Norway’s sovereign wealth fund, the biggest in the world, has just sold all the equity shares of Duke Energy it owned from its portfolio. Duke did not meet the fund’s stringent “ethical” standards according to press reports, joining 110 other companies on the do-not-own list. The fund already made clear, in previous statements, that it would not own utilities that produced 30 percent or more of their energy from coal. Duke managed to slip under that limit in 2015. Their coal-fired generation declined to "only" 29 percent of its generating mix.
So what happened? The Norwegians, changing focus somewhat, instead took aim at Duke for discharge of harmful substances from its coal ash ponds--a problem that will take Duke years to correct. The fund cited the “unacceptable risk” involved in owning shares in a company that might have to take responsibility for all that environmental damage. In a sense, Norway’s fund, with its enormous holdings, cannot be nimble and responsive like individuals or smaller institutional investors. They need to anticipate risk and act ac-cordingly.
Interestingly, Duke boasts that it has kept a place in the Dow Jones Sustainability Index for eleven years in a row. That index works on an ESG (environment, social, governance) formula, much like the “triple bot-tom” sustainability approach developed by one of the big consulting firms. Creating indexes of stocks or bonds is a big business in itself. And indexes need components. One can only be so fussy in constructing an index or it has too few components. The ESG Sustainability indexes make corporate relations people proud but they also influence serious ethical investors, many of whom believe that no company that burns fossil fuels qualifies as sustainable. (We suspect that most of these "focused" investors do not approve of nucle-ar power either regardless of its low carbon emissions profile.)
As analysts and investors, we might suggest there are other definitions of sustainability. For instance, are businesses that cannot support their cash needs from current operations sustainable? Or are businesses that can sell their product only if subsidized by the government truly sustainable? In the case of electric power generators, should investors categorize them in gradients, that is, some more sustainable than oth-ers, or just write off the entire non-renewable sector as unsustainable? In other words, should manage-ment from some electric utilities get extra credit for trying? That judgment turns the matter into some sort of qualitative or moral issue. Related: Despite Criticism, Prime Minister May Gives Go-Ahead To Hinkley Point
Sensible investors might want to look at it as a long term risk question. Does the company in question, which relies on fossil fuels for power generation, incur greater risks than one that does not? And what is the attendant risk that government's act to diminish the value of fossil fuel generation assets either through an outright ban or a punitive taxation scheme for example? Do yield hungry investors price utility stocks (and bonds for that matter) in such a way as to reflect fossil fuel risk differentials? If not, rational investors should either exit those firms with significant dependence on fossil fuels or demand higher levels of compensation for the risk.
In sum, we don’t view the Norwegian fund's decision as indicative of an elevated ethical standard. The question for us is whether their risk avoidance methodology is sharper and more long term oriented than other very large institutional investors. Will the Norwegian's decision on Duke per se, matter in the mar-ket? Probably not for a while. But it looks like a harbinger of things to come.
By Leonard S Hyman and William I. Tilles for Oilprice.com
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