Applying ESG to fossil fuels - an interview with Carlota Garcia-Manas (RLAM)

29 April 2020
A combination of global initiatives, government commitments and societal demand is placing the energy sector into the spotlight. We spoke with Royal London Asset Management (RLAM) to determine how the transition to a low carbon economy is impacting investments.

A black and white photograph of Carlota Garcia-Manas

Extinction Rebellion protests, the UN Climate Change Conference (COP26) and extreme environmental events such as the Australian Bushfires have all made headline news, as has the UK Government’s pledge to become carbon neutral by 2050. All of this is fuelling demand for clean energy alternatives – but how is all of this impacting pensions?

Along with our primary asset managers RLAM, we’re signatories of the UN-backed Principles for Responsible Investment (PRI), and supporters of the goals outlined in the Paris Agreement. As a result, we appreciate that there is demand for “accelerated energy transition”, or a speeding up of the move from traditional energy sources such as oil, gas and coal to renewable energy sources.

According to Carlota Garcia-Manas, Senior Responsible Investment Analyst at RLAM, the key lies in finding the balance between reducing emissions caused by fossil fuels, and keeping energy affordable while still aiming to generate returns on investment.

What is fossil fuel divestment?

“Fossil fuel divestment is linked to exiting a particular investment - or applying a pre-investment filter - where you basically do not invest in fossil fuels at all, or you don't invest in companies that have exposure beyond a certain threshold to fossil fuels,” explains Carlota.

Divesting from fossil fuels ultimately aims to push forward the decarbonisation process; in theory, if companies that extract, process or sell fossil fuels are no longer making money, they may move to renewable alternatives quicker. However, an accelerated move to clean energy could present its own challenges.

“On the one hand, there’s an objective to decarbonise the economy to be in line with initiatives taking place in the UK and Europe, and on the other hand, you have Goal Seven of the UN Sustainable Development Goals - create access to affordable and clean energy worldwide,” says Carlota. “So you want to increase access to energy, but you also want to decarbonise the economy.  Unfortunately, only parts of the energy spectrum can achieve both economic growth and lowering carbon emissions at the same time, so there are lots of frameworks to consider when it comes to developing a strategy that’s in line with the Paris Agreement, the UN Sustainable Development Goals and ultimately our customer’s money.”

Looking at fossil fuel exposure through this lens then, we can see the following: 

  • Environment – By remaining invested and being able to vote at AGMs and influence company behaviour, we can promote the move to a low-carbon energy system to support both the aims of the Paris Agreement, and Goal Seven of the UN Sustainable Development Goals. 
  • Social impact – Staying invested enables us to promote the skill transition for those employed in ‘traditional’ forms of energy production, as well as to advocate for a gradual transition process so that renewable energy is affordable and doesn’t compound existing fuel poverty within the UK.
  • Governance – Engaging with investee companies can help to drive forward this change, with evidence showing that engagement with a clear aim of improving corporate governance around climate issues can have an impact.

Making clean energy affordable

Divesting from fossil fuels may be in line with certain moral standpoints, but it doesn’t guarantee that the practice will stop as a result.

“Divestment may be a moral consideration, but neither an individual nor company divesting from a fossil fuel company guarantees their emission removal from the real economy,” she says.Divestment in this instance might mean losing a seat at the table – a seat that could be used to have conversations and cast votes to drive change.

One such conversation might be about how moving to low carbon energy sources too quickly could cause financial havoc for millions of Britons. For instance, it’s estimated that 4.5 million UK households are currently affected by fuel poverty, which occurs when a household has ‘fuel costs that are above average and, if they were to spend that amount, they would be left with a residual income below the official poverty line.’

Goal Seven of the UN Sustainable Development Goals aims to ‘ensure access to affordable, reliable, sustainable and modern energy for all’ and so an overnight transition to low carbon alternatives may well fail to meet the ‘affordable’ aspect of this goal. 

This isn’t lost on RLAM, who take this and other factors into account when looking at ways to balance competing priorities. “Over the last few months we have engaged with distributors of gas and electricity. Some of their market research has identified that 80 per cent of households in some regions of this country are unwilling or unable to pay their current cost of utilities. Any costs of transition by refurbishing the gas grid, changes to boilers or mandatory home insulations will need to be means-tested to avoid exacerbating fuel poverty and access to these services by vulnerable households.

So how do they work towards targets outlined in the Paris Agreement whilst making sure vulnerable customers aren’t left behind? 

Engaging for impact

Studies have shown that asset managers who actively engage with the companies they invest in can create change in behaviour.

“In 2015, Professors Dymson, Li, and Karakas undertook an analysis of 600 companies and over 2,000 engagements that took place between 1999 and 2009,” says Carlota. “They found statistical evidence that what they called “aggressive” engagement - or a dialogue that has clarity of objectives for corporate change - had a significant positive impact on the performance of the engaged company. Our engagement focuses on aligning companies strategies with the Paris goals, and is likely to result in efficient exploitation of existing assets, and/or the diversification to new energy solutions, all while taking into considerations social factors such as impacts this may have on communities, employment and energy affordability.”

To achieve this, RLAM are being proactive, talking with oil producers and utility firms to find out when their countries are committing to net-zero by 2050, how they’re aligning to that, and what that means for their business. “We are always keeping a very close eye on their leadership and how they are adjusting to that,” adds Carlota.

RLAM also actively work with Climate Action 100+. Launched in 2017, the initiative has attracted over 450 global investors with over $40 trillion in assets. The objective of this initiative is to engage with the top 100+ high emitters worldwide, with a clear aim of improving corporate governance around climate issues.

“Another initiative we’ve signed up to is the Just Transition,” says Carlota. “This is spearheaded by the Principles for Responsible Investment with academic support from the London School of Economics. Its objective is to take into consideration the social implications of the energy transition.  

Initiated as a call from Unions concerned about the job losses associated with the closing of coal mines and other traditional energy businesses, it encompasses now an effort to make sure that the re-training, re-skilling of workers and communication with communities is not forgotten in the dialogue with companies around energy transition considerations.”

In conclusion

Engagement with investees allows us to create meaningful change at a sustainable pace, whilst still working to generate returns for customers. 

Of course, as the global energy sector evolves, so too might our position on fossil fuel divestment, which will be subject to ongoing review. We’re looking for ways to be part of the solution to invest in a responsible way that provides good outcomes for all, which is why it’s important to take into consideration the people impacted by or involved in the transition to a low carbon economy whilst contributing to change that will benefit society and the environment. 

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.