Pensions and climate change

Why pensions, why fossil fuels?

Pension funds are some of the largest investors in the world and in 2016 UK pension fund assets were greater than the national income.[1] With the government now requiring many more workers to join a pension fund through auto-enrolment, their influence over the wider economy will only grow. The money we put aside for our retirement is becoming increasingly powerful.

Yet at the same time industry practice ignores the concerns of fund members and the wider economy. Profit is paramount. Investments are made for short-term financial gain. Members views, and their future welfare, is by and large not considered relevant.

Gylemuir pupils show off their new solar panels, installed by the Edinburgh Solar Cooperative in 2016. Photo by  Colin Hattersley.
Gylemuir pupils show off their new solar panels, installed by the Edinburgh Solar Cooperative in 2016. Photo by Colin Hattersley.

This state of affairs is untenable in a world where pension funds bear such a major responsibility for the future health of our economy and indeed, our society and environment.

Scotland’s local councils bear the responsibility of looking after their workers in their retirement. To do this they invest in the Scottish Local Government Pension Scheme, a £35.4 billion pension scheme with 505,769 members across Scotland and administered by 11 local councils.[2] One in 10 Scots are a member of the fund and the scheme’s advisory board estimates one in five of the population have a financial interest in the fund.

We believe that everyone has a stake in how pension funds are invested and that council pensions, managed with input from our elected local councillors, have a major role to play in creating a pensions industry that is not just paying out pensions, but also making sure we will have a future worth retiring for.

Common Weal, UNISON Scotland and Friends of the Earth Scotland believe Scotland’s councils can take the opportunity to lead the pensions industry out of its short-term thinking and towards an investment practice that takes on the biggest challenge of our age: climate change.

What is divestment?

Divestment, also known as disinvestment or divestiture, is the process of selling a financial asset. We are calling for funds to publicly commit to divest from fossil fuels and reinvest in social housing and renewable energy.

Across the world 701 institutions, with total investments valued at $5.5 trillion USD, have committed to divest from fossil fuels (see below).

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In Scotland the Universities of Glasgow, Abertay, West of Scotland and Queen Margaret, along with the United Reform Church, have fully committed to divestment, whilst the Church of Scotland, Heriot-Watt and Edinburgh Universities have made partial commitments.

Five pension funds in the local government scheme have committed to cut their fossil fuel investments: the Environment Agency Pension Fund, Haringey, Waltham Forest, Southwark and South Yorkshire.[3]

These funds haven’t just cut their investment in fossil fuels: many have also committed to increase investment in sustainable projects like local renewable energy.

The need for a just transition

Scotland needs investors willing to put money back into local communities.

We are in the midst of a housing crisis. 62 per cent of social housing falls beneath the Scottish Housing Quality Standard and 335,000 households are on social housing waiting lists. Inequality is rising and 1 in 7 young people in Scotland are unemployed[4]. Tightly squeezed budgets at Holyrood and local councils mean the public sector is not providing the investment needed to kick-start local economies and drive economic regeneration.

These challenges would be serious on their own. But Scotland also faces massive job losses from the oil and gas industry. Recently thousands of jobs have been lost as companies have cut costs to make up for lower oil revenues. With production having peaked in 1999[5] there can be no long-term future for oil and gas extraction in Scotland.

Stark as this picture is we believe we can turn these challenges into an opportunity.

Scotland has been leading the fight against climate change with world-leading legislation and carbon emissions falling considerably over the last 10 years.

In 2015 world leaders, recognising that the burning of fossil fuels is damaging the earth’s ability to support life, signed a historic treaty aimed at limiting global warming to 1.5°C.

With the world making the shift away from fossil fuels and towards renewable energy Scotland can continue to lead the way in tackling climate change by taking money out of fossil fuels and putting it back into local economies.solarpanel_final

Scottish councils are already investing small amounts in renewable energy and sustainable housing. In this report we will show how much more could be achieved if they committed to end investments in fossil fuels and reinvested significant sums in socially and environmentally beneficial projects.

Action is needed elsewhere in the Scottish economy. But whilst wider and deeper reform of the financial system is also necessary, what we are proposing in this report is something that can happen right now, within existing structures.

The need for action is urgent in order to avert the environmental and economic costs of climate change and to rebalance the economy to one which provides enough decent jobs making things in clean ways. Shifting our economy away from dependency on fossil fuels will be critical in responding to the climate crisis, but this transformation is also an opportunity to build thriving local economies.

The threat of the carbon bubble

Whilst there are plenty of positive reasons to divest and reinvest, doing so would also cut pension funds’ exposure to the risks inherent in owning shares in an industry that’s on the way out. Scotland is taking a weighty financial gamble when it invests its pension wealth in fossil fuels.

This is because the value of fossil fuel companies is directly linked to the amount of coal, oil and gas that the companies control and can physically burn.

To cut carbon emissions in line with the climate policies established by governments, like the Scottish Government’s world leading Climate Change Act, there is a limit on the amount of fossil fuels that can be burnt. Climate policies reduce the volume of usable fossil fuel reserves. The resulting excess reserves are known as unburnable carbon.

At the UN’s Paris summit in 2015 the world’s governments agreed to an aim of limiting global warming to 1.5°C above pre-industrial levels. It has been estimated that this requires at least 80% of known fossil fuel reserves to be kept in the ground. If we are to meet globally agreed targets to cut carbon emissions the vast majority of fossil fuel companies’ reserves are unburnable.

Neither the share prices or business models of fossil fuel companies reflect this reality. Companies such as BP and BHP Billiton are extracting the fossil fuels that are driving us headlong into a dangerously scorched future, warmed by 6°C or more.

If and when government action reduces demand for fossil fuels the carbon bubble will burst and fossil fuel companies share value will plummet. Unable to sell their unburnable carbon reserves, fossil fuel companies will be burdened with useless machinery and infrastructure, no longer required in a world running on renewable energy.

The carbon bubble is evidence that climate change is a financial, as well as environmental threat to society.[6]

Mark Carney, Governor of the Bank of England has warned that the “vast majority of [fossil fuel] reserves are unburnable” if climate change is to be limited to safe levels as pledged by the world’s governments.[7]

In 2015 the deputy head of the Bank of England’s Prudential Regulation Authority said “we are seeing evermore frequent ‘record’ weather events; storms; floods; hotter summers; intense rainfall. As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies may take a huge hit.”[8]

Later that year Carney gave a widely publicised speech which concluded starkly: “There is a growing international consensus that climate change is unequivocal… once climate change becomes a defining issue for financial stability, it may already be too late.”[9]

The Bank of England’s work on climate change should be a wake up call for investors, pension funds and councils to think very seriously about whether their investment plans are consistent with a sustainable future.

Fund managers and investment professionals have been slow to change the way they invest to protect their investments from these risks.

A 2015 report by Scottish Environment Link concluded that “Scotland’s financial sector, with a particular focus on pension funds and longer term investments, is heavily reliant on the fossil fuel industry and carbon based assets…” The report called for public and private investors to move quickly to “divest fossil fuel investment assets to reduce or eliminate risk related to carbon.”[10]

There is a strong financial case to say that government action on climate change makes fossil fuel investments inherently risky, and that they should be avoided by long-term investors. If this case is understood divestment is simply an act of self defence for investors.

However the carbon bubble also reminds us that government action could fail, and fossil fuels could continue to be profitable long into the future. If this were to happen climate change would spiral out of control with the global economy pounded by rising seas inundating coastal cities, the spread of diseases, mass extinctions, extreme weather damage, loss of human life and the collapse of nation states.

The future of pension funds is intrinsically linked with that of the wider economy. They will not be able to escape the damage that fossil fuels will wreak on our future economy. Instead they must cut out carbon risk and invest in a way that actively contributes to fighting climate change.

Notes

[1] Source: http://www.actuarialpost.co.uk/article/pension-fund-assets-in-22-markets-up-to-$36–4tn-in-2016-10614.htm

[2] Source: http://lgpsab.scot/sab-annual-report-201516/

[3] For more details see here.

[4] Sources: http://www.bbc.co.uk/news/uk-scotland-37940847 http://www.bbc.co.uk/news/uk-scotland-scotland-business-37223040

[5] Source: http://www.bbc.co.uk/news/uk-scotland-scotland-politics-26326117

[6] For a more detailed discussion of the carbon bubble see this article published on Reinvest Scotland: http://reinvest.scot/financial-topics/carbon-bubble/

[7] For more about this speech read the article in the Guardian website: https://www.theguardian.com/environment/2014/oct/13/mark-carney-fossil-fuel-reserves-burned-carbon-bubble

[8] Full text of the speech can be found on the Bank of England website: http://www.bankofengland.co.uk/publications/Pages/speeches/2015/804.aspx

[9] For more about this speech read this article on the New York Times website: http://www.nytimes.com/2015/10/01/upshot/one-of-the-worlds-most-powerful-central-bankers-is-worried-about-climate-change.html?_r=0

[10] ‘Scotland and the Carbon Bubble: a report for Scottish Environment Link’, January 2015.

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