Which sector should be the pilot for ‘industrial scale’ 2°C transition plan resolutions in 2017?

| 13 October 2016
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Preventable Surprises proposes two changes in AGM strategy for 2017:

  • Moving from 2°C stress tests to <2°C transition plans (from risk disclosure to preparing for action).
  • Upscaling from a case-by-case focus on companies to sector-wide ‘industrial scale.’

 For the industrial scale strategy to succeed, we suggest selecting a sector other than fossil fuels as a pilot, a sector where all concerned parties can learn to collaborate afresh. This is because of the lack of alliances between campaigners and climate-aware investors within the fossil fuel sector, and because of attitudes of senior investment decision-makers. If the 2017 pilot succeeds, we would expand into other carbon-intensive or high-risk sectors, including fossil fuels. These recommendations reflect the context we are now in: Greenhouse gas emissions from all sectors need to have peaked by 2025 at the latest if we are to meet COP21 targets.

 In earlier dialogues, the three sectors below have emerged as prime candidates for action, alongside work on fossil fuels. If resources existed, the ideal would be to pilot all three sectors in 2017. The reality, however, is that Preventable Surprises and no doubt other organisations need to prioritise.

 Auto Manufacturers

Pros

  • Transportation accounts for around 26% of greenhouse gas emissions, more than any other sector except electricity, of which passenger vehicles account for around 60% and medium/heavy duty trucks a further 23%.
  • About 75% of emissions from auto manufacturers are fleet emissions from use of vehicles. Pressure on companies to improve emissions performance will have a direct effect on demand for fossil fuels globally.
  • Around 80% of the global passenger vehicle market has some form of regulation on fleet emissions, and the regulation is tightening. Most regulations are still inconsistent with a 2°C scenario and it is doubtful that the auto sector can meet a 2°C transition through fossil fuel vehicles, so development of advanced vehicles is an economic imperative, especially given the beginnings of outright bans on certain fossil fuel vehicles (e.g. Paris, Norway).
  • Some companies are already well advanced (e.g. Toyota, Nissan) with heavy investment in electric and/or hydrogen technology. Almost all companies have developed eco-efficient vehicles and it is clear what steps companies can take to improve emissions performance.
  • The sector is highly concentrated, with a mix of US, Japanese and EU market leaders. 14 companies make up 84% of global passenger vehicle sales. The concentration lends itself to focused investor engagement in Europe and the US in particular.
  • The sector is already under pressure to conform to existing regulations following the VW scandal and evidence that the issues are more widespread.
  • Traditional business models are very likely to be disrupted by a combination of technology (e.g. electric cars and driverless, sharing clubs) and public health concerns (especially in China & India). These provide investors with more “defensible” reasons for asking for new business models which “just happen” to be low carbon as well.
Market Cap ($bn) Share of global sales
1 Toyota Japan 222 11%
2 Volkswagen Germany 97.1 13%
3 Daimler Germany 95.2 3%
4 BMW Germany 70 3%
5 Honda Japan 59.3 4%
6 Ford US 59.3 8%
7 General Motors US 54.6 13%
8 Nissan Japan 45 7%
9 Hyundai South Korea 30.5 6%
10 Renault France 27.5 3%
11 Tata Motors India 22.1 1%
12 FCA Italy 19 6%
13 PSA Peugeot Citroen France 14 4%
14 Mazda Japan 11.9 2%

Cons

  • Auto manufacturers need significant investment in R&D to improve vehicle emissions and shift to alternative fuels and some companies will push back firmly if they feel competitively disadvantaged.
  • Uptake of alternative vehicles relies on a charging infrastructure currently dominated by fossil fuel companies who have no incentive to facilitate innovation.
  • Engagement with policy makers may achieve more than engagement directly with companies, given that the sector is dominated by regulation.

 Electric Utilities

Pros

  • Electricity generation is responsible for 30% of greenhouse gas emissions, more than any other sector.
  • Power companies are direct customers of fossil fuel producers, hence a visible intention to reduce fossil fuel consumption should have more impact on producer thinking than in other sectors with a more indirect relationship, or where fuel is a smaller item of overall costs.
  • Nearly 40% of investors have shown they are willing to support a 2°C transition plan resolution at Southern Company with comparatively little effort (cf Chevron & Exxon).
  • There is already good momentum in this sector. Several groups are planning to focus on the utility sector. In the US, this includes those promoting proxy access and the Sustainable Investments Institute and, in Europe, CCLA/Aiming4A.
  • The sector is reasonably concentrated, with a mix of US and non-US market leaders. 12 companies make up 35% of market value, 36 companies make up 60%.
  • Some companies are already well advanced (e.g. ON, ENEL) with top leadership involvement. Several are members of WeMeanBusiness.
  • There are small and mid-sized utilities who might see ‘first mover’ advantage in getting defacto investor support for ambitious transition strategies (e.g. AES, NRG). A growing number of well informed and high profile analysts (e.g. Tony Seba) see major disruption on the horizon (e.g. decentralised renewables).
  • In the US there are also a multitude of small generators who might be susceptible to local consumer pressure if mobilised by local NGOs and these organisations may be willing to partner with investors in a way that has not yet happened with large environmental NGOs.

 

 

Total Sector Equity Value (bn USD)
 

1,178,140

NAME Market Value (bn  USD) Share Total Sector MV
DUKE ENERGY                     49,684 4.2%
NEXTERA ENERGY                     49,093 4.2%
IBERDROLA                     44,092 3.7%
SOUTHERN                     43,038 3.7%
DOMINION RESOURCES                     41,530 3.5%
ENGIE                     38,012 3.2%
ENEL                     37,946 3.2%
AMER.ELEC.PWR.                     28,728 2.4%
KOREA ELECTRIC POWER                     26,637 2.3%
EXELON                     25,775 2.2%
PG&E                     25,680 2.2%
EDF                     24,785 2.1%

 Cons

  • Many of the biggest utilities have “clunky assets” and how, collectively, all their corporate strategies can be aligned with a <2C world is a major challenge.
  • Linked, utilities are unlikely to be havens of forward thinking mavericks. Strong opposition from management, especially outside the EU, can be expected.
  • Autos are more concentrated and the fact that there more EU companies/investors might make it an easier pilot. Insurance and electric utilities are probably equally concentrated.
  • Engagement with policy makers may achieve more than engagement directly with companies, given that the sector is dominated by regulation, especially in Europe. 

 

INSURANCE

Pros

  • Well-run insurance companies should be more receptive to Level 2 resolutions (transition plans vs. Level 1 stress tests) than other sectors. Insurance companies should have an intrinsic focus on risk management, both on the liability side (to accurately price natural catastrophe and related underwriting risks) as well maximising the long-term return of their invested assets.
  • Campaign impact: the sector is larger than the other two sectors: Total insurance sector MV = US$1.7tr, compared to US$1.2tr for all electricity producers and US$0.9tr for all car manufacturers. Insurance companies have been labelled “systemically important” by regulators and whilst this is related to GFC, this could be extended to the climate crisis.
  • Claims related to climate risk are material and have increased five-fold since the 1980s costing the sector US$50bn annually on average, according to Bank of England research(1). According to research from Munich RE, the number of climate related incidents is also increasing:
  • Unlike the other sectors, the insurance sector represents a systemic risk to the entire financial system if risks are mis-managed. Solvency ratios of insurers are constantly monitored by market regulators. A 2015 paper from the Bank of England and its Prudential Regulations Authority unit (PRA) sees climate change as having a material impact on insurers’ solvency. Investor action could prompt other regulators to follow.
  • As a result of the above, the sector has pioneered ESG risk analysis, in particular on climate-related risks. Many are members of PRI and also Principles for Sustainable Insurance(2) which has focused on underwriting, public policy work, and ESG integration. The sector is also an active focus for Ceres and the Cambridge Institute for Sustainable Leadership, which also convenes ClimateWise. Preventable Surprises might be able to be the catalyst for these groups to extend their work to cover what has been missing to date and what is a good asset-management-risk strategy, namely stewardship that is fit for purpose.
  • The sector is dominated by European, US, and UK companies which is the optimum campaign outreach. Moreover, some insurance companies are showing strong leadership on stewardship already (e.g. AXA, L&G).
  • With limited conflicts of interest, Preventable Surprises is able to challenge this sector constructively yet assertively.
  • The insurance sector could then become a role model for the asset management industry in general. Today, at best asset managers are externalizing the problem to companies by asking what they are going to do. Very few are speaking convincingly about their own climate change strategies. If insurance companies address the asset-management risk part of the equation and start to talk convincingly about ‘investing in a time of climate change’ and ‘unhedgeable risk,’ this could be the catalyst for much wider change in the finance sector, with regulators, and in the public at large.
NAME Market Val. (bn USD) Share Sector MV Country
ALLIANZ (XET)                              73,286 4.3% Germany
AMERICAN INTL.GP.                          69,706 4.1% USA
AIA GROUP                          64,673 3.8% Hong Kong
AXA                          58,965 3.5% France
CHUBB                          50,743 3.0% Switzerland
METLIFE                          49,123 2.9% USA
PRUDENTIAL                          48,861 2.9% UK
SWISS RE                          33,853 2.0% Switzerland
ZURICH INSURANCE                          33,284 2.0% Switzerland
PING AN INSURANCE ‘H’                          33,187 2.0% China
PRUDENTIAL FINL.                          31,511 1.9% USA
TRAVELERS COS.                          31,377 1.9% USA
MUENCHENER RUCK.                          31,325 1.9% Germany
AVIVA                          27,392 1.6% UK
MARSH & MCLENNAN                          27,277 1.6% USA
SAMPO ‘A’                          26,802 1.6% Finland
MANULIFE FINANCIAL                          26,105 1.5% Canada
TOKIO MARINE HOLDINGS                          25,934 1.5% Japan
ASSICURAZIONI GENERALI                          25,143 1.5% Italy
AFLAC                          24,439 1.4% USA
GREAT WEST LIFECO                          23,925 1.4% Canada
AON CLASS A                          23,669 1.4% UK
ALLSTATE                          22,669 1.3% USA
LEGAL & GENERAL                          20,296 1.2% UK
CHINA LIFE INSURANCE ‘H’                          18,232 1.1% China

 Italics indicates indicates membership of PSI. Underlined indicates membership of the group and/or its investment arm in PRI. Bold indicates membership of related leadership group (e.g. CISL, Focusing Capital on the Long term).

Cons

  • Compared to utilities or autos, the “enabling” link between how the insurance sector operates today and climate change is not as immediately obvious to the general public, trustees or even some campaigners—there would need to be an education drive and this would not be funded by the insurance sector.
  • Some ESG investors who are climate aware and generally supportive of resolutions (e.g. other insurance companies) might pull back from challenging their peers.
  • Relatively low market concentration levels of top 10 insurance companies compared to other sectors. Top 10 Insurance MV = 30.5% vs. 36.9% for the Top 10 Energy Utilities or 67.8% for Top 10 car manufacturers’ MV.

Recommendation

Extend the campaign to the top 25 companies = 53.4% of the overall sector MV (Total Sector Equity value = US$ 1,689, 197bn) 

 

 

Endnote:

All data sourced from Datastream as of 29 February 2016.

  1. Excerpt from the same Bank of England and PRA paper: “The resulting inflation-adjusted overall losses from weather-related loss events have increased roughly fourfold in the past 30 years to reach an average of US$140 billion per annum during 2010-14. Insured losses have also increased from an average of around US$10 billion per annum in the 1980s to around US$50 billion per annum over the past decade.”
  2. The PSI Principles for Sustainable Insurance (PSI) issued in June 2012 established the international best practice for the sector. There is no mention of insurance companies as major investors and their stewardship role.
  • We will embed in our decision-making environmental, social and governance issues relevant to our insurance business.
  • We will work together with our clients and business partners to raise awareness of environmental, social and governance issues, manage risk and develop solutions.
  • We will work together with governments, regulators and other key stakeholders to promote widespread action across society on environmental, social and governance issues.
  • We will demonstrate accountability and transparency in regularly disclosing publicly our progress in implementing the Principles.