How can an offshore wind company contribute more to global warming than an oil company? That’s the question asset managers have for MSCI, the creator of an increasingly popular temperature-scoring tool used by investors.
Royal Dutch Shell, Europe’s biggest oil major, is on track to generate 2.72°C of global warming, according to MSCI’s Implied Temperature Rise metric. Orsted, the largest operator of offshore wind farms, has a warming score of 3.19°C.
Fund managers that invest in clean energy are unhappy with MSCI’s metrics. “If it's just used for engagement, I do not have a problem with it,” says Craig Mackenzie, head of strategic asset allocation at Aberdeen Standard Investments (ASI). “The problem I do have is that these temperature scores are being used by our clients.”
Orsted is the seventh-largest holding in ASI’s Multi-Asset Climate Solutions Fund, which Mackenzie manages.
Orsted is not the only renewable energy company to get a failing grade. Xinyi Solar, a giant solar panel maker listed in Hong Kong, has a score of ‘over 4°C’, the highest possible under MSCI’s scoring system. Others involved in the transition away from fossil fuels also fare poorly. Tesla is a 2.6°C company; Nio, a rival Chinese maker of electric vehicles, is headed for warming of 3.38°C; Contemporary Amperex Technology, which produces batteries for electric vehicles, has a rating of more than 4°C.
Implied temperature-rise ratings provide investors with a rough and ready way to gauge a company’s contribution to climate change. MSCI begins by allocating a share of the planet’s carbon budget – the amount of CO2 equivalent that can be emitted before warming exceeds 2°C – to around 10,000 public companies. The final rating is calculated by comparing a company’s projected emissions with its budget and then working out how much temperatures will rise if the rest of the economy over or undershoots the global carbon budget by the same amount.
MSCI’s methodology contains some features that companies such as Orsted could view as unfair. It begins calculating firms’ emissions in 2020. Businesses that made big cuts before that date are not rewarded for doing so. MSCI also disregards some firms’ decarbonisation targets even if they have been approved by rival methodologies.
The point of my fund is to invest in companies that are saving the planetCraig Mackenzie, Aberdeen Standard Investments
Few institutional investors currently use implied temperature-rise scores. A report released in November by the Task Force on Climate-related Financial Disclosures revealed that just 3.3% of asset managers and asset owners have calculated them. But that figure is likely to increase.
The TCFD suggests investors calculate implied temperature rise scores for their portfolios – and while it does not insist upon them, they are included in its standard reporting template. UK-based asset managers and life insurers will be required to produce TCFD-style reports from the middle of 2023. Regulators in the European Union and six other jurisdictions are also introducing similar disclosure requirements for at least some financial firms.
BlackRock is a fan
Temperature scores have also been adopted by BlackRock, which has begun disclosing how much warming its funds are likely to generate using MSCI’s methodology. The iShares Core S&P 500 Ucits ETF, for example, is on track to warm the world by 2.5°C to 3°C. BlackRock manages $9.5 trillion and its decision to use MSCI’s methodology means far more asset owners have access to its ratings and can allocate capital accordingly.
The fact that TCFD reports include temperature scores has already prompted some UK pension funds to demand that their asset managers report them. “The guidance in that TCFD report is I should do temperature alignment scores, and MSCI is the leading provider for these scores,” says Mackenzie.
That puts managers of funds that invest in energy-transition companies with high temperature scores in a bind. “The point of my fund is to invest in companies that are saving the planet,” Mackenzie says. “My concern is that this method gets used widely. The whole of the industry gets penalised. It’s far less important for companies whose sole business is renewable energy to have those targets.”
What will the managers of clean tech funds do? “I’m going to start selling these nasty renewable energy companies,” says Mackenzie, with more than a hint of sarcasm.
What makes a net zero target
As temperature alignment scores become more widely used, investors are likely to ask more questions about how a company such as Shell could be a greener investment than Orsted. There are at least three potential explanations: Shell is unusual for an oil company; Orsted could disclose more details about its emissions-cutting plans; and MSCI could be more transparent about how it projects emissions and calculates the carbon budgets for the companies it rates.
Shell is doing some things right. The oil major emits more than 600 megatonnes of carbon a year, but plans to reduce them by 3.2% a year, taking it to net zero by 2050 – a target that MSCI deems credible.
That is a standard most of Shell’s peers have not met. ExxonMobil has a temperature score of more than 4°C, meaning it is “on track for warming that would contribute to a climate disaster”, according to MSCI. Chevron and Saudi Aramco are on the same trajectory.
Those companies all have targets to lower their carbon emissions, but MSCI ignores them because the firms have produced insufficient data. Shell’s smaller European rival TotalEnergies is also on track for a climate disaster because its target covers just 8.95% of its carbon footprint. Its target is so limited that emissions will continue to grow at 0.77% a year, according to MSCI. Shell’s target, by contrast, covers its entire carbon footprint.
Orsted produced just 13.1 megatonnes of carbon in 2020 – around 2% of Shell’s emissions. MSCI expects this to drop to 11.7 megatonnes in 2025 and then stay at that level until 2070. According to MSCI’s projections, the Danish company’s emissions have to drop by more than three-quarters by 2050 to reduce its contribution to global warming to just 2°C.
The wind-turbine operator has promised to get to net zero by 2040, and it set out a detailed plan to do so in October. MSCI says it needs more information to validate that target.
“There is an Orsted target for 2040, however this target is missing significant information,” says Oliver Marchand, MSCI’s global head of ESG research and development. “The team has researched for these values, but they could not find them in publicly available disclosures.”
By its own admission, MSCI is taking a long time to analyse Orsted’s plan. “MSCI aims to review and validate new corporate carbon data approximately within a three-week period,” a spokeswoman says. “Additional validation of data can extend this timeframe – as has been the case for Orsted – or during a holiday period; for example, Christmas.”
Other providers of warming methodologies have moved faster. Science-Based Targets Initiative (SBTi), an organisation backed by the United Nations and the World Wide Fund for Nature, endorsed Orsted’s target in November, making it the first energy company in the world to get the SBTi’s approval.
SBTi also assigns temperature scores to companies. It says Orsted is on track to create just 1.5°C of warming. It doesn’t give Shell a rating because unlike competing methodologies, SBTi only gives temperature scores to firms that volunteer to go through its validation process.
I wouldn’t start from here
MSCI gives both Orsted and Shell the same carbon budget in 2020 as their actual emissions that year. A company that began decarbonising 10 or 15 years ago would start from the same place as a business that had made no serious cuts. It then projects a company’s annual emissions out to 2070 and works out its share of the planet’s carbon budget in a scenario where warming is limited to 2°C.
Orsted and Shell were given an initial carbon budget using their emissions in 2020 as a baseline. Yet the two firms are not starting from the same place. Orsted used to be called Dong Energy, a Danish oil and gas producer that looked a lot like a mini-Shell. Dong sold much of its fossil fuel investments, invested in bigger – and therefore cheaper – wind turbines and rebranded itself. It has already largely completed the transition to net zero that Shell has yet to begin.
MSCI classifies Orsted as a utility, which means it has to make smaller cuts to its emissions than an oil and gas producer. Shell must halt more than 70% of its emissions by 2030 and 98% by 2050 to keep its score below 2°C.
Orsted has reason to feel aggrieved that MSCI – and most of the other methodology providers – treat 2020 as year zero. According to the Transition Pathway Initiative (TPI), a group set up by two UK asset owners, Orsted reduced its carbon intensity, the amount of carbon produced per unit of electricity generated, by more than 80% between 2016 and 2020. Shell reduced its own carbon intensity by 2% over the same time period.
Criticism of MSCI for selecting a baseline year that disadvantages some firms may be misplaced, according to TPI's chief technical adviser, Rory Sullivan. “You need to start somewhere,” he says. “That’s a really tricky and tough one; any year can be criticised.” More listed companies disclose their emissions than in years past. “We have significant improvements in disclosure over the last few years and it’s likely that the 2020 disclosure set is more complete,” Sullivan adds.
The issue with implied temperature rise is that there is no consistency in the marketRory Sullivan, TPI
TPI says Orsted is aligned with a 1.5°C warmer world, according to its forward-looking climate methodology. TPI’s metric, which is run by the London School of Economics, produces an output similar to a temperature score, but there are only four possible outcomes for each stock: 1.5°C, below 2°C, compatible with national pledges (2°C to 2.5°C), and not compatible. Shell will become aligned to “national pledges” on carbon reduction in 2029, according to TPI’s method.
There is no regulator for temperature scores. The TCFD suggests financial firms publish the temperature trajectory of their investments, but it doesn’t say how they should calculate them. A group called the Portfolio Alignment Team, set up by Mark Carney, the UN’s Special Envoy for Climate and Finance, has published 26 recommendations for the companies that run temperature-score methodologies.
MSCI has dedicated a lot of resources to overhauling its temperature scores to comply with those recommendations. It even ditched the tool’s old name – Warming Potential – because the new temperature scores are not comparable. The MSCI Implied Temperature Rise metric is closer to the PAT’s view of what a temperature-scoring methodology should look like, and Marchand says the overall response from investors has been largely positive.
“I would say the large majority of clients are really excited,” says Marchand. “We do get some pushback. We are very used to that to be honest; people find two or three where they disagree.”
Some asset managers use several providers of temperature scores because they want different perspectives on the likely path of a particular company’s emissions. Amundi, Europe’s largest asset manager, uses “three different methodologies because these methodologies are not totally stabilised yet”, according to Jean-Jacques Barbéris, the firm’s head of institutional and corporate clients coverage.
So far, there is little sign that investors are pulling money out of funds with high temperature scores. Mackenzie’s worst fears are yet to be realised. “The implied temperature rise debate is about how you convert future emissions projections into a number,” Sullivan says. “The issue with implied temperature rise is that there is no consistency in the market.”
Temperature scores are still in their infancy and can be useful guides to the energy transition. Fund managers are employed to make decisions based on their own reading of the data or their intuition. If they think a renewable energy firm with a temperature score of 3.19°C has a more credible route to net zero than an oil company that emits 47 times more carbon, they should bet their money that MSCI has got it wrong.
Additional reporting by Nell Mackenzie
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