Repost: Short selling is a poor hedge against carbon risk

Photo by Chris LeBoutillier on Unsplash

The readership of Carbon Risk has grown a lot since I started this newsletter. Although I often provide links to many of my early posts, there are still plenty of early articles that current Carbon Risk readers probably haven’t seen. So I thought I’d start occasionally reposting some of the most important articles from the Carbon Risk archives, adding some colour as to how those posts have aged.

Arguably the most important thing that has changed since this article saw the light of day is what happened the day after it was published. I posted it on 23rd February 2022, the day before the Russian invasion of Ukraine.

Energy security was right back on the global agenda, and carefully constructed short positions taken out on fossil fuel producers were looking dangerously ill thought out. For example, the share price of coal miner Thungela Resources (previously the coal assets of Anglo Resources before the miner had divested it in mid-2021) soared 230% over the following seven months as coal demand surged.

The idea that that by taking out short positions on carbon intensive companies, investment institutions are taking out ‘portfolio carbon offsets’ was always on shaky foundations. The world of portfolios is not the same as the real economy anyway. If it had been adopted as acceptable, it would quickly become an excuse for inaction.

The recent attempt to purge “greenwashing” claims by financial institutions could be a welcome nail in this particular ideas coffin. However, the regulatory framework isn’t settled yet. The Partnership for Carbon Accounting Financials (PCAF), which was created to help financial institutions assess and disclose greenhouse gas emissions of investments, has yet to offer guidance on the role of shorting in a portfolio.

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Investment institutions and asset allocators are under pressure to align their portfolios with net-zero targets. In addition to security selection and the use of carbon allowances and credits, a third way to reach net-zero targets has been gaining attention - short selling carbon intensive stocks.

In a submission document to the Australian Prudential and Regulatory Authority (APRA), hedge fund titan AQR Capital Management outline three reasons why they believe that short selling helps meet net-zero targets. The first is to hedge the risks of any remaining carbon intensive investment exposures in a portfolio, the second is to impact the business operations directly, while the third channel is that “short positions are effectively ‘portfolio carbon offsets’ which can be counted against carbon exposures on the long side”.