What began as a group of American students lobbying their campuses to offload their holdings in the fossil fuel industry has now become a more significant movement.
So far, it has prompted a reported $5.46 trillion being withdrawn from the coal, oil and gas industries by organisations as diverse as leading universities like King’s and Bristol, the Norwegian Sovereign Wealth Fund and the Church of England.
The idea is simple: make these industries less profitable relative to renewables, hastening the global transition from the former to the latter. But the reality is far more damaging.
Consumer activism can be an effective, market-friendly way to bring about change. But it needs two conditions to be met. First, its projected scale needs to be sufficiently large to influence the producer. And second, the economic damage to everyone else as a result of non-market selection must be proportionate to the prospective achievements. The divestment campaign targeted at sin stocks – particularly when directed at pension funds – satisfies neither.
Fundamentally, large companies depend on financing in order to realise major projects, and the financial markets are a vital source. This is particularly true for the fossil fuel industry, which needs large amounts of capital to finance costly exploration and extraction operations. In theory, then, it should be vulnerable to an orchestrated effort to starve it of funding.
Except empirical evidence is lukewarm on this. A study by the University of Oxford’s Smith School of Enterprise and the Environment concluded that, although this concept has credence in the very long run, “direct impacts on equity or debt are likely to be limited” and “sizeable withdrawals are likely to escape the attention of fossil fuel management since oil and gas stocks are some of the world’s most liquid public equities”. It also points out that in some cases it is wrong to think about the divested capital as funds lost to the company, since neutral investors are likely to want to increase their share of holdings in them.
But while the lack of impact on the producers is one thing, losses incurred in pursuit of this strategy are another. It’s one thing for a private company to choose what it invests in, another for a taxpayer-backed fund to knowingly jeopardise its performance.
Take pension funds. We rely on the performance of the assets they hold to minimise the financial impact an ageing society will have on future generations, to ease the funding gap in some public sector pensions, and to ensure that those contributing to private funds are adequately rewarded down the line. The performance of the assets held by local government pension schemes won’t affect the benefits received by its members, which are calculated on a career-average basis, and it is taxpayers who will pick up the shortfall if returns disappoint.
Proponents of divestment will claim that such strategy need not mean hampered financial performance. Lately, the idea of “stranded assets” has gained some currency, stipulating that, in the long-run, stocks with heavy fossil fuel exposure are at risk of becoming worthless as the renewable energy “switchover” takes place. This was the basis of the recent row involving the Parliamentary Contributory Pension Fund, when in November last year it was accused of “a complete disregard to the financial risks of carbon exposure” by the Green MP Caroline Lucas.
Once again, however, there is limited evidence of financial markets pricing in this risk at any significant level. Theoretically, any portfolio which arbitrarily limits the range of moves it can make will be constrained in its ability to diversify-away risk, and will also incur additional costs as every move will have to be assessed for its fossil fuel exposure.
According to one University of Chicago study, a divested portfolio will produce yields on average lower by 0.7 per cent over a 50-year period than an equivalent non-divested one. Another, by CalTech’s Bradford Cornell, focused specifically on the performance of American university endowments, and found that the “the mean risk-adjusted shortfall due to divestment for a weighted average across the five universities is approximately 0.23 per cent per year, each year.
The challenges that climate change brings are of generational importance. But that is all the more reason for adopting solutions which will make our economies stronger, not weaker; our societies richer, not poorer. Taking full advantage of tomorrow’s new technologies will require the fruits of today’s prosperity. Pursuing ineffective and inefficient solutions endangers them.