How can climate change action impact Canadian portfolios?

Investment advisor speaks out on potential green energy winners, the perils of overfixation, and the growing power of engagement

How can climate change action impact Canadian portfolios?

Climate change action is by no means a new investment theme; after all, the environmental piece of ESG is by many accounts the first one that investors latched on to. But following the events of the pandemic, as well as recent weather events such as the heat wave and wildfires that have engulfed British Columbia, that interest can be expected to build with more intensity.

“It’s been said that the extreme weather we’ve been seeing would be pretty much impossible without human-driven climate change being involved,” said Graham Priest, investment advisor at BlueShore Financial. “You're going to be looking at people continuing to gravitate towards clean energy from things like coal, oil, and gas.”

As climate change increasingly takes a toll on humanity and the world, Priest said investors will correspondingly want to mitigate any climate-related risk in their portfolios. From a regulatory standpoint, the walls are also closing in on heavy greenhouse gas emitters as government actions focusing on green investment, carbon taxes, and climate-focused disclosures gather pace.

“In the near to medium term, we should expect investors to focus on sectors like clean energy,” Priest said. “Within that space, you have Brookfield Renewable Partners, one of the world’s largest publicly traded renewable energy companies; it has hydroelectric, wind, and solar generation facilities, as well as energy-storage assets. It also sells the bulk of its power production under long-term, fixed-rate power purchase agreements.”

Another interesting company through a green-energy lens, he said, is First Solar. The company is a global leader in thin-film solar panels, a technology that’s able to produce energy at a lower cost per watt than what’s been possible with traditional panels.

Of course, investors must be careful not to let their sustainability focus turn into blinders. As Priest noted, people who overfixate on climate change action as an investment theme might end up being too concentrated in certain sectors. Portfolios riding on the popularity of electric vehicles, for example, might get left behind if hydrogen fuel cells were to suddenly advance and overtake EVs and the associated battery technologies.

“You'd want to be diversified within the clean energy space, just so you can participate in strong returns from dark horse sectors,” he said. “On the flipside, there have been promising companies in cutting-edge sectors that have enjoyed a lot of hype, but in the end haven’t managed to go mainstream.”

Rather than invest in renewables, some investors might instead want to engage with the worst climate offenders as shareholders and secure a commitment from them to do better. That’s exactly what happened in late May this year, when a small activist fund called Engine No. 1 was able to rally larger shareholders in Exxon, pushing the company to install three more environmentally minded individuals to its board of directors.

“There has been a stronger tendency for members of the community to take up good recommendations that are set forth,” Priest said. “There’s a sense that fund managers that pride themselves in advancing radical types of climate recommendations are now more able to get larger shareholders, like pension funds, to vote alongside them. In turn, that puts pressure on the board of directors to make changes.”

Historically, fossil fuel companies might have been inclined to dig in their heels and resist those types of calls. But as more of them see the proverbial writing on the wall, many are hoping to get ahead of the curve. Increasingly, large companies are accepting the need to pivot and direct their resources to new technologies so that they can participate and stay relevant in the energy sector, whatever form it ends up taking.

Of course, not every company is converting to the church of ESG. Even with the recent slew of net-zero commitments from Canadian oil firms, a large majority of energy players still have large carbon footprints that, in the fullness of time, could inflate their costs of capital to untenable levels or expose them to regulatory action. That means Canadian investors who have a passive domestic equity bias could be taking on more risk than they realize.

“If you look at the S&P 500, or any of the other major global indices, you’ll see that energy has a relatively lower weighting there than it does in the S&P/TSX composite,” Priest said. “There have been times in the past where energy's been over 20% of the Canadian index, and recently it’s fallen to almost 50%. If someone has index-based exposure that just moves according to the benchmark, and it remains overweighted toward energy, they might be susceptible to declines over time.”

Amid the slow but sure global economic reopening, vehicular and air traffic has come back, and demand for fuel has resurged. With the resulting rise in oil prices, a sense of near-term bullishness has spread among many players in the energy space. But from where Priest sits, there’s every chance of that movement fading in the long term.

“You’ll see with utilities, for example, that prices of utility scale renewable energy prices have fallen over the past decade, and are now significantly below coal and gas generation,” he said. “Over time, it will be less expensive to do things that are positive for the climate. If some of these utility providers continue to focus on things like coal and gas, it can come to a point where the world will leave them behind.”