What Institutional Investors, Energy Companies, and You Should Know About Carbon Reporting

• Jurisdiction: United States,Federal
• Citation: Vol. 26 No. 1
• Publication year: 2017
• Author: by Aaron Ezroj
• topic: Business of Law,Environmental Law,Insurance Law,Energy & Natural Resources

What Institutional Investors, Energy Companies, and You Should Know About Carbon Reporting

by Aaron Ezroj^*

I. INTRODUCTION

Policymakers have started asking institutional investors to report on their exposure to the carbon economy. This reporting forces investors to consider whether they are investing in companies that have a high carbon footprint or that generate a large percentage of their revenue from fossil fuels. This article provides guidance on the latest developments in carbon reporting. The guidance should help attorneys advise institutional investors on their reporting obligations and how to guard against what some financial analysts have dubbed a "carbon bubble." It should also help attorneys advise energy companies on how concerned institutional investors will view them.

II. BACKGROUND

Demand for fossil fuels could drop rapidly as a result of changing consumer preferences, technological advancements and/or strengthened government regulations. Some financial analysts believe that today's financial markets do not accurately reflect these risks and instead support a "carbon bubble" with inflated valuations for fossil fuel companies. A Barclays' utilities researcher and analyst explained the issue, stating that "a carbon emissions trajectory consistent with a 2 degree pathway—which the entire world supported in the Paris Agreement—would reduce the revenues of the upstream fossil-fuel industry globally by a cumulative $33 trillion by 2040 relative to the current trajectory the world is on."¹ If valuations are inflated to this degree, reduced demand could force the value of fossil fuel companies to plummet.

Pension funds, which are long-term investors, are already aggressively divesting from fossil fuels to guard against a potential carbon bubble. In 2014, a large Swedish national pension fund announced that it would no longer hold investments in twelve coal and eight oil-and-gas production companies. The fund's Chief Executive Officer explained that the decision would "help to protect the fund's long-term return on investment."² In 2015, the California legislature required the California State Teachers Retirement System and California Public Employees Retirement System to divest from their more significant thermal coal investments by July 2017. One of the fund's Chief Executive Officers explained, "As long-term investors, we see the world moving toward a low-carbon future in which fossil fuel reserves that companies continue to develop may actually become a liability, which could take a toll on shareholder value."³

Private institutional investors also have started divesting hundreds of millions of dollars from fossil fuel investments and have been placing their money elsewhere, investing billions of dollars in renewable energy. In 2014, prior to the Paris climate change conference, Germany's Allianz SE said that it would decrease investments in companies using coal and increase investments in companies focused on wind power. A company spokesman said that the decision was made with "an eye on the 2C goal of the Paris climate negotiations as well as the economic risks involved."⁴ Other major private institutional investors, including France's Caisse des Depots, AXA and CNP Assurances, have similarly pledged to divest from coal companies and invest in alternative energy companies.⁵

III. CARBON REPORTING PROGRAMS

While a number of institutional investors are working to guard against a possible carbon bubble, many still have been slow to react. In an effort to better understand industry-wide risks and with the hope that more institutional investors will work to guard against a possible carbon bubble, policymakers have also moved to create optional and mandatory carbon reporting programs. The voluntary Montreal Carbon Pledge asks institutional investors to report on the carbon footprint of all investments in their portfolio. The mandatory French Energy Transition Law requires such reporting. A mandatory California Department of Insurance data call required companies to report specifically on fossil fuel investments.

A. Montreal Carbon Pledge

The Montreal Carbon Pledge was launched with support of the United Nations Environment Programme Finance Initiative in 2014. More than one hundred investors, managing more than $10 trillion in assets, have already voluntarily signed the Pledge. Signatories to the Pledge commit to measure and disclose the carbon footprint of all investments or specific asset classes in their portfolio throughout the world or a specific geographic region. The Pledge does not prescribe a specific accounting methodology for aggregating the carbon footprints of individual investments; in particular, it does not specify whether calculations should aggregate both direct and indirect emissions.⁶ The United Nations Environment Programme and the Greenhouse Gas Protocol, however, have issued guidelines on good practice which individual companies are largely using. Therefore, there is at least some degree of consistency when sourcing carbon footprints from individual investments.

[Page 32]

B. French Energy Transition Law

In 2016, Article 173 of the French Energy Transition Law became effective.⁷ The Article mandates that institutional investors operating in France report on the carbon footprint of investments in their portfolio. The Article does not prescribe a specific accounting methodology for aggregating the carbon footprints of individual investments, but the French government has indicated that it may do so in the future. Measurements are also supposed to be made regarding indicative targets that are consistent with the national low-carbon strategy articulated in France's Code de l'Environnement.⁸ Presumably, aggregations will be based at least in part on individual company calculations where United Nations Environment Programme and the Greenhouse Gas Protocol's guidelines on good practice were used.⁹Nonetheless, it still remains unclear whether carbon calculations should aggregate both direct and indirect emissions for individual investments.

C. California Department of Insurance

In 2016, the California Department of Insurance's Fossil Fuel Investment Data Call required insurers with more than $100 million of annual premiums nationwide to report certain thermal coal investments and other fossil fuel investments.¹⁰ Specifically, all these insurers have been required to report investments in companies that generate 30% or more of their revenue from thermal coal and investments in utility companies that generate 30% or more of the energy that they produce using thermal coal.¹¹ The California Department of Insurance has also required these insurers to report investments that generate 50% or more of their revenue from oil and gas and investments in utility companies that generate 50% or more of their electricity from oil, gas and thermal coal.¹² Energy companies are classified in the Bloomberg Industry Classification Standard and Global Industry Classification Standard, or the basic material industry section of the Industrial Classification Benchmark classifications.¹³ Portfolio managers and investment consultants should be able to explain whether companies classified in such a manner meet the reporting thresholds established by...