As the climate becomes increasingly volatile, with temperatures rising and unexpectedly severe hurricanes, droughts, floods, forest fires and other natural disasters occurring worldwide, the debate over how to combat and mitigate it has become ever more intense. Policy makers in most countries, business leaders, non-profits, and individuals are all grappling with this question and with how to change regulation, business practices and consumption habits. The debate also encompasses investing and a number of organizations have decided to divest from fossil fuels or have come under pressure to do so, the Harvard and Yale endowments among them (neither has agreed to divest). Individuals have also been trying to decide what they can do, not just as consumers, but also as investors.
Divest or Engage?
Environmentally conscious investors have been heatedly debating this question for several years and there are strong arguments on both sides. Some organizations, such as the Unitarian Universalist Association, have decided not to divest from the sector – although many have reduced their holdings – but to actively engage with the management of fossil fuel companies to get them to improve their business practices. These investors have made a strong case that divesting from fossil fuel companies simply lets them off the hook, freeing them from their most vocal and troublesome shareholders and that the only way to drive change is for environmentally conscious investors to stay involved. According to this point of view, divesting from fossil fuels allows investors to feel better about their portfolios but does not actually accomplish anything to combat climate change.
Those opposed to divestment also argue that the real issue is consumption of fossil fuels and that the real way to effect change is to reduce consumption through greater energy efficiency and use of clean technologies and working to put a price on carbon. This is true, of course, but it is not incompatible with divesting.
Bill McKibben of the organization 350 and others counter argue that decades of engagement with the fossil fuel industry has led to only minimal progress. Oil giants such as BP, Royal Dutch Shell and Exxon Mobil have certainly changed their rhetoric and have at last recognized the reality of climate change and their part in it. In some cases, they have even accepted the need for a price on carbon. Nonetheless it appears to be unrealistic to expect these companies to fundamentally change their business models. The onus therefore falls on us as investors and as consumers to change our practices. This counter-argument in favor of divestment appears to be gaining steam, with pressure mounting on both private and public sector endowments to divest. The New York State public pension funds have been moving in this direction and the Rockefeller Foundation – whose money originally came from Standard Oil, of course- has already divested.
As the typical individual investor is not going to be taking part in shareholder engagement, this key argument in favor of continuing to hold positions in fossil fuel companies in order to have a voice at the table does not apply. But if an individual investor believes strongly in combating climate change and in protecting the environment more generally, the ethical argument against holding these investments is very clear.
But what about the investment consequences?
An additional argument often fielded by supporters of divestment from fossil fuels is that this will deprive the industry of needed capital. This is easier said than done. An individual decision to divest will not have any effect whatsoever on the availability of capital for the fossil fuel sector. It is unlikely, in fact, that the divestment movement will reach critical mass until big institutional investors find that the fundamental financial argument for avoiding fossil fuels is compelling. On the positive side, it seems that capital is already shunning the coal sector, as noted by Bloomberg (“Wall Street’s Cold Shoulder Drove This CEO Out of Coal Business”; October 7, 2019).
The financial argument against divestment is simple: by eliminating a major sector of the economy from consideration investors will hurt their performance. They will not be able to properly diversify their portfolios and will lose out when fossil fuel investments do better than other segments of the market. This will hurt the performance of their portfolios and reduce the potential value of their savings.
The response to this is very clear: as global concerns over climate change continue to mount, external pressures on the fossil fuel sector will only grow. This will lead to increased regulation such as carbon pricing and restrictions on the ability of fossil fuel companies to develop their energy reserves (the current US administration’s attempt at rolling back this regulatory trend in order to increase fossil fuel production amounts to trying to block out the sun with a finger and will probably not succeed).
In addition to these supply side concerns, demand for fossil fuels is already coming under pressure. In many parts of the world solar and wind power have become cheaper than fossil fuels, even without subsidies. Moving to a cleaner energy matrix is becoming financially as well as environmentally advantageous. As these trends continue fossil fuel companies will likely face shrinking demand (as has already happened with coal) and will find themselves stuck with billions of dollars’ worth of stranded assets in the form of oil reserves that they will never develop and will have to write down or charge off. This makes them potentially a very unattractive long-term investment.
What to do?
For the investor with a long-term investment horizon who is concerned about climate change: consider and assess divestment from fossil fuels. Careful consideration of this question while maintaining the goal of doing the right thing for your long-term financial future may help you sleep better at night.
Disclosure
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