Responsible Investing and Oil Companies

Last month, yet again, we saw record global temperatures!

In March, global temperatures were 1.68C higher than the pre-industrial average, well in excess of the benchmark set out within the Paris climate agreement of 1.5C above pre-industrial levels.

Climate scientists are concerned that the earth is heating up faster than expected which could mean that we reach a tipping point earlier that originally predicted. A survey of nearly 90,000 climate related studies shows a 99.9% consensus within the scientific community that humans are altering the climate by burning gas, oil, coal and wood.

Why Is This Important?

Global warming has been linked to a number of natural disasters and humanitarian crises around the world including droughts, flooding, heatwaves and wildfires.

The human suffering caused is unimaginable with millions facing starvation and malnutrition in the Horn of Africa. Closer to home, we have seen hundreds and thousands of people evacuated from their homes in Europe due to wild fires and flooding.

Another impact is the economic cost of natural disasters. In the US and Australia, for example, the cost of home insurance has gone up significantly with homeowners in certain at-risk areas either unable to obtain insurance or being unable to afford insurance. As such, the respective governments have had to step in and become the insurer of last resort.

Increasingly, governments around the world have had to step in to either re-build infrastructure destroyed or damaged by extreme weather events or they are having to build adaptations to protect infrastructure and people from future extreme weather events.

The cost to governments and more importantly us, the tax payer, is immense and is set to increase dramatically.

As well as speeding up the transition to renewable energy, governments could impose penalties on fossil fuel companies who are contributing to global warming.

Responsible Investment

Given the concerns around climate change, more and more investors are focused on the impact their investments are having on people and the planet and are looking to avoid investing in companies which negatively impact the planet.

One sector that investors are increasingly concerned about is fossil fuels, especially oil companies.

On the one hand investors are concerned about the negative impact burning fossil fuels is having on the climate but they are also concerned about how a switch to renewables and the threat of possible government intervention might impact the share price of oil companies.

There has been much discussion as to how best to view shares in oil companies and there are a number of different approaches.

Divestment

More and more people are looking to align their investments with their values and, as such are looking to avoid sectors, including fossil fuels, that either harm the planet or are not aligned with their ethical or religious values.

There have been growing calls for large institutional investors to divest from oil companies although it is questionable as to what impact this may have on the underlying companies themselves. The vast majority of shares will be traded on a secondary market so avoiding oil company shares is unlikely to deprive them of any capital.

Active Engagement

An argument for retaining at least some shares in oil companies is that investors will have a voice and can challenge the board of directors, for example, at an Annual General Meeting. By engaging with oil companies investors can influence the direction of travel towards, say, more investment in renewable energy although this is likely to be a slow process.

Rather than just individual investors calling for change, so coalition of investors have formed which can add even more pressure on existing directors.

Other Forms of Engagement

It is not just shareholders who can actively engage with the board of directors. Bond holders can also have a voice especially where companies are looking to issue or roll over debt. For example, Bond holders could refuse to allow a company to re-finance their debts unless certain environmental considerations are met.

Increasingly, we are seeing Private Equity investors looking at ways they can buy companies and transition them to become much greener and, at the same time, improving their share price and ultimate sale value.

Stranded Assets

Increasingly, however, the decision to avoid shares in oil companies comes down to returns and the impact on the share price of stranded asset risk.

Given the need to transition away from oil in order to meet carbon emission targets and to keep the global temperature within the 1.5C pre-industrial limit, it would seem likely that the demand for oil will decline.

A 2022 McKinsey report highlighted that the key drivers for a decline in the demand for oil are likely to be:

Increased energy efficiency.
Growing electric vehicle adoption.
Increased government spending on clean energy.
The continued electrification of transport.

According to the report , peak oil demand is likely to be between 2025 and 2030.

Given the risk of stranded assets, it would seem logical for oil companies to begin the move to renewable energy themselves, however it is apparent that oil companies are doing all they can to slow the transition to renewable energy.

We know that the demand for oil is not going to disappear overnight and there are still sectors of the economy that are heavily dependent on oil, for example, certain chemical processes will continue to require oil and the aviation industry will continue to satisfy our demand for flying.

Having said that new technology is being developed all the time which could disrupt existing oil dependent sectors.

Reviewing Your Portfolio

There are a number of fund managers offering investment funds that screen out exposure to oil companies and these can take the form of both active and passive investment funds.

If you are looking to avoid oil companies within your portfolio, it make sense to review the funds that you hold. Some fund managers, for example, look to integrate Environmental, Social and Governance (ESG) factors into their investment approach and this may still involve holding oil companies within their fund.

Conclusion

It is difficult to know what the long-term outlook for oil company shares will be but oil companies are certainly facing mounting headwinds in the form of:

The need to transition to cleaner forms of energy.
The overall decrease in the demand for oil.
The impact of government intervention in the form of penalties or a carbon tax.

What we can’t escape from is the fact that global temperatures are continuing to rise and this is having a detrimental impact on our homes, our lives and our planet.