC World
Index whereas, from the start of the century,
with commodity prices reaching unprecedented
heights, they have shown a sharp rise. This was
the result of very strong demand from emerging
markets such as China, just after a sustained
period of underinvestment caused by low prices,
particularly in upstream oil & gas. In the last few
years, however, the returns in this sector have
fallen back. Share prices of especially US coal
companies came under pressure due to the
technological breakthrough in the field of shale
gas exploration and production. Vast reserves of
natural gas have been unlocked in the US over the
last 10 years through the application of hydraulic
fracturing and horizontal drilling. This cheap and
abundant natural gas has displaced coal-fired
power generation in many regions in the US and
in turn this has sharply reduced the demand for
domestic coal. US coal producers have had to
either close their mines or find ways to export
their coal into the international markets. On top of
that, tougher environmental regulations reduced
the demand potential for coal in the future,
putting additional pressure on the share prices
of these companies.
Recently, the share prices of oil and gas
companies have also come under pressure,
largely because of the sharp decline in oil and
gas prices since mid-2014. The drop in oil prices
is mostly a result of cyclical supply/demand
dynamics. A combination of the unlocking of large
amounts of oil supply from the US, a change in
strategy of the largest oil producer in the world
Saudi Arabia, and weaker than expected demand
growth from emerging markets have created a
strong decline in global oil prices and in some
regional gas prices that are linked to oil. The high
oil prices that we have seen in the past 10 years
have fuelled investments in technologies such
as hydraulic fracturing and horizontal drilling,
but also in other relatively expensive sources
of oil supply such as deepwater, arctic and tar
sands. Hydraulic fracturing and horizontal drilling
in particular have generated a strong increase in
oil production from the United States. Whereas the
Organization of Petroleum Exporting Countries
(OPEC) had until recently countered such supply
increases by reductions in its own production
volumes in order to protect the price, OPEC (and
especially Saudi Arabia) changed course towards
the end of 2014. Since it is the lowest-cost
producer it decided to no longer support the oil
price and instead to produce in order to protect its
market share.
ABP Climate change Technical Annex 12
Through this strategy it aims to curb the growth
of the more expensive energy supply sources,
including alternative sustainable sources of
energy, while at the same time fuelling global
demand for oil through lower prices. The cost of
this strategy for them and other OPEC members
comes in the form of (at least temporarily) a sharp
reduction in available government funds.
Finally, we should mention that these analyses of
risks and returns have been based on historical
trends. Historical returns in particular have limited
use for forecasting future performance. In order to
say something about possible risks and returns of
investing in companies with fossil fuel reserves,
it is therefore important to look at the valuations
of such companies and what they imply. We do
this in the following section.
6. Background: Valuation
When assessing the potential future return
contribution of any sector, including the energy
sector or the fossil fuel companies in particular,
we need to understand the valuations. Valuation is
a critical factor in any investment decision. Even if
the outlook for a certain company or sector looks
unattractive, for instance due to slowly growing or
even falling demand for its products, investments
in that company or sector can still generate
attractive returns, depending on the extent to
which the outlook is already reflected in current
valuations. Although we can make a number of
general remarks regarding sectors as a whole, it
is important to note that we assess valuations on
a company-by-company basis. There are many
different aspects to such assessments, including a
company’s strategy and its position in the market,
the expected future levels of investment, the risks
inherent in its investment plans and the actual
implementation thereof, the company’s cost control
and its debt position.
As mentioned before, in a transition scenario not
all the proven reserves of coal, oil, and gas can
be produced and burned. In order to understand
whether this poses a risk to the share prices of
the group of listed companies holding some of
these reserves, we need to understand what the
valuations of these companies imply, making a
9
APG internal analysis, using a weighted average of all 76
companies in the MSCI AC World Index with available reserves
data, weighing by index weight.
distinction for this purpose between coal on the
one hand and oil & gas companies on the other.
The listed coal companies together represent by
far the greater part of the reserves (402 Gt or 72%
of the total emissions potential of listed companies).
The combined market value of these companies,
in both developed and emerging markets, is around
€670 billion at the time of writing. If we exclude
the diversified mining companies and the utilities
from this group (whose market values arguably
represent a lot more than just their coal mining
activities), the total market value of the more ‘pure
play’ coal companies is €157 billion. This means
that collectively this subset of 46 companies
(representing 254 Gt or 63% of the total reserves
of listed companies) is worth less than half of
the value of the single largest oil & gas company
ExxonMobil. While a full assessment of the
valuation of these companies is beyond the scope
of this paper, it seems highly unlikely that these
valuations imply that all coal reserves will be
produced and burned.
For listed oil & gas companies the situation is
different. In developed markets in particular, the
valuations generally imply that all of the proven
reserves (and some of the probable reserves) will
be produced. These companies represent 59 Gt
of emissions potential or less than 11% of the
emissions potential of the top 200 listed companies
(and less than 2% of the total emissions potential).
Furthermore it is worth noting that the average socalled ‘reserve-life’ or R/P ratio (reserves divided
by current production) for oil companies typically
available in our investable universe is only around
15 years9. In other words, if they continue to
produce at the current level they will have used up
all of their reserves long before the demand for oil
& gas disappears, even in a low-carbon scenario.
This is partly explained by the fact that the marginal
production costs for these oil and gas fields, which
are mostly already in production, are very low.
The companies with the larger oil and gas reserves
on the other hand are typically the National Oil
Companies (NOCs) that are owned by governments
of resource-rich countries, often in emerging
markets. Saudi Aramco, the Saudi NOC, has a
reserve life of more than 70 years for instance.
Most of these companies are not available for
outsiders to invest in.
ABP Climate change Technical Annex 13
Within the energy sector, individual company
valuations can differ and reflect different
expectations, also through time. We assess these
differences continuously and use them in order
to take individual company exposures that may
differ from the general average market weights.
In general, however, our conclusion is that,
despite the fact that the lion’s share of the proven
global reserves of coal, oil and gas (including a
proportion of the reserves of listed companies)
will inevitably remain in the ground in a transition
scenario to a low carbon economy, we do not see
this as a major threat to the share prices of these
companies. On the one hand, the valuations of the
companies that own most of these reserves (coal
companies) do not reflect full production and, on
the other hand, the companies whose valuations
do reflect full production (Western oil and gas
companies) represent only a small fraction of the
total and, given their current production levels,
they will have produced all of their reserves long
before demand disappears. For the development
of new reserves, however, it is important that
these companies show caution in their investment
decisions, both as regards cost and as far as the
life of the projects is concerned. This is not only
important in the present situation, with the sharp
drop in oil prices we have seen, but particularly
in the future, too, with possibly higher oil prices.
When oil prices are high, the risk that companies
will invest in high break-even projects is greatest.
10
IEA World Energy Outlook, November 2015; IEA Renewables
Information – Excerpt – Juli 2015.
7. Background:
The existing portfolio
As of 30 September 2015, ABP’s total
investment in the energy sector was €27 billion
or approximately 8% of the total assets under
management. This includes total investments in
the broad energy sector, including the oil & gas
industry, the coal industry, power generation,
electric utilities and related investments in
suppliers and infrastructure such as pipelines,
transmissions cables and power distribution grids.
Roughly 38% of these investments was in listed
equities, 24% was in listed commodity futures,
19% was in illiquid instruments and 19% was in
bonds.
Figure 6 shows our exposure broken down by fuel
type, compared with global energy demand figures
from the International Energy Agency (IEA) for the
year 201310.
Not included here are the investments in
commodity futures (mostly oil and oil products).
In contrast to the other categories, these
investments do not serve to finance part of the
energy value chain and would give a distorted
view if we included them. Excluding these
commodity futures, our investments in the energy
sector totalled €21 billion.
ABP Climate change Technical Annex 14
12
%
5% 5
%
9%
21
%
3
1%
29
%
9%
41 %
5%
%
33
Figure 6. ABP’s energy investments analysed by fuel type compared with the breakdown of global primary
energy demand. The fuel types are nuclear, renewables, charcoal and solid biofuels, coal, oil, and natural gas.
The analysis shows that our greatest exposure is to
natural gas. Our coal exposure is significantly below
the share of coal in the global fuel demand mix.
The differences compared with the global energy
supply picture mainly reflect the opportunities
or lack of opportunities for investing in certain
fuel types. Charcoal, for instance, is used mainly
in developing countries with limited access to
electricity or other sources of energy.
Methodology
Where data was available, we have used a lookthrough approach for our portfolio in order to
split the exposures to companies that are active
in multiple fuels, such as integrated oil & gas
companies. Our oil & gas company exposures,
for instance, have been broken down on the
basis of the production volumes. In the case of
electricity generators, the breakdown is as far
as possible arrived at on the basis of production
volumes per fuel type. The aggregated fuel type
breakdown includes exposures to all parts of the
specific fuel value chain (upstream, midstream,
downstream).
Comparability
In 2014, we produced a detailed analysis of our
energy sector investments, which was included
in our responsible investment report for 2014.
In that exercise we arrived at an estimate
that approximately 10% of our investments
was energy-related. This figure is not directly
comparable with the analysis in the present
document, partly because we have refined the
methodology this year. Last year, for example,
we included our total investments in diversified
mining companies. This year we have better data
and we have included only the share of coal in
a company’s total revenue. In the case of large
diversified mining companies, this makes a big
difference. Other effects are fluctuations in share
prices and more detailed analyses in the case of
oil and gas companies and power producers for
example.
The analysis is also not directly comparable with
the one on which our investment of €1 billion in
renewable energy in 2014 was based, because
those calculations only took account of the direct
investments in renewable energy projects and
investments in companies that were predominantly
active in renewables.
ABP Climate change Technical Annex 15