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Weighing the Risks of Investing in Energy Companies

A Shell station outside Ahmedabad in western India. Concerns that fossil fuel companies may become poor investments have drawn Royal Dutch Shell's attention.Credit...Amit Dave/Reuters

LONDON — Norway’s economy is highly dependent on oil and gas production, yet the Nordic country’s largest private pension fund manager, Storebrand, worries about the risks of investing in companies that extract fossil fuels. Figuring that tighter regulations on carbon emissions will emerge in the coming years in an effort to combat climate change, Storebrand has decided not to invest in businesses that it believes will be hurt most by those new rules: coal companies and large producers of oil from tar sands.

“The business case is the main driver for what we do; companies with a sound and systematic environmental performance also perform better financially,” said Christine Meisingset, Storebrand’s head of sustainability.

Ms. Meisingset and Storebrand, which manages about 500 billion kronor, or about $74 billion, are among the fund managers beginning to think skeptically about fossil fuel companies — not so much because they or their clients disapprove of their activities, but because they think the securities issued by these companies may prove poor long-term investments.

The reasoning, which has caught the attention of major oil companies like Royal Dutch Shell, is that after a period of relative inaction, world governments may be heading toward adopting tougher rules on emissions, transforming the economics of the energy business.

The recent proposal by the United States Environmental Protection Agency to cut emissions by the electric power industry by 30 percent from 2005 levels by 2030 was the clearest omen of a coming change.

Energy analysts and environmentalists say the E.P.A. proposal could prove a catalyst for a wider deal on emissions, possibly at a United Nations summit meeting on climate change in Paris next year.

If so, analysts say, energy companies may need to rethink their approach. The Carbon Tracker Initiative, a London-based group that applies financial analysis to environmental issues, estimates that over the next 10 years the international oil industry may invest as much as $1.1 trillion in projects that require a price of $80 to $95 per barrel of oil to be viable.

Heavy carbon taxes or other rules that significantly raised costs could turn many of those projects, particularly those in the tar sands of Alberta, Canada, and the deep waters off Brazil and the United States into money-losing white elephants, the group figures.

“In our analysis, a big chunk of projects don’t make financial sense if you apply climate policy,” said Anthony Hobley, the group’s chief executive.

Groups like Carbon Tracker are highlighting the risk that energy companies might be stuck with what are being called “stranded assets,” or large amounts of resources that the industry will not be able to produce. That danger for the industry and investors would be accentuated, these analysts say, if world governments adopt tough programs designed to restrict the increase in average global temperatures to the 2 degrees Celsius widely considered necessary to head off the most devastating effects of climate change.

The International Energy Agency, an intergovernmental research organization based in Paris, said in a study last year that in that case, as much as two-thirds of proven fossil fuel reserves might not be commercialized by 2050, unless carbon capture and storage, a technology that strips out CO2 and injects it into the ground, is widely used.

Investment professionals say that while their clients are not panicking, they are at least beginning to think about the possible implications of tightening regulation on emissions. “Investors don’t know whether they should be invested in these stocks. They are part of everyone’s portfolio,” said Kevin Bourne, an executive at the FTSE Group, a subsidiary of the London Stock Exchange that provides financial indexes.

With backing from the Natural Resources Defense Council, an environmental group based in New York, Mr. Bourne has produced a global index called the FTSE Developed ex Fossil Fuels Index that is designed to provide an investment benchmark for financial products that exclude companies in the fossil fuel extraction business. These stocks, which are mostly listed in the United States, Canada, Britain and Australia, have a collective market valuation of about $2.6 trillion and make up 9 percent to 12 percent of world markets.

While the energy industry is closely watching these developments, which might hurt its stock prices or make raising capital more difficult, the reaction so far is polite dismissal. In a public letter from J. J. Traynor, head of investor relations at Shell, responding to inquiries from shareholders “regarding the ‘carbon bubble’ or ‘stranded assets’ issue,” the company said it believed “that the risks from climate change will continue to rise up the public and political agenda.” However, the company said that given the expected strong growth in demand for energy in the coming years, “We do not believe any of our proven reserves will become ‘stranded.'”

Investment professionals say that there hasn’t been a mass exodus out of fossil fuels. The action has been mostly limited to divesting coal mining stocks, which are an easy target because they make up less than 1 percent of the global market value of fossil fuel stocks, according to FTSE. Stanford University recently said it would purge coal stocks from its endowment.

The issue seems unlikely to fade away, especially for investors who take a long-term approach. “Sustainability and climate change are inextricably linked to thinking about things in the long term,” said Jane Goodland, a senior consultant at the pension advisory firm Towers Watson in London.

Ms. Goodland said that even though the major energy companies might not be in investors’ cross hairs now, they should be following the debate. “Any company not paying attention to what its stakeholders are saying and thinking is playing a risky game,” she said.

And early indications are that investors might be able to live without oil companies — at least in their stock portfolios. FTSE said that when it recently ran a seven-year retroactive test of its index against a more conventional developed-world index, there was little difference in performance.

A correction was made on 
June 12, 2014

An earlier version of this column misstated the surname of the producer of the FTSE Developed ex Fossil Fuels Index. He Kevin Bourne, not Mr. Morrison.

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