My Concerns About Investing in Fossil Fuels

Oil and coal, more recently natural gas have driven the global economy for the past 200 years. As recently as 2008, coal generated half of our electricity in the UK. However we are now entering a new age for power generation in response to the global climate emergency. The transition to clean energy such as hydro, wind and solar is well underway and will be disruptive.

Due to the activities of climate protestors such as Greta Thunberg, the oil industry can no longer maintain its 'business as usual' approach. The same goes for sectors dependent on oil as well as the banks who finance their operations and also their insurers who underwrite the risks.

The Transition

The oil industry now appears to accept the science of global warming but they maintain that the demand for fossil fuels will be there for several decades and this justifies their policy to continue with exploration for new oil fields and finding new areas to drill such as the Arctic. Investors who may well be sympathetic to the climate arguments, may well agree the transition will be a long and gradual process and therefore continue with a balanced allocation which contain oil and gas stocks - now renamed as 'non-renewable' energy.

However, I would suggest the transition is moving much more quickly than the oil industry cares to acknowledge. Governments around the world are developing policies to deliver a carbon-neutral economy by 2050. To achieve this, they will need to implement policies now to have any chance of meeting their goal. Here in the UK for example, there will be no more gas central heating boilers in new properties from 2025; coal-fired power stations will be history at the same date.

In a recent announcement, the European Investment Bank says it will no longer fund fossil fuel companies after 2020 as it aligns its strategy with IPCC climate targets. The UK government is now coming under intense pressure to stop providing finance to fossil fuel developments via its UK Export Finance agency. The tap is being turned off to an industry which is preventing the world from hitting its GHG reduction targets.

Secondly, the costs of renewables have fallen dramatically in recent years. It is now cheaper to generate electricity from wind and solar compared to traditional fossil fuels or nuclear. Introduce new battery technology to even out the lack of continuity associated with limitations of renewable generation, and it's difficult to make the case for new fossil fuel generation just on cost considerations alone.

As weather patterns - heatwaves, drought, wildfires, hurricanes - become more extreme, public opinion will harden against the fossil fuel industry.

There is no doubt about the transition from the old oil-based economy to the new, clean renewable energy economy. What is not clear at present is when the tipping point is reached. After this point, the old economy will fall away very quickly.

As can be seen from the chart covering the past 5 years, the commodities and oil sector has not performed well compared to the global equities market represented by the Vanguard fund.

Global Equities v Commodities & Energy Sector

How Will Investments be Impacted

As many readers know, the investing process is cyclical - some sectors do well one year and others another year. There is a reversion to mean - equities will outperform bonds for a period and this is reversed as government bonds provide stability during periods of uncertainty. The general advice to investors is to hold a diverse mix of assets.

However, the energy transition is not cyclical but structural - its a one way process which has implications for investors because the transition will cross the tipping point which will mean changes will happen far quicker than 'experts' predict and therefore relying on past performance will carry significant risks. The billions of dollars still being ploughed into coal, oil and gas projects will become a liability to the lenders and their insurers as these have a high risk of default and a legacy of worthless stranded assets. There are many examples throughout history where new technology has disrupted the traditional way of doing things.

 

Walney Extension Cumbria
providing clean power for 1.2m homes

Of course, the smart operators will have already adapted to the changes in energy. For example, one of my recent acquisitions, Orsted has transformed itself over the past decade from oil, gas and coal business under its previous name DONG (Danish Oil & Natural Gas) to become the world leader in offshore wind. Shell are trying to take tentative steps away from the oil and gas sector and into biofuels, carbon capture and wind/solar. They have signed a 5 year deal with BSR to provide solar power for its renewables arm Shell Energy. However 98% of their global operation is focussed on traditional oil & gas so I'm not sure how easy it would be to transform a global oil major or indeed how committed they really are to clean energy. Shareholders should certainly be concerned and pushing for change.

The projection for demand for their products from the oil majors is well into the 2040s but these projections have been overly optimistic in the past. I personally suspect we are already close to peak oil and the coming decade could well see a steep decline in all forms of coal/oil extraction which we simple cannot afford to use if we are to limit global warming to 1.5C or even 2.0C as recommended by the IPCC.

Conclusion

In February, I put my multi-asset global index funds under the spotlight and was a little surprised to see the level of exposure to oil majors in my Vanguard Lifestrategy compared to the HSBC Global Strategy. Since then I have made several changes to my portfolio to reduce this exposure to fossil fuel investments.

As I re-position my portfolio towards more climate-friendly funds, I am naturally looking to filter out coal, oil and gas however, with my global index funds, this is not so easy. Even the so called ESG 'green' options all hold oil majors such as Exxon Mobil, Shell and Chevron for example. My Vanguard Lifestrategy has 25% of its equity portion invested in the FTSE All Share index which has a high exposure to the likes of Shell and BP - currently 18% - so I have repeatedly asked Vanguard UK to consider lowering the allocation to UK equities and also to introduce some climate-friendly alternatives. Nothing so far...

I remember back in 2007/08, the investing community ignored or under-appreciated the risks posed by the sub-prime mortgage crisis in the US which led to the global market crash and governments having to bail out the major banks to prevent them going under. The effects are still being worked through a decade later. My concern is this could happen on a bigger scale as investors and lenders fail to appreciate the risks associated with this global energy transition. We have  President Trump who is openly skeptical about climate change and very supportive of coal, oil and gas - he could well be in power for another 5 years.

The past 5 years have been the warmest on record and it's looking likely this trend will continue and 2019 will be the second warmest on record as the heatwave rips across Europe and the Arctic wildfires burn for weeks. Its a paradox that these past few years will most likely be the coolest of the next 50 years due to the accumulated CO2 playing out through the system.

So, I will look to further divest fossil fuels and embrace the clean energy of the future. Hopefully the likes of Vanguard and Blackrock will respond to investor demands for climate-friendly funds and I hope readers will lobby their fund managers to offer environmentally friendly alternatives. I will keep a little more cash in reserve to maybe take advantage of any sudden downturn in the markets.

Feel free to share any thoughts on the energy transition in the comments below - all opinions and views welcome as ever.

Greencoat UK Wind - Portfolio Addition

Last year I made a start in aligning my portfolio towards my values and lifestyle with a re-jig of my portfolio away from oil and gas and introducing new additions such as TRIG, Bluefield Solar and Foresight Solar. In May I topped up my holdings in Orsted and BG Positive Change and also decided to add this large renewable infrastructure trust to my green portfolio. The recent share offering raised an additional £375m and UKW is the largest renewable infrastructure trust with a market value in excess of £2bn and a constituent of the FTSE 250.

The trust has a fairly simple business model operating a portfolio of 34 onshore and offshore wind farms throughout the UK. The trust was launched in 2013 and over this period, returns for investors including dividends have just about doubled making it the best performing trust in the renewables sector. Total returns over the past 5 years compare well with other holdings... UKW 73% v TRIG 70% v Vanguard SRI Global 80%

In February, the trust agreed to purchase a 35.5% share in two Scottish windfarms owned by SSE with a combined capacity of 322MW from 99 wind turbines. This takes UKW total capacity to around 950 MW of electricity, sufficient to power 550,000 homes.

Stronelairg Wind Farm Nr Fort Augustus, Scotland

UKW's aim is to maintain progressive dividends for shareholders in line with RPI inflation and preserve capital over the long term. The trust pays quarterly dividends and the target for the current year is 6.94p. which means a yield of 5% based on the current share price. The company's target is for a total shareholder return including dividends of 8% to 9% per year.

In the coming week, UKW will announce interim results for the 6 months to end June 2019.

I don't imagine the re-alignment of one small investor's portfolio towards more climate-friendly investments will be moving the climate emergency dial very far. This will be done by the likes of large sovereign wealth funds and pension funds.

However, I think that when lots of small investors start to rethink the relationship between financial goals and the future security of the environment, it could have a significant impact. Apart from all this it just makes me feel a bit better. This now takes the total 'green' portion of my portfolio to 50%.

“I have always been that girl in the back who doesn’t say anything. I thought I couldn’t make a difference because I was too small.” Greta Thunberg.

As ever, this article is merely a record of my personal investment decisions and should not be regarded as an endorsement or recommendation - always DYOR!

Finsbury Growth & Income - Portfolio Sale

I have held this UK-focused investment trust in my portfolio since 2011 and have been more than pleased with the performance, returns and increasing flow of dividend income over the past 8 years. The start of 2019 has been no exception with a return of over 20% in the past six months.

However, alarm bells started to ring over the recent suspension of Neil Woodford's flagship £3.5bn Equity Income Fund and the relationship between a star manager and brokers Hargreaves Lansdown. Many thousands of ordinary investors in the fund have seen the value of their holding fall, a reduction in the dividend and are prevented from selling until at least the end of the year.

Of course funds and investment trusts are very different beasts. However there is always a balance between risk and reward, particularly in relation to equity investments. Nick Train runs a very concentrated portfolio of just 20 or so holdings with the top 10 accounting for 80% of the portfolio which means investors are exposed to quite a high degree of risk should just one or two of these holdings come a cropper.

HL has been in the FGT portfolio as long as I can recall and accounts for around 7% or 8% so the negative news surrounding the Woodford affair in recent weeks has resulted in the HL share price falling by 20% in early June. Not only does FGT have a significant holding in HL but HL clients hold 12.5% of FGT shares. This could be seen by some as giving rise to a conflict of interest, however unconscious or unintended from both sides.

Yesterday another portfolio holding, AG Barr (makers of IRN BRU energy drink) issued a warning on profits and their share price fell by 30%. This is a smaller part of the portfolio accounting for just 2.3%.

Last week the shares in Lindsell Train Investment Trust fell by 30% when HL announced it was dropping two related funds from its Wealth 50 list of favourites. They said this was due to a conflict of interest. Investors then experienced similar problems to the Woodford funds and faced a block on transfers out to other platforms.

Given that FGT makes up only 2% of my portfolio, it would not make a great deal of difference either way. However, for me the risk/reward balance has definitely shifted in recent weeks and after weighing up all the factors and given the share price stands at an all-time high point, I have decided to call it a day and sell my long-standing position.

One final reason for the sale, as a life-long supporter of Everton FC (since 1966), it irks me to see the holding of Manchester Utd. in the Train portfolio!

The sale price was £9.35.

As ever, this article is merely a record of my personal investment decisions and should not be regarded as an endorsement or recommendation - always DYOR!

Polar Cap Technology Trust - Results

In January 2017, I added Scottish Mortgage to my SIPP and the following year I added Mid Wynd to my ISA and in June 2018, I decided to add a third tech-focussed trust, Polar Capital Technology.

Launched in 1996, the trust has grown rapidly and now has assets under management of over £1.9bn. It is a global trust  however 70% of the holdings are listed in the US. The trust has been managed by a team led by Ben Rogoff since 2006.

The trust has just over 100 holdings and the top 10 account for 41% of the portfolio and include tech giants Microsoft, Alphabet (Google), Apple, Facebook, Amazon, Tencent and Alibaba. These tech companies are fundamentally transforming the way we live our lives in a similar way to the impact of the industrial revolution.

The combined market cap. of the so-called FAANG stocks - Facebook, Apple, Amazon, Netfix and Google - now exceeds the total annual GDP of the UK. I believe the long term growth prospects for this sector offer investors significant rewards. Yes, these tech stocks have done well since the market turmoil of 2008/09 - PCT share price up 640% for example - and there is likely to be some volatility but I see no reason why the sectors ability to disrupt and grow should not continue.

Results

The trust has today released results for the year to end April 2019 (link via Investegate). Net assets have increased by 24.8% compared to the benchmark World Technology index 21.4%. Over the same period, the FTSE All Share advanced by just 2.6%.

Over the last three years the trust has more than doubled returns for shareholders - very similar to Scottish Mortgage.

3 Yr Performance July 2016 to July 2019
(click to enlarge)

My three technology holdings which includes SMT and Mid Wynd will account for around 14% of my portfolio (SIPP/ISA). I am thinking I would not wish to hold much more than this weighting due to the volatility of the share prices.

My initial purchase price was £12.50 which represented a 2% discount to NAV and today, with a wider more attractive discount of 9%, it stands at £13.76 - a gain so far of 10%. The trust does not pay dividends.

As ever, this article is merely a record of my personal investment decisions and should not be regarded as an endorsement or recommendation - always DYOR!

Half Year Portfolio Update

I normally post a review of my portfolio at the end of each year. However, as there have been quite a few changes to my portfolio over recent months, I decided to post a short interim review covering the past 6 months.

On the political front, Mrs. May has been unable to get her Brexit deal through the Commons after 3 attempts and decided to step down so we will shortly have a new PM - Boris Johnson or Foreign Secretary Jeremy Hunt.

Despite the assurances, I'm not sure either will get much further in delivering Brexit given the numbers in our 'remain' parliament have not changed...but maybe, just maybe!  We had a referendum - a binary choice of leave or remain - and the nation decided to leave the EU. In my opinion, the way to move forward is for our politicians and senior civil servants to embrace the concept of democracy, accept and respect the outcome and implement the result - or at least stop trying to frustrate the efforts of others. It's really not so complicated. 

Surely this has to be resolved one way or the other before the end of this year.

  

Climate Change

On a more positive note, there has been huge progress on climate with the government committing to net zero carbon emissions by 2050 as recommended by a report from the Climate Change Committee. I look forward to the policies being developed to implement this legislation which will have a big impact on every aspect of out lifestyle and economy.

In the past week we have seen record temperatures of 45C in France so these changes cannot come soon enough if we are to avoid some of the worst predictions of the scientific community. Earlier in the year we had record temperatures of 21C...in February. 

However, the UK is responsible for just under 2% of global CO2 emissions so however quickly we decarbonise our economy, we are still depending on the rest of the world to make a similar commitment. For example China is responsible for around 30% of GHG emissions and the US around 15%.

  

As I said in a previous post, if I become aware of a threat I have a responsibility to do something. Last year, I decided to make some adjustments to my portfolio to divest from fossil fuels and bring on board more ethical/green funds which I believe are attempting to address some of the big issues raised by climate change. In May, I posted my thoughts on this subject.

Portfolio Returns

Markets generally have recovered from the sharp downturn at the end of 2018.

I have just updated my spreadsheet with the returns including dividends of my actual investment portfolios - sipp flexi drawdown and ISAs - for the 6 months to 28th June.

The FTSE 100 started 2019 at 6,734 - and has gradually recovered the ground lost towards the end of last year and has reached 7,425 a gain of 10.2% - if we add back in say a further 2.0% for dividends paid, this will give a ballpark total return figure of 12.2% for the past half year.

My Vanguard Lifestrategy 40 fund is a diverse mix of global equities and bonds and provide a good benchmark for a cautious/balanced global portfolio. The fund is up 9.0% over the year to date.

  

Investment Trusts & Funds

Over the 6 month period I have sold City Of London, Smithson and luckily Woodford Patient Capital. I have also disposed of my largest single holding, Vanguard Lifestrategy 60 due to its overweight 15% allocation to the FTSE All Share.

With the proceeds and a top up to my ISA for the new tax year, I have added several more 'green' funds - Lyxor Green Bond, Vanguard SRI Global, TRIG, FP WHEB Sustainability, a top up to my BG Positive Change fund, Greencoat UK Wind, and a sizable position in Orsted. I have recently added a new 'green' page to my blog which includes a visual chart of the holdings.

The better returns for the period came from Edinburgh Worldwide +30% (but now sold), Mid Wynd 22%, Polar Capital 20%, TR Property 17%, Tritax Big Box 18%, Scottish Mortgage 15% and Finsbury Growth & Income up 21%.

The total return for my basket of trusts over the half year was 16.0%.

Index Funds

As mentioned earlier, my VLS 60 is now sold. Over the past half year I have added to my VLS 40 also HSBC Global Strategy. The best performance was delivered by Baillie Gifford Managed Fund with 17% return for the 6 months.

The contribution from my index collectives has been positive in line with global markets generally with a total return of 12.8%.

Green Funds

Again all are showing a positive return for the period notwithstanding that most have not had a full 6 months in my portfolio. The better returns have come from Impax Env. Markets up 24%, largest holding TRIG 11%, iShares Clean Energy 12% and Vanguard SRI 9%. I am pleased to see good progress on Orsted (second largest holding) which I purchased in April at 500 DKK and is currently up 13% at 568 DKK.

The total return including dividends for my green allocation which currently makes up 46% of the total portfolio is 9.8%.

(click to enlarge)

The Complete Basket

As a whole, the portfolio has delivered a total return of 13.0% over the past 6 months.

I was a little apprehensive moving my portfolio towards more sustainable funds but the performance so far has given me more confidence to add to this sector when opportunities arise. I certainly feel much better investing in the likes of Orsted, a global leader in offshore wind, rather than funds with a high weighting to big oil companies. 

So, a feel-good factor + decent returns from ethical investing, what's not to like?

As always, if you keep track of portfolio returns, feel free to leave a comment and share with others how your investments have fared over recent months.