The economics of divestment

May 15, 2013

The basics
The world has agreed that 2 C is the desired upper limit for global warming. The 2010 U.N. conference, for instance, acknowledged this (and considered 1.5 C a likely improvement). Limiting global temperature rises to 2 C will require 60-80% of the worlds fossil fuel reserves to remain unburned, according to the Carbon Tracker Initiative (http://www. carbontracker.org). Over 50 years (20002050), the carbon budget is about 886 gigatons, with one-third burned so far: 565 gigatons is whats left, if we are to remain under 2 C .1 However, 200 fossil fuel companies have reserves of 745 gigatons. When one includes governments and private companies, it becomes 2795 gigatons. Hence, divestment!

Unburnable carbon
...using just the reserves listed on the worlds stock markets in the next 40 years would be enough to take us beyond 2 C of global warming. Unburnable Carbon

The Carbon Tracker Initiatives Unburnable Carbon report is a thorough investigation of the carbon bubble. The key points: Most of the worlds fossil fuel reserves are unburnable if the world is to avoid catastrophic climate change. If government action takes place, trillions of dollars of fossil fuel reserves are worthless stranded assets. However, ExxonMobil spends $37 billion a year looking for new reserves. In general, fossil fuel companies spend hundreds of billions of dollars a year for exploration; clearly they dont expect the bubble to burst.
1 With 80% certainty. Figures vary with dierent levels of certainty, and the 2013 Unburnable Carbon report has slightly higher gures.

 Without changes, we have only roughly 15 years before the carbon budget is exhausted. (Last year was 31.6 GT.) The size of the carbon bubble is estimated to be at least $6 trillion over the next decade thats only what fossil fuel companies will spend in exploring new reserves. In addition: China and India have signicant coal reserves (together, over 20% of the worlds). While coal provides most (65%) of the carbon in the worlds fossil fuel reserves, natural gas is also a signicant (13%) contributor. Even carbon capture and storage can only extend the budget for 2050 by 125 gigatons. After 2050, the budget shrinks to 75 GT. These ideas are going mainstream and, e.g., were featured in an article in the Economist magazine.2 The banks Citi and HSBC have expressed similar worries. In 2004, Shell overstated its reserves and created a scandal that lost much money. Its likely the value of fossil fuel companies will drop after their reserves become devalued. The Economist writes Fossil-fuel rms live and die by a measure called the reserve replacement ratio, which must remain above 100%. It is clear that the ratio will have to drop below 100%.

Mutual funds
Many socially responsible mutual funds do invest in fossil fuel companies. For instance, Parnassus Equity Income Fund is 14% invested in fossil fuels.3 The Green Century Balanced Fund4 is a mutual fund that does not invest in fossil fuel companies; it has three stars from MorningStar, indicating a fair market value.5 In fact, the fund is owned by Trillium, which has engaged in shareholder advocacy for climate change for years. It has not invested in fossil fuels since 2005.6 Portfolio 21 investments7 has a policy of not investing in fossil fuels, and they support the divestment campaign. They write We do not own these stocks because our research tells us that these companies pose too much risk to the environment and society, and that they face too much risk based on their business operation prole.8 Morningstar gives them a 3 star rating, as well, and writes This socially responsible investing fund would be more attractive if it were cheaper.9
3 http://www.guardian.co.uk/sustainable-business/blog/fossil-fuels-pension-divestment 4 http://www.greencentury.com/funds/Green-Century-Balanced-Fund

2 http://www.economist.com/news/business/21577097-either-governments-are-not-serious-about-climate-change-or-fossil-fuel

to http://quotes.morningstar.com/fund/gcblx/f?t=GCBLX. their report http://www.trilliuminvest.com/wp-content/uploads/2013/01/ Trillium-Fossil-Fuel-Free-Investing.pdf. 7 http://portfolio21.com/ 8 http://portfolio21.com/blog/fossil-fuel-free-investing-a-response-to-the-counter-arguments/. 9 http://quotes.morningstar.com/fund/PORTX/f?t=PORTX.

6 See

5 According

 Pax World investments describes on their website their middle-of-the-road approach: complete avoidance of fossil fuels has been rejected as impractical, but a best-of-class approach is embraced as a bridge strategy that encourages investment in renewable energy and the transition from an industrial-age economy fueled by coal and oil to a sustainable economy fueled by clean, renewable energy.10 Nonetheless, they have a mutual fund that does not invest in fossil fuel companies (unfortunately, the Global Environmental Markets fund has only two stars from MorningStar), and in general they avoid investment in any company whose primary business is coal mining and production. Many mainstream environmental groups are behind the curve; however, the Sierra Club and the Wilderness Society are two examples of groups that have divested. 11 Some have argued12 that as universities and pension funds divest, there will be an investment opportunity for those without aversion to fossil fuels. That is, it seems most righteous to take the prots being made in the eld to use to campaign against those prots. Likely universities will not follow this line of thought.

The cost of divestment

Swarthmore has estimated that divestment would cost $204 million in ten years, or the equivalent of a tuition increase of $13,000 per year.13 Swarthmore argues not that the fossil fuel companies themselves would make them so much money, but that they would have to restructure the endowment and invest in index funds. (This is an argument for starting with direct holdings.) On the contrary, In addition, Swarthmore pays for most of its yearly budget from its endowment. (Harvard is similar.) That may explain their added reluctance relative to smaller schools. Swarthmores claim rests on the assumption that investment managers will not be able to screen out fossil fuels. That is likely to change as divestment becomes more popular. For example, according to SRI professionals, divestment will go mainstream. First Armative Financial Network conducted a survey of over 450 SRI investment professionals and over half indicated that institutional investors were interested in divestment.14 Moreover, the Aperio Groups report Building a Carbon-Free portfolio has estimated the risk incurred by excluding fossil fuel companies to be tiny.15 In any event, this is why were asking for a longer timeframe for full divestment.

10 http://www.paxworld.com/advisors/approach/sustainability-research/key-issues-briefs/fossil-fuels 11 http://www.thenation.com/article/174149/why-arent-environmental-groups-divesting-fossil-fuels 12 http://www.forbes.com/sites/timworstall/2013/05/03/naomi-kleins-massive-investment-opportunity-in-fossil-fuels/ 13 http://www.insidehighered.com/news/2013/05/17/swarthmore-tries-estimate-price-fossil-fuel-divestment 14 http://www.firstaffirmative.com/resources-news/news/sri-professionals-survey-majority-of-retail, -institutional-investors-interested-in-fossil-fuel-free-portfolios/. 15 http://www.aperiogroup.com/system/files/documents/building_a_carbon_free_portfolio.pdf.

New IMPAX report

IMPAX Asset Management recently released a report16 on the economic impacts of fossil fuel divestment. Their ndings? That fossil fuel free portfolios outperform the average portfolio. Here are the key points (direct quotes): The worlds listed fossil fuel companies, whose share prices are partly based on their proven reserves, are grossly overvalued. The key areas for investor campaigns to bring about change are to encourage fossil fuel companies to: 1) Stop investment in further fossil fuel exploration; and/or 2) Modify their business models towards one with a lower emissions-intensity, and/or to invest aggressively in renewables. Impax examined various alternative approaches to portfolio construction: The MSCI World Index without the fossil fuel energy sector (the Fossil Free Portfolio). Replacing the fossil fuel stocks of the MSCI World Index with a passive allocation to an investable universe of renewable energy and energy eciency stocks (the Fossil Free PlusAlternative Energy (Passive) Portfolio) Replacing the fossil fuel stocks of the MSCI World Index with an actively managed portfolio of renewable energy and energy eciency stocks (the Fossil Free Plus Alternative Energy (Active) Portfolio) Replacing the fossil fuel stocks of the MSCI World Index with an actively managed allocationof stocks selected from a wider range of resource optimisation and environmental investment opportunities (the Fossil Free Plus Environmental Opportunities (Active) Portfolio). The results show that removing the fossil fuel sector in its entirety and replacing it with fossil free portfolios of energy eciency, renewable energy, and other alternative energy stocks, either on a passively managed or actively managed basis would have improved returns with limited tracking error.

16 http://www.impaxam.com/media/178162/20130704_impax_white_paper_fossil_fuel_divestment_uk_final.

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