Fossil Fuels : An ESG Screening Approach
There is a growing interest among global investors in divesting, or minimizing exposure to, Fossil Fuels in their portfolios. Specifically, more than 1,200 global institutional investors, with $14.6 trillion in combined assets, have committed to divesting from fossil fuels in 2020. These investors seek to position themselves in opposition to the physical effects stemming from climate change, and seek to prepare their firms for future regulation around fossil fuels.
Some regulators and standard setters have established requirements and criteria to identify and tackle fossil fuels; however, the definitions, measurements, and investment products used to mitigate fossil fuel exposure can vary widely and, in some cases, prove to be confusing for investors.
Framework
To help clients navigate this landscape, State Street Global Advisors has created a framework that detects and classifies fossil fuels in a comprehensive and sensible manner. The framework focuses on the following activities, which are generally associated with fossil fuels:
- Oil Extraction and Power Generation
- Natural Gas Extraction and Power Generation
- Thermal Coal Extraction and Power Generation
- Shale Extraction
- Oil Sands Extraction
- Arctic Oil and Gas Exploration
POV Screening Approach
State Street’s standard Point of View (POV) screens employ, where possible, a 10% revenue threshold, and focus specifically on entities with direct involvement (vs. ownership criteria) in a particular area such as fossil fuels. In addition, our POV screens leverage best-in-class ESG data provided by Sustainalytics and are updated on a quarterly basis. We apply focused lists and 10% revenue-based metrics with the intention of concentrating our restricted securities on those issuers with meaningful involvement in the product, issue, or topic in question, rather than more indirect or minimal involvement. Our intention is not to screen every issuer that touches the topic in question, but rather to screen those with notable involvement. This allows us to balance screening preferences with other investment considerations.
Fossil Fuel POV Screen
While our approach to fossil fuel exclusions follows State Street’s standard approach shown in Figure 1, we are also able to provide some level of customization in our screening process. For example, investors can adjust the revenue thresholds of each specific screen and expand the “blacklist” to include indirect/ownership dimensions, or add/remove a particular metric or indicator (see Figure 2).
Another means of customization is using the volume of CO2 emissions (in millions of tons) owned by a company as a means of identifying fossil fuels. While that method has the upside of allowing for a more granular understanding of the volume of emissions, it introduces some subjectivity in the screening process. In other words, we would need to establish specific emissions thresholds (in million tons of CO2) to flag companies in violation of the screen.
Conclusion
Our preferred POV screening approach focuses on flagging companies that derive a particular percentage of their revenue from involvement in fossil fuels. This approach enables us to narrow down the focus our of screening methodology and identify companies whose business models and operations are significantly dependent upon owning and burning fossil fuels. It also aligns with the standard screening framework we use for other products and services, such as tobacco and controversial weapons, making it an easy complement to other POV screens.