Sustainable Investing Can Be Blurry
September 9th 2020
Written By: Jinjoon Lee
There’s one area where risk ratings are possible. Can environmental, social and governance risks be quantified? With the notable exception of car- bon emissions, probably not—but that doesn’t mean the exercise isn’t useful for investors.
Interest in sustainable investment is ballooning. One sign is the money given to mutual funds: In the first half of 2020, net flows into sustainable funds totaled $20.9 billion in the U.S., according to Morningstar, compared with $21.4 billion for 2019 as a whole.
Fund managers that don’t specialize in ESG strategies are scrambling to incorporate them into their investment frameworks. There is an industry of risk ratings, but these come with a problem: The correlation between companies’ ratings of the same stock is low because they measure performance differently. An example is Tesla. MSCI rates the electric-car maker highly because of its environmentally friendly products, while FTSE Russell gives it a middling score for other reasons. This confusion gives ESG ratings a reputation for fuzziness.
Quantifying the risk to earnings from a given concern is a pleasingly sharp-edged alternative. Lon- don fund manager Schroders has developed a tool, SustainEx, to put a value on a company’s “externalities”—the unpaid costs of its activity borne by society. The rationale from 18% this year while natural gas-fired power’s share will decline to 35% from 40%. That comes after more than a decade over which coal gradually lost share.
RBC analyst Christopher Louney estimates that natural gas burn for electricity could decline 2% year over year in 2021 while coal generation picks up 6%—at the conservative end of his forecast.
Despite cheerleading from the White House, the reversal will do little to salvage coal’s bleak future. But it reveals how cutthroat the natural gas business has been in recent years. There have been other surges—in 2018 natural gas prices struck close to $4 and temporary gas-to-coal switching was observed—but those rallies weren’t as sticky as analysts predict this one will be and were never enough to shift the annual share of electricity away toward coal.
Luke Jackson, team leader for North American natural gas at S&P Global Platts, expects natural gas prices to average $2.90 for the remainder of 2020 and $3.30 for 2021, while RBC’s Mr. Louney estimates prices will edge up to $2.60 in the fourth quarter and gradually move up to $2.80 by the end of 2021.
The shift will vary significantly by region. The Midwestern and Southeastern power markets, which need to bring in natural gas through pipelines, already are see- ing signs of natural gas-to-coal switching, according to Mr. Jack- son. Pipelines are running at full capacity, leading to regional gaps in natural gas prices. As an example, prices for the Chicago Citygate index in the Midwest averaged $2.05 in August, while the price in Dominion South—a hub close to the gas-producing Marcellus and Utica basins—was $1.21. The Mid- west and the Southeast also still rely on coal for a substantial share of their electricity generation: The hydrocarbon accounted for 49% and 44% of electricity generated in the respective markets as of mid- day Friday. The Northeast, on the other hand, is closer to dry gas ba- sins and hasn’t seen signs of coal switching yet. That could change in winter months when heating demand surges.
Yet none of this portends a last- ing comeback for coal-fired power. As recently as 2015, coal was the largest fuel source for electricity in the U.S., but low natural gas prices and rigorous environmental standards have pushed many coal generators to shut down. An additional 25 gigawatts, roughly 11% of coal power capacity as of year-end 2019, is expected to retire by 2025, according to the EIA. Already, many coal plants are unable to operate enough hours to cover costs and some have evaluated plans to run only during seasons with high demand.
This may not be the last time that market forces temporarily re- verse the tide. Coal’s fade to black could be a long one.
Sources: FactSet (futures); U.S. Energy Information Administration