US investors are increasingly using transition strategies to target companies that could play a vital role in decarbonisation, including fossil fuel companies which are outperforming clean energy peers.
Assets in US climate transition funds have grown fourfold in the last 18 months to US$9.3bn at the end of June, according to data from Morningstar Direct.
While clean energy funds mostly invest in renewable power and other climate technologies, transition funds allocate money to a broader range of high-emitting businesses which are adapting to a low-carbon economy and can include oil and gas companies.
American Century Investments, a US$225bn asset manager based in Missouri, launched a sustainable investment strategy in September that has targeted energy companies such as ExxonMobil and oilfield services firm Baker Hughes.
“We think the best way to decarbonise the society is to own the stocks of brown businesses and actively engage with them to drive real-world outcomes,” said David Byrns, senior investment analyst at American Century.
Under the strategy, the asset manager identifies companies in sectors that are making efforts to reduce greenhouse gas emission intensity and shift to lower-emitting revenue streams.
The fact that the fund is not using an exclusion strategy makes it less controversial in anti-ESG states. “It is the one that we could bring down to the state of Texas because it's not focused on excluding a large portion of their economy,” Byrns said.
The transition approach can also complement traditional clean energy investing, which often has high exposure to growth stocks and tends to come under pressure amid high interest rates, he added.
Capital intensive
With the Federal Reserve lifting its key interest rates to a 22-year high in an effort to rein in inflation, demand for capital-intensive renewable projects has waned as expensive debt eats into investment returns.
The iShares Global Clean Energy ETF, which comprises mostly solar and wind power companies, fell more than 22% last year. The iShares Global Energy ETF, which tracks oil and gas heavyweights, rose about 4%.
Some ESG-focused investors that have previously avoided fossil fuel companies have started engaging with oil executives in the past year, William Nygren, chief investment officer at Harris Associates, told a media conference last month.
Russia’s invasion of Ukraine has raised awareness of energy self-sufficiency and its societal impact, Nygren said. “Those investors are now getting more nuanced with energy.”
Cash-rich oil
Oil and gas companies that benefited from the soaring energy prices in the past two years are now well positioned to maximise returns for shareholders through share buybacks and dividends, said Mark Lacey, head of global resource equities at Schroders.
“The conventional energy sector now has companies with incredibly strong balance sheets,” he said, adding that some companies are generating record free cashflows, with dividend and buyback yields topping 10%.
While the oil and gas sector is attractive to US investors focused on total returns, it remains controversial as shareholder payouts far exceed renewable energy investments.
In 2022, the oil and gas industry spent 39% of its cashflow on dividend payouts and share buybacks, according to the International Energy Agency. Less than half the cash went to oil and gas capital expenditure, the lowest percentage in more than a decade.
The fact that oil and gas companies are investing less in creating new supply is an acknowledgement that energy transition is underway, said Aniket Shah, managing director and global head of sustainability and transition strategy at Jefferies.
“They are figuring out what they want to do,” he said.
Some energy companies are betting on nascent technologies such as direct air capture to tackle climate change. Occidental Petroleum last year agreed to pay US$1.1bn for a carbon capture technology company to help it develop plants that strip carbon dioxide from the atmosphere and bury it underground.
President Joe Biden’s landmark climate law, the Inflation Reduction Act, also provided lucrative subsidies for the fledgling technology, which remains controversial amid questions over its effectiveness and expense.
Yet some ESG-focused investors say more progress is needed for them to consider investing in oil and gas companies which continue to spend tiny portions of their revenues on low-carbon alternatives and resist more ambitious climate action.
“We don’t have an exclusion policy,” said Bruce Kahn, portfolio manager of the Shelton Sustainable Equity Fund. “But right now, those opportunities don't seem attractive. They have not really demonstrated progress towards a sustainable world.”