FFI Perspectives

Fossil Fuel Underperformance: Short-term Phenomenon or Secular Trend?

For the year 2015, our FFIUS outperformed the S&P 500 by 1.51%, showing an increase of 0.78% where the S&P500 decreased 0.73%. And since its launch in June of 2014, the FFIUS has outperformed the S&P500 by 2.96%, showing a 2.09% increase compared to a 0.87% decrease for the S&P 500 for the same time period.

FFIUSvsSPX062014012016

Date FFIUS S&P 500
31-Dec-14 193.91 2,058.90
31-Dec-15 195.41 2,043.94
% Change 0.78% -0.73%
26-Jun-14 181.41 1957.22
29-Jan-16 185.19 1940.24
% Change 2.09% -0.87%

 

Those who remain bullish on the fossil fuel sector would point out that the time frames for FFIUS performance measurement are relatively short and that no intelligence about long-term performance can be derived from these numbers. We agree. It is our view that much of the outperformance of the FFIUS over the past year and a half was due to significantly lower oil prices influenced by OPEC’s increasing production to protect market share, and the slow global growth that has reduced demand for coal in particular. These factors could reverse over the next year or two, potentially sending fossil fuel stocks higher in the near term. Or maybe not.

We established the FFIUS not as a way for investors to express short-term views on oil prices, but as a way for investors to track the performance of a broad market index against a fossil-free counterpart, a useful tool for investors concerned about the financial implications of climate risk and more specifically about the carbon bubble. In the past year, an increasing number of investors have come to view the carbon bubble[1] as a major economic risk. The growth in number of institutional investors who have chosen to divest from fossil fuel companies reflects this trend. In September of 2015, a much-publicized report by Arabella Advisors for Divest-Invest noted that by that point, 436 institutions and 2,040 individuals in 53 countries, with holdings representing $2.6 Trillion in assets, had committed to divesting from fossil fuels. Participants at the World Economic Forum in Davos in January indicated that “failure of climate-change adaptation and mitigation” was the number one risk in terms of impact to countries and industry, an acknowledgement of the significance of the COP21 agreement signed in Paris this past December.

One thing is certain: investors who are at the forefront of addressing risks from climate change in their portfolios will be better equipped to manage those risks and to take advantage of opportunities presented by the changing energy markets. We see three main climate investment themes becoming clear:

  1. Stranded Assets

The risk of stranded carbon assets will be top of mind for many, with some companies more at risk than others. Some investors will choose to divest entirely, others will analyze and select certain energy securities to be long or sell short, and some will engage companies in the hopes of improving disclosures and persuading companies that shareholder value is enhanced by eschewing the high cost, high carbon capital expenditures that are inconsistent with a carbon-constrained world.

  1. Carbon Efficiency

While divestment and stranded assets focus on the suppliers of fossil fuel, carbon efficiency deals with energy usage. The measurement of a company’s carbon footprint is a starting point for investors, but we expect to see more nuanced measures emerging that are industry specific and that allow for better comparisons of carbon efficiency between companies in the same sector. Having more specific methods of comparing the relative carbon intensity of different businesses, e.g., as a function of sales or market cap, will empower investors to make more informed choices about the climate-related risks of a given business.

  1. Renewable Energy

Renewable energy will continue to become more cost competitive with fossil fuels, and investors will need to determine the best way to implement this theme in portfolios especially given that some portion of investment in this area is being made by the oil majors.

So while the outperformance of the FFIUS over the past year is not surprising to us, it is an indicator of a trend toward a low-carbon economy that will impact not only fossil fuel companies, but companies across all sectors of the economy. The FFIUS is a financial tool developed in response to what is becoming a mainstream secular investment trend. The increasing sophistication of investors will drive product development, and FFI will broaden its range of tools to anticipate those investors’ needs.

 

[1] Our research in The Carbon UndergroundTM 2015 report showed that the potential CO2 emissions from the reported reserves of the top 200 public coal, oil, and gas companies increased to 555 gigatons (Gt) from 546 Gt in 2014 and from 504 Gt in 2010. However, using carbon budgets based on IPCC models, The Carbon Underground 200 companies can burn only 115 Gt of reserves through the year 2050 for the world to have an 80% chance of limiting global temperatures from rising 2˚ C compared to pre-industrial times, the amount likely to prevent the most dangerous impacts of climate change. If indeed we can only reasonably burn a fraction of the currently-reported reserves of the top 200 public fossil fuel holders, we are then experiencing a carbon bubble.

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