A group more than 20 institutional investors and pension funds has released details of a campaign they have embarked on calling on major fossil fuel-linked companies to adjust accounting assumptions and disclosures to account for the effects of the Paris Agreement.

The Paris Agreement is a multi-nation pact developed by parties to the United Nations Framework Convention on Climate Change (UNFCCC) to combat climate change. The agreement’s main goal is to limit the global temperature increase in this century to below 2 degrees Celsius above pre-industrial levels, and to work toward limiting the increase to 1.5 degrees. The Paris Agreement was drafted in December 2015, and went into effect as of November 2016.

Clearly the implementation of the agreement will have a major impact on energy companies, as it implies a major transition over the coming decades in the world’s primary energy sources, from those that rely on carbon-based fossil fuels to cleaner, renewable sources. Companies who businesses rely heavily on fossil fuels will need to undergo major transformations, impacting their operations and the valuation of their primary assets.

In an investor  statement released today, Natasha Landell-Mills, Partner and Head of Stewardship at investment manager Sarasin & Partners, one of the signatories of a letter sent to the companies wrote that last week’s announcement by energy major bp that it would record a financial impairment of $13 – $17.5 billion represents a major milestone in this campaign. bp’s impairment was driven by the change in its oil and gas price assumptions to $55 per barrel and $2.90 per million British thermal units, respectively, and represent 13% – 17% of the company’s net assets.

Landell-Mills praised bp’s actions, writing,

“This move by BP should be commended. It is hugely important, not just to BP shareholders who now have greater clarity over climate risks embedded in the business, but it has far-reaching implications for the world’s ability to deliver on its commitment to the Paris Agreement.”

The group of investors engaged bp in its campaign in November, and sent parallel letters to other energy majors, including Royal Dutch Shell and Total. While Shell and Total have also lowered their oil and gas price assumptions, the statement notes that most other companies have yet to bring their assumptions in line with the Paris Agreement, and calls on them to do so:

“Other fossil fuel dependent companies need to sit up and take note. Based on our analysis of major European fossil fuel companies’ 2019 financial statements… it is clear that almost none have aligned their critical accounting assumptions with the Paris Agreement. The level of BP’s impairments demonstrates the potential materiality of this risk hidden in companies’ balance sheets.”

The engagement letters sent to the companies asked for the issuance of the following specific disclosures (source: Sarasin & Partners):

  • How critical accounting judgments including, but not limited to, commodity prices, discount rates, and asset lives have been tested against credible economic scenarios that are consistent with achieving net zero carbon emissions by 2050 to 2070 and any adjustments made to these assumptions.
  • The results of sensitivity and/or scenario analysis linked to variations in these judgements/ estimates, including one that is Paris-aligned if this is not used as the base case.
  • Adjustments to distributable reserves to reflect energy transition risks to ensure dividends are not paid out of capital as per requirements under Part 23 of the Companies Act 2006; and threshold assumptions that would trigger cuts to dividends.
  • Consistency between BP’s disclosed climate-related risks set out under “Risk factors” and the assumptions that underpin the long-term viability statement and in the accounts.
  • Consistency between the assumptions (notably long-term oil and gas prices and carbon taxes) used in the company’s capital expenditure planning process and those used in the accounting process.

Signatories of the letter include representatives of the following investment managers and pension funds:

Sarasin & Partners LLP, Local Authority Pension Fund Forum, Environment Agency Pension Fund, Brunel Pension Partnership Ltd, Church of England Pensions Board, Church Commissioners for England, LGPS Central, M&G Investment Management, EOS at Federated Hermes, Jupiter Asset Management, Merian Global Investors, GO Investment Partners LLP, UK Shareholders Association, Aegon Asset Management, PKA, P+, KBI Global Investors, NN Investment Partners, Bank J. Safra Sarasin Ltd., Candriam, Indep’am, CBIS, Committee on Mission Responsibility Through Investment of the Presbyterian Church U.S.A