If Norway’s Finance Ministry and Parliament agree, GPFG will still invest in oil and gas stocks, but under different terms and at a reduced level. GPFG holds 4 per cent of its fund, about $36 billion, in oil stocks with additional amounts in corporate bonds and approximately $36 billion in Norway’s Statoil.

Mindy Lubber, the executive director of CERES, a sustainability think tank, calls the Norges move a “shot heard around the world.” We concur.

Investment funds use indexes to efficiently invest large amounts of money across thousands of companies. The Norwegian Fund uses the FTSE index, and, for this recent analysis, the MSCI World Index Fund, as a proxy for its holdings. Most broad indexes include oil stocks.

Takeaways from the Norges Bank decision:

First, the bank has concluded that overall performance will improve by ridding the fund of this whole sector of financial laggards. A comparison by the Bank of the performance of an index of just oil stocks and of five large oil companies – Exxon Mobil, BP, Royal Dutch Shell, Chevron and Conoco Philips –against the broad equity market tells the story. Since the 1970’s, oil and gas stocks drove the equities market; they led most indexes up in good times and down in bad.

That dynamic has changed, as shown in the chart here. Instead of correlating with the broader stock market, oil and gas stocks have “decoupled.” So while the stock market has been rising, oil prices and stocks are declining. And it is the consensus within Norway that the current low oil price environment will continue through 2060.

Second, Norway’s budget depends on oil revenues, so it reasonably applies a fiscal stress test to its oil investments, which is a tighter standard than the usual market analysis. Standard indexes and financial analysis adjust gradually, based on a long-term historical based approach. Money managers who advise pension funds usually defend their inaction in the face of whole sectors in decline with genuflections to market theories that support passive investment and bemoan the costliness of unwinding carefully planned index strategies. A fiscal stress test looks at the current budget and challenges traditional fund-manager recalcitrance when a government loses revenue – a circumstance that requires undesirable cuts to services and/or tax increases.

Third, there is nothing theoretical about the bank’s recommendation. Norway’s fiscal health is closely aligned with the financial fortunes of the fund. As oil prices and oil equity fortunes decline, so does the ability of the country to meet its annual budget. IEEFA has published extensive research (“Making the Case for Norwegian Sovereign Wealth Fund Investment in Renewable Energy Infrastructure” and “How Renewable Energy Holdings Can Contribute to the Growth of Norway’s Pension Fund in a Time of Oil Industry Uncertainty”) exploring the relationship between Norway’s fiscal health and its oil exposure. The Bank and the Finance Ministry agree that action must be taken. Last year was the first in almost 20 years that annual oil revenues were insufficient to cover the fiscal needs of the country. Over the next 40 years, estimates are that the country will have to make annual drawdowns from the principal of its $900 billion fund to make ends meet.

Fourth, with this new approach, the fund is unlikely to continue to apply the typical “Buy and Hold” to oil stocks. Individual companies will be under greater scrutiny and individual decisions can be made about each one.

Fifth, the fund will have more freedom to engage companies on performance or governance issues. When companies are not included in an index, it is no as longer so difficult to sell the stock of those companies, making divestment a real alternative if management refuses to respond.

Sixth, the action suggested by the Norges Bank has important implications for fund managers everywhere. We doubt there are any money managers in the world with a better understanding of oil markets than Team Norway. Replacing oil stocks in Norway’s index comes at a time when the fund is raising its asset allocation of equities to 70 per cent from 60 per cent, an increase that will not add oil stocks.

Seventh, while there are those who argue that action is not needed because institutional investors rarely hold significant chunks of any given company, institutional investors in fact hold as much as 4-5 per cent of their equities in oil and gas stocks and more in bond portfolios (the Norway fund is also exiting high-yield corporate bonds). The $2 billion loss by investors in EnerVest earlier this year reminds us that many funds are invested also in private equity arrangements with oil and gas interests.

Finally, and perhaps most important, institutional investors and proponents of divestment now have a potent new argument for fossil-free portfolios. We argue that while institutional funds do not necessarily have to adopt new strategies immediately, they must prepare.

When a stock or a whole sector that is as significant as oil and gas underperforms for so long a period and with such a negative outlook, fiduciary intervention is necessary. Doing nothing is irresponsible, and money managers and fiduciaries who ignore Norway do so at their peril.

Tom Sanzillo is IEEFA’s director of finance. This article first appeared on IEEFA’s website

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Indeed, GPFG is facing an unusually opportune moment this summer, as Parliament considers whether to enact a mandate that would have the fund put up to 5 per cent of its $900 billion in wealth into unlisted infrastructure holdings.

Such a move would allow the fund to capture value and reap stable returns especially from the fast-growing global renewable energy sector.

The fund would be joining an investment trend that is gaining momentum – 62 per cent of sovereign of wealth funds held infrastructure investments in 2016 and an additional 7 per cent were considering doing so.

Our report outlines how GPFG can proceed and describes the opportunity in renewable-energy infrastructure in detail. One of our core findings is that assets bought and sold across this space now—in wind farms and solar plants – yield returns and retain value.

A mandate by Parliament would mirror a recommendation already in place by Norges Bank.

While Norway’s Finance Ministry has been reluctant to approve such a move, citing concerns over assorted risks, Parliament has the authority to advance such a move.

Skeptics may very well argue that renewable energy comes with too much risk. And indeed, while renewable energy is no more immune to regulatory and political risks than investments that that include telecommunications and transportation holdings, these risks can be mitigated, as has been demonstrated for quite some time now by well-managed funds that have developed robust methods do just that. Our report shows how risk mitigation can be accomplished through a combination of in-house expertise, co-investment and strategic investment strategies.

Infrastructure is a long-established asset class embraced by many of the world’s leading investment funds, and renewable energy accounts for roughly 42 per cent of all unlisted infrastructure transactions. It is practically becoming a separate investment vehicle unto itself.

The industry outlook is positive. Government regulators and energy ministries in most countries are finding that wind and solar developers are offering competitive prices for power generation. This lowers the cost of electricity for host-country businesses and households and makes such investments that much more appealing. More and more governments recognize also that technology-driven, market-based renewable energy solutions will help address climate change – a fact that increases their appeal further and that adds to the growing global momentum around renewables.

Growth across the global economy over the next several years is expected to create demand for $3.3 trillion in various infrastructure investments, particularly in emerging economies.

Well-managed infrastructure investments bring returns of 12 to 15 per cent annually, with investments in renewable infrastructure producing steady, returns that exceed expectations. Brookfield Asset Management, among the models mentioned in our report, operates exemplary funds that return 10 to 20 percent annually.

The renewables sector is no longer the experimental space it once was, having entered a long-term growth cycle with a strong outlook driven by low costs, competitive prices, policy advances and rapid uptake. The sector is also diversifying by adding wind and solar investments to long-held hydropower portfolios.

Our report includes five recommendations on how Norway can move forward on this front:

1. By creating an investment mandate requiring managers to invest 5 per cent of the fund’s assets in unlisted infrastructure, including renewable energy investments.
2. By expanding GPFG specialized in-house professional staff resources, with a focus on developing a team comparable in quality to those found among other top institutional investors.
3. By establishing partnerships with established investment funds that have a track record in the unlisted infrastructure field, and co-investing with those funds under mutually beneficial arrangements.
4. By setting aside a portion of the fund’s infrastructure investment for listed utility companies that have significant and promising portfolios in renewable energy.
5. By putting a firm and prudent commitment in place to invest in infrastructure projects in emerging markets.

These five moves would allow the fund to capture value from a growing market that offers reliable returns. These investments would not be correlated to the fund’s equity and bond portfolio, which is to say they would add risk diversification. They would provide steady cash flow and they would be anti-inflationary.

The opportunity in infrastructure investment is enormous and immediate – in developed and emerging economies alike – and the risk is manageable.

Tom Sanzillo is IEEFA’s director of finance. This article originally appeared on the IEEFA website

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The evidence is all around us. One exhibit, of many, is in the report IEEFA published this week – “Red Flags on Exxon: A Note to Institutional Investors” – which includes the chart above.

The crucial detail in the picture is the crossover it shows. ExxonMobil and the S&P 500 Index once rose and fell in tandem, gaining in the long haul as the oil company and the stock market reaped robust returns for investors.

That changed in late 2014, when Exxon went south.

It’s a trend we think is likely to continue. Exxon’s performance is driven by oil prices, which are low and are expected to remain low. And it is, frankly, on the wrong side of history as the global energy economy evolves into a less fossil-fuel reliant animal.

ExxonMobil is providing a shrinking amount of cash distributions to investors. Over most of the past decade the company averaged shareholder distributions of over $30 billion annually. Last year, the company returned barely half that, $16 billion, to investors. This year the number will  probably be smaller.

Many of ExxonMobil’s financial metrics, as we detail in our report (revenues, net income, end-of-year-cash balances, long-term debt and free cash flow – measures used by management and investors to hold the company accountable) show signs of deterioration. The six charts in our news release tell the tale.

The company and its subsidiaries have reduced capital expenditures on future projects, a move that reflects a pullback of future production and revenues due to the combined effect of high investment costs and low oil prices (the latter being a factor over which it has limited control). Economists at the World Bank, the International Monetary Fund, the U.S. Energy Information Administration and in the private sector see low prices continuing. For ExxonMobil, many other oil companies and most importantly, for investors, this signals a future of diminished prospects.

ExxonMobil is still a gargantuan force, but it is not what it was in years past, when seven of the top 10 stocks in the S&P 500 ranked by market capitalization were oil companies. It is a less important company now than the likes of Google or Apple. Payouts to investors are not sustainable because for the better part of a decade now ExxonMobil’s shareholder distributions, that is, its stock buybacks and dividends have exceeded the company’s operating revenues.

As the company navigates the financial rapids of fast-changing energy markets, it is now involved in an escalating controversy over how transparent it has been in its evaluation of climate-change risk. The company has been subpoenaed by a number of state attorneys general looking into potential securities violations on this front, and the U.S.  Securities and Exchange Commission is conducting an inquiry. The question in this context is whether ExxonMobil has accurately calculated its reserve levels, a key metric for investors.

At the very least, investors can expect a long-term, highly publicized legal entanglement in several venues. This will stand in contrast to a history of strong and steady corporate guidance around competition, political conflicts, supply and demand changes and new geology.

This will only complicate ExxonMobil’s already-challenging operating environment.

The days of ExxonMobil providing outsize financial returns are over, barring a new investment rationale. Our report includes a series of questions that institutional investors in particular should be posing. Among the challenges for ExxonMobil is to answer them, particularly those that have to do with how and when the company will turn its current financial deterioration around and improve shareholder value.

Tom Sanzillo is IEEFA’s director of finance. This article was originally published by the Institute for Energy Economics and Financial Analysis

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It calls for a carbon footprint analysis of the funds’ holdings and advertises an opening for a climate-risk investment-strategy consultant. While the RFP is shrouded in pension-speak, its aim is clear: to introduce a series of asset-allocation decisions that will minimize fossil fuel risk and optimize portfolio returns.

Such a goal is becoming easier than ever to achieve. Fossil-fuel holdings, once a mainstay of pension fund portfolios, have grown less relevant over the past 30 years. A recent report by As You Sow, a San Francisco think tank, explains why (“Unconventional Risks: The Growing Uncertainty of Oil Investments”). The report documents several indicators that point to increasing structural risks that include declining revenues and profits, mounting debt, and falling prices.

The study comes against the backdrop of an oil-industry decline that began a generation ago. Seven of the 10 biggest companies in the Standard and Poor’s 500 Index were oil companies in 1980. Today, Exxon Mobil is the only one still there. For decades ahead of the 80s, oil and gas companies drove increases in the S&P indexes with quarter after quarter of rising cash flow and dividend growth. By the mid-1990s, these stocks remained profitable but no longer drove larger stock market returns. And while U.S. stock markets have soared in recent years, Exxon Mobil has posted eight straight quarters of market-lagging performance.

Oil is cheap today, much to the consternation of oil-industry executives, and likely to stay cheap. This reality is tearing at the very fabric of the old energy economy. Market coordination between major oil companies and state-owned enterprises (and between state-owned enterprises) has collapsed, and in its wake global competition prevails –nation against nation, company against company, company against nation.

Low prices create a huge impairment to oil producers who face higher extraction costs everywhere they look, and of course low prices are bad news for countries dependent on oil revenues for fiscal stability. The Canadian oil sands industry, for example, once a bright spot for fossil fuel investors, has been battered by years of failed projects and bankruptcies. Conventional oil exploration is simultaneously hobbled by rising costs. Big oil companies are cutting their capital spending now, a move that assures diminished profits. Natural gas markets are plagued by oversupply.

Oil and gas companies, if they are to weather the new energy economy, must pivot toward a low-carbon future. Investors much do the same. Those who choose otherwise –companies and investors alike – run the risk of following the coal industry into ruin and of logging 100 percent losses.

Which is where the importance of the New York City RFP is apparent: issued in September at the behest of Bill de Blasio, who is not just the mayor but also chairman of the city’s five pension funds, the notice was overshadowed by a simultaneous announcement that the city was divesting from coal.

It deserves more attention than it has received, however, because it sets a timely example for institutional investors and pension fund beneficiaries everywhere. The mayor – and the city’s pension boards – through this initiative are acting like fiduciaries are supposed to act. They are telling their money managers that they want a responsible plan to minimize carbon risk amid deep market changes and that they want a plan that will also achieve the funds’ targeted returns. These goals were contradictory in years past. In the current investment climate they are not.

Institutional investors need not be part of any charade that suggest fossil fuel investments are safe, and indeed should prepare solid exit strategies now.

A recent paper by former SEC Commissioner Bevis Longstreth makes clear that fiduciaries are obligated now to avoid holding fossil fuel assets whose risk exceeds any potential benefit. Just this month, Kathy Hipple, who teaches in the sustainability MBA program at Bard College, publicly questioned (with co-author Perry Goldschein) whether fund managers who invest in fossil fuels are meeting their fiduciary responsibilities.

The service being performed by the de Blasio administration in its push to reduce its pension funds’ carbon footprint through sound asset reallocation helps moves the ball forward and suggests a model others can follow. You can bet that assorted money managers and most of Wall Street will oppose the initiative, so a good plan will depend on the consultant, the skill and will of the mayor and his staff, support from the funds’ boards and the city comptroller.

Full transparency around whatever happens is crucial, and public scrutiny is key.

Institutional investors everywhere today should be equipped with a solid exit strategy from fossil fuels. The type of plan New York is contemplating, in addition to allowing a prudent path to divestment, can increase leverage for demanding clear plans from oil companies on either pivoting toward renewables or returning dividends to shareholders. Absent such a tool, fiduciaries are unprepared for the necessary transition.

Institutional investors have mostly shrugged off total losses on coal stocks and the huge hits they have taken on coal-industry bonds, but coal was always a negligible holding with negligible expectations – small assets, modest growth and limited attention to innovation. Coal investments performed historically more like risky fixed-income gambits than equities. It’s been years since any pure-play coal company was a top S&P holding, and today most fail to meet even penny-stock standards.

Oil and gas are different, and their losses will be far more consequential. Losses will grow and and headline risks will rise. Significant industry contraction is already under way. While oil and gas executives are busy securing their parachutes, Wall Street looks the other way, and its refrain can be heard now. No one saw this coming.

Some institutional investors, by contrast are behaving as responsible fiduciaries, as Mayor de Blasio has chosen do. They can expect grief from opponents but they can know also that they are acting in the best interest of pension beneficiaries.

Tom Sanzillo is IEEFA’s director of finance. This article was originally published by the Institute for Energy Economics and Financial Analysis

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