Early analysis: TPI toolkit shows companies are building capacity to manage transition risk

There is a growing need amongst investors to better understand how the transition to a low-carbon economy could affect their portfolios.

Responding to this need, a group of asset owners and asset managers with over £2 trillion of assets under management, led by the Church of England National Investing Bodies and the Environment Agency Pension Fund, recently launched the Transition Pathway Initiative (TPI).

The TPI is an asset-owner led initiative, which assesses companies’ progress on the transition to a low-carbon economy. It is based on a publically available online tool, hosted by the Grantham Research Institute at the London School of Economics, which enables the quality of companies’ management of carbon emissions to be scrutinised, and their current and future performance tracked against international climate targets. The TPI focuses on high-impact sectors and the largest companies by market capitalisation.

Delivering on the overall objective of the Paris Agreement to keep warming of the planet below 2°C and to pursue efforts to limit it to 1.5°C will require above all a fundamental shift away from burning fossil fuels and from energy-intensive manufacturing, towards renewables and energy-efficient technologies.

Among companies and perhaps whole industries there will be winners and losers. The overall cost to society of the low-carbon transition has been found to be manageable, but financial risks nonetheless exist, particularly if investors are poorly informed about the companies they are invested in.

One area of focus has been on whether companies who extract fossil fuels could be sitting on ‘stranded assets’, as demand for fossil fuels falls along the low-carbon transition. However, the risks (and opportunities) are not just confined to coal mining, oil and gas production. Rather they affect a host of other sectors of the economy, including energy-intensive manufacturing industries such as iron and steel, and cement, as well as transportation.

For investors, transparent and accurate information on how the companies they are investing in are moving towards a low-carbon economy is therefore essential, which is why a number of international initiatives are underway to improve the quality of such information, notably the FSB Task Force on Climate-Related Financial Disclosures.

The TPI is intended to contribute to this improvement in the information base, with a particular emphasis on asset owners’ investment decisions and engagement activities. Many data providers and initiatives hold information on companies’ progress to reduce carbon emissions, but the TPI’s framework is intended to bring that progress to life in a way that is easy to understand, open to all and that can inform engagement.

The first set of results, released in January 2017, assessed how the world’s 20 largest companies by market capitalisation in both the oil and gas, and electricity utilities, sectors are managing their carbon emissions.

Using data from FTSERussell, the data partner for the TPI, companies are scored on a scale of 0-4: companies on level 0 are unaware of or not acknowledging climate change as a significant issue for the business, while companies on level 4 have progressed all the way to making a strategic assessment of climate change, by for example setting long-term, quantitative targets for reducing carbon emissions. All the data used to make the assessments are sourced from public disclosures by companies.

   

Out of the 40 companies assessed, only one is on level 0, i.e. it does not provide any acknowledgement of climate change as a business issue. All other companies are at least acknowledging climate change as a business issue.

But few of the companies assessed are at the top of the scoreboard (7 out of 40 are placed on level 4), so most companies still have room for improvement.

The typical company (15 out of 40) is at level 2, which is described as ‘building capacity’. These companies explicitly recognise climate change as a significant issue for the business, have a policy commitment to action, have some form of carbon emissions reduction target and disclose their direct emissions and emissions from bought electricity (so-called Scope 1 and 2 emissions).

The most common factors stopping companies progressing to level 4 are that they have not set quantitative targets for reducing operational carbon emissions (26 out of 40 haven’t) and that they have not had operational emissions data verified (22 out of 40 haven’t).

The analysis shows that electricity utilities are marginally more advanced in managing carbon emissions than oil and gas producers. Though, as with the oil and gas sector, more electricity utilities are building capacity (i.e. are on level 2) than are on any other level, there are relatively more level 3 and 4 electricity utilities. In comparison, there are relatively more oil and gas producers on levels 0 and 1, at the bottom of the scoreboard.

Few oil and gas producers have set energy or carbon emissions reduction targets (only 5 of 20 have) and only 2 out of 20 oil and gas producers provide information on the business costs associated with climate change, compared with 8 out of 20 electricity utilities.

Electricity utilities

Oil and gas producers

The next steps

The TPI will publish more results later this year, covering a wider range of sectors and testing whether companies’ current and planned future carbon emissions are aligned with the overall objectives of the Paris Agreement and the national pledges or Nationally Determined Contributions made to the Agreement.

So far most of the companies that have been assessed have left the starting blocks, but there is room for improvement in managing transition risk from carbon emissions. The TPI will help asset owners engage more with companies they are invested in to make sure they are well positioned for the move towards a low-carbon economy.