Wealth Management

Is the Climate Changing for Fossil Fuel Investments?

As the world embraces a low-carbon economy, should investors change how they view fossil fuel investments?

Over the past decade, conversations around climate change have often been laden with political overtones, wrapped tightly with competing agendas, opinions and research. However, mounting data and international cooperation has created a significant shift in thinking that is now re-framing the conversation for investors.

As governments and industry make a significant move toward a global low-carbon economy, investors can no longer assume that an energy sector powered predominantly by fossil fuels is where growth lies.

Which poses the question: should investors position themselves now for this paradigm shift and the range of investment opportunities within it?

An Awareness of the Problem

Many experts agree that human-induced climate change is having a significant impact on the environment and society, representing one of the most pressing challenges of our time.1

Over the last 150 years we have seen a 40% increase in atmospheric carbon2, and global sea levels have risen nearly eight inches since 1880 due to heat absorbed from increased greenhouse gases (GHGs). NASA satellite imaging indicates that this process is accelerating rapidly, with a potential rise between one and four feet by the year 2100, which would threaten 11 of the world’s 15 largest cities.3

Economic growth and global stability depend on vital natural resources. With a rapidly changing climate, we face significant risks to global food, water and energy supplies.

A signal that globally, governments, corporations and investors are taking the threat of climate change seriously, is the momentum coming out of the December 2015 United Nations Climate Conference in Paris, also known as COP21. Following two weeks of intense negotiations, a final agreement was reached across both developed and developing countries, signaling an unprecedented diplomatic achievement and further mandate for action.

A Changing Climate for Investors

The U.S. economy is already beginning to feel the effects of climate change. Over the next two decades, the physical and policy implications of a changing climate will increasingly affect the future performance of American businesses, and will likely steer investment decisions in areas such as energy, agriculture, coastal property and infrastructure.4 These effects of climate change will likely affect corporate profitability and government budgets on a global scale, creating long-term ripple effects in the markets.

At present, the global economy is so fossil fuel dependent that a wholesale shift away from fossil fuels and the technological infrastructure built around them may not be feasible in the foreseeable future.

That said, there are business, investor and economic trends—highlighted in an Institute for Sustainable Investing Issue Brief—that point to a significant shift toward a lower-carbon energy sector.

Risks and Opportunities

From 2004 to 2014, renewable energy investments increased from $45 billion to over $270 billion. During this same time period, renewable energy accounted for 48% of global new generating capacity, increasing the global share of renewable energy for electricity to over 9% and creating opportunity for investors.5

There are also risks of not addressing a portfolio’s exposure to fossil fuel-related assets.

The Institute’s brief notes that environmental risk factors could strand fossil fuel assets in a range of sectors, leaving investors exposed to unanticipated write-downs, devaluations or conversion to liabilities.

Developing a Portfolio Strategy

Today, investors who are interested in engaging in climate action and prioritizing both positive environmental impact and financial return have access to a range of options. These options include investment approaches, tools and reporting that can be used separately or in concert across a total or partial portfolio. Morgan Stanley’s Climate Change and Fossil Fuel Aware Investing Framework includes the following approaches which begin with reducing exposure to fossil fuel producing investments and extend to shareholder activism.

Most investors interested in establishing a fossil-fuel aware portfolio can follow a four step roadmap to evaluate and apply this framework:

  1. Assess: In other words, “know what you own” by assessing your portfolio exposure to fossil fuels and companies with large carbon reserves.
  2. Evaluate: Take a close look at the feasibility of investment solutions, including any factors that may limit implementation options; for example, existing exposure to illiquid alternatives or comingled funds.
  3. Define: Consider your overall climate change and fossil fuel aware objectives, then to integrate these goals into the overall investment strategy.
  4. Implement: For individual investments this can take the form of an investment plan—or, for institutional clients, an Investment Policy Statement. This step helps to clarify and formalize the investor’s priorities, risk tolerance, return objectives and time horizon.

Ultimately, the goal is to develop a long-term investment plan which seeks to achieve both the desired climate- and fossil fuel-aware goals and financial objectives.

With the support of a Morgan Stanley Financial Advisor, Private Wealth Advisor or Institutional Consultant, investors can take actionable steps toward understanding their exposure and the impact of climate change and fossil fuels on their portfolios and shifting their investments toward building a more resource efficient economy.

This is an edited excerpt from Morgan Stanley Wealth Management’s primer, “Climate Change and Fossil Fuel Aware Investing: Risk, Opportunities and a Roadmap for Investors.” For more information on Investing with Impact, talk with your Morgan Stanley Financial Advisor, or use the locator below to find a Financial Advisor near you.