Climate change could potentially have devastating environmental, social and economic repercussions for our generation and for future generations. I believe that climate change, as well as other environmental, social and governance factors, represent significant long-term business risks for companies. As such, companies which manage these risks can, in my opinion, offer exceptional long-term investment opportunities.
Climate change has become an extremely topical issue– and for good reason. According to the World Meteorological Organisation, the 16 hottest years of the past 100 have occurred since 2000. Meanwhile, 2016 was the warmest year since records began and the 40th consecutive year in which the average temperature exceeded the 20th-century average.
If those statistics aren’t already alarming, we now know that sea levels have risen 19 cm from when first measured and carbon dioxide emissions are up a massive 42% from pre-industrial levels.
Figure 1: Impact of climate change
The effects are most profound among some of the poorest economies in the world, especially those dependent on agriculture. Meanwhile, settlement patterns mean that an increasing number of people are exposed to extreme weather conditions. For example, between 1970 and 2010, the global population located in flood plains has grown by 112% and in cyclone prone coastlines by 192%.
The general agreement is that mitigation is less costly than adaptation so what are we doing about it?
The Paris Agreement of 2015 marked a watershed moment in terms of action against climate change. Under the accord, world leaders agreed on a carbon use target which we must remain beneath in order to keep global temperatures under a two degree raise from pre-industrial times. According to the terms of the agreement, approximately 80% of fossil fuel reserves must remain untouched in order to achieve these targets.
WHAT FOSSIL FUEL DIVESTMENT MEANS IN PRACTICE
While the response of the Paris Agreement marks significant progress, in order to meet its agreed objectives there will need to be a significant contribution from the private sector. The divestment movement has grown remarkably quickly, driven mostly by educational and religious institutions.
Figure 2: The evolution of fossil fuel divestment
The divestment of fossil fuels is a complicated issue in practice, because most industries use them in some way, even if indirectly. The most extreme response would be to remove all exposure to fossil fuels however a more pragmatic approach is to focus on those companies directly involved, i.e. those specifically on those that profit from the extraction of burning fossil fuels.
Table 1: Fossil fuel divestment in practice
I believe investing in companies which offer the right combination of compelling fundamentals and leadership in combating climate change in their respective industry is an approach will be rewarded with superior long-term investment returns. In my opinion, the strong management of carbon risk is strongly representative of management of long term business risks, helping investors to identify companies who are best positioned to manage the long term challenges to their respective businesses and avoid the laggards.
Author: Brian Kennedy is a fund manager at Davy Asset Management, with responsibility for the Davy ESG Equity Fund and Davy ESG ex Fossil Fuels Fund. To find out more contact www.davyassetmanagement.com or your financial adviser.
1 National Oceanic and Atmospheric Administration (NOAA)
2 World Bank
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