Wednesday, July 18, 2018

Time To Divest From Fossil Fuels?

The Institute for Energy Economics and Financial Analysis put out a press release, Fund trustees face growing fiduciary pressure to divest from fossil fuels:
A paper published today by the Institute for Energy Economics and Financial Analysis details the growing rationale for divesting from the fossil fuel industry.

The paper—“The Financial Case for Fossil Fuel Divestment”—is aimed primarily at trustees of investment funds that continue to hold stakes in a sector that is freighted with risk and is not likely to perform nearly as well in the future as it has historically—regardless of whether oil prices rise or fall.

Kathy Hipple, an IEEFA financial analyst and co-author of the report, said fund trustees everywhere have a pressing fiduciary duty to re-examine their investment commitments to fossil fuel holdings.


“Given the sector’s lackluster rewards and daunting risks, responsible investors must ask: ‘Why are we in fossil fuels at all?’” Hipple said. “The sector is ill-prepared for a low-carbon future, based both on idiosyncratic factors affecting individual companies, as well as an industry-wide failure to acknowledge, and prepare for, an energy transition that is gaining momentum and changing the very nature of how energy is produced and consumed.”

This paper describes divestment “as a proper financial response by investment trustees to current market conditions and to the outlook facing the coal, oil and gas sectors.” It concludes that “future returns from the fossil fuel sector will not replicate past performance.”

It details how the global economy is shifting toward less energy-intensive models of growth, how fracking has driven down commodity and energy costs and prices, and how renewable energy and electric vehicles are gaining market share.

And it cautions that fossil fuel companies’ exposure to litigation on climate change and other environmental issues is expanding and notes that campaigns in opposition to fossil fuel industries have become increasingly sophisticated and potent.

Key points from the paper:
  • The fossil fuel sector is shrinking financially, and the rationale for investing in it is untenable. Over the past three and five years, respectively, global stock indexes without fossil fuel holdings have outperformed otherwise identical indexes that include fossil fuel companies. Fossil fuel companies once led the economy and world stock markets. They now lag.”
  • A cumulative set of risks undermines the viability of the fossil fuel sector. Climate change is hardly the only challenge facing the fossil fuel industry. The broader factors bedevilling balance sheets stem from political conflicts between producer nations, competition, innovation, and attendant cultural change. These risks can be grouped into a few broad categories, such as “pure” financial risk; technology and innovation risk; government regulation/oversight/policy risk, and litigation risk.”
  • Objections to the divestment thesis rely upon a series of assumptions unrelated to actual fossil fuel investment performance. Detractors raise a number of objections to divestment, mostly on financial grounds, arguing that it would cause institutional funds to lose money or that it would undermine their ability to meet their investment objectives, thus ultimately harming their social mandates. Such claims form a dangerous basis for forward-looking investment and are a breach of fiduciary standards.”
Arguments against divestment are rebutted in detail. An FAQ section provides a guide to divestment.

Tom Sanzillo, IEEFA’s director of finance and the lead author of the paper, said the fossil fuel industry is afflicted by what has now become a long-standing weakness in its investment thesis, “which assumed that a company’s value was determined by the number of barrels of oil (reserves) it owned.”

“In the new investment environment, cash is king, which creates a conundrum for the industry,” Sanzillo said. “Aggressive acquisition and drilling will likely lead to more losses for investors. If oil and gas companies pull back, on the other hand, and acknowledge the likelihood of lower future returns and more modest growth patterns, their actions will only confirm the industry is shrinking financially.”

“Historically, fossil fuel companies were drivers of the world economy and major contributors to the bottom line of institutional funds. This is no longer the case,” Sanzillo said. “Whether oil prices are rising or falling the investment thesis cannot replicate the sector’s strong past performance.”

“In the new investment thesis, fossil fuel stocks are now increasingly speculative. Current financial stresses — volatile revenues, limited growth opportunities, and a negative outlook — will not merely linger, they will likely intensify. Structural headwinds will place increasing pressure on the industry, causing fossil fuel investments to become far riskier.”

The paper, published jointly with Sightline Institute was co-authored also by Sightline’s director of energy finance, Clark Williams-Derry.
The full report, The Financial Case for Fossil Fuel Divestment, is available here.

Let me begin by admitting my bias against divestment of any sort, except maybe cigarettes which OPTrust and Dr. Bronwyn King sold me on but I'm still not comfortable with in a financial and fiduciary sense, only in a moral sense as I detest tobacco and think it's a global health scourge.

What about Big Oil and climate change? Don't I care about the environment? Of course I do but I don't get emotional when analyzing the oil & gas sector as I understand the world still relies on fossil fuels and that isn't going to change any time soon:
The federal government's latest international energy projections are out, and there’s no question we’re living in a time of enormous change—and perhaps remarkably little progress.

The International Energy Outlook from the U.S. Energy Information Administration tries to identify the big trends and projections affecting the energy world through 2040. Some of the trends include:
  • The world is getting hungrier and hungrier for energy, but that’s mostly about China, India and the rest of the developing world. Energy consumption in countries that belong to the Organization for Economic Cooperation and Development (basically the industrialized world) is expected to go up 17 percent by 2040. Consumption in countries outside the OECD is projected to nearly double.
  • Renewable energy and nuclear power are projected to be the fastest-growing energy sources, increasing by 2.5 percent per year. Thanks to new sources opened by fracking, natural gas is projected to be the fastest-growing of the fossil fuels, and by 2040 half of all the natural gas produced in the U.S. will be shale gas.
  • Because of improving technology, the world will continue to get more efficient in energy use, and that will have an impact on greenhouse gases.
Yet for all that, the EIA projects the world’s overall energy mix won’t change much at all by 2040 (click on image).


Yes, renewables and nuclear are the fastest-growing sources. But overall, the percent of energy produced by fossil fuels will only drop from 84 percent today to 78 percent in 2040. Renewables only grow from 11 percent to 15 percent, and nuclear rises from 5 percent to 7 percent. Liquid fuels drop by 6 percent, largely because of rising prices. And despite all the debate about the decline of coal and rise of natural gas, the overall percentage of those two fuels barely changes at all. Given that picture, we still be pumping out plenty of greenhouse gases. EIA is predicting a 46 percent increase in global warming emissions during the study’s time frame.

There are important differences in what’s happening in developed nations versus emerging ones. For example, even though the EIA is projecting a small 1 percent drop in the share of coal used by 2040, it expects a dramatic increase in coal consumption between now and 2020, most of it coming from the developing countries that need cheap forms of energy to house and feed their growing populations and to industrialize.

Projections aren’t karmic. They depend on taking current trends and best estimates of what will happen if those trends continue. But it’s a fair question: if there’s so much activity around new energy sources, then why don’t the projections look different? Why don’t the changes have more traction?

The answer may lie in the fact that we haven’t, globally speaking, really reached consensus on the fundamentals: What kind of energy sources should we be using? What economic changes are we willing to make to back up those choices? What are developed nations willing to do to help poorer countries improve their citizens’ lives without depending so heavily on fossil fuels? Those of us living in the developed world have already reaped the benefits of industrialization based on cheap coal. It’s not surprising that developing nations would be tempted to follow the same path—and harder for us to preach to nations that are still building their economies.

The fact is that the changes we’re making on energy are working on the margins, and that’s why the long-term projections only show marginal shifts. If you want big shifts, you have to start making big changes—and that means persuading the public that those changes are worth making.
Admittedly, this article above was published five years ago and the public is more keenly aware of the need to do something to tackle climate change but it doesn't change the fact that the developing world is hungrier for energy and is looking at all cheap sources of energy to industrialize and grow.

More importantly, I'm a skeptic in regards to whether we can quit fossil fuels because whether we like it or not, our societies run on fossil fuels.

Sure, renewable energy is growing fast, there has been a lot of improvement at the margins but the keyword is margins, not in overall global energy consumption.

It's also true that China and India are very aware of the risks of climate change and they are doing something about it but their economies still rely heavily on fossil fuels to grow.

If I really want to be cynical, there are too many people living on this planet and if you really want to reduce your carbon footprint, you should have fewer kids and ditch your car.

Yes, forget McDonald's and cow 'emissions', the real problem driving climate change is your car and those diaper wearing babies which will grow up and contribute a lot more to global warming over their life.

So stop blaming the fossil fuel industry, look in their mirror, stop driving and procreating!

In all seriousness, people get so emotional on climate change, "we must do something about it", but in their emotional frenzy, they throw out all logic and rational thought.

And to my amazement and shock, pensions are jumping on board on this trend to divest from fossil fuels.

Nina Chestney of Reuters reports, Ireland commits to divesting public funds from fossil fuel companies:
Ireland committed to divesting public funds from fossil fuel companies on Thursday after parliament passed a bill forcing the 8.9 billion euro ($10.4 billion) Ireland Strategic Investment Fund (ISIF) to withdraw money invested in oil, gas and coal.

Members of Ireland’s Dail (Parliament) passed the Fossil Fuel Divestment Bill, which requires the fund to divest direct investments in fossil fuel undertakings within five years and not to make future investments in the industry.

In an amendment, the bill describes “fossil fuel undertakings” as those “whose business is engaged, for the time being, in the exploration for or extraction or refinement of a fossil fuel where such activity accounts for 20 percent or more of the turnover of that undertaking.”

The bill also said indirect investments should not be made, unless there is unlikely to be more than 15 percent of an asset invested in a fossil fuel undertaking.

The ISIF is managed by Ireland’s National Treasury Management Agency. As of June last year, the fund’s investments in the global fossil fuel industry were estimated at 318 million euros across 150 companies.

“This (bill) will make Ireland the first country to commit to divest (public money) from the fossil fuel industry,” said independent member of parliament Thomas Pringle who introduced the bill to parliament in 2016.

“With this bill we are leading the way at state level ... but we are lagging seriously behind on our EU and international climate commitments,” he told lawmakers.

Ireland was ranked the second-worst performing European Union country, in front of Poland, in terms of climate change action in June by environmental campaign group Climate Action Network (CAN) Europe.

The world’s top oil, gas and coal companies face rising pressure from investors to shift to cleaner energy and renewables to meet international greenhouse gas emissions cut targets.

Fossil fuel divestment has gained traction over the past few years as pension funds, sovereign wealth funds and universities, have sold oil, gas and coal stocks, especially after the 195-nation Paris climate agreement set a goal in 2015 of phasing out the use of fossil fuels this century.

Norway’s $1 trillion sovereign wealth fund, the world’s largest, is barred from investing in firms that get more than 30 percent of their business from coal and it has also proposed to drop its investments in oil and gas.

The government will give its opinion about that broader divestment in October.

In the United States, New York City announced a goal earlier this year to divest its $189 billion public pension funds from fossil fuel companies in five years.
Now, I understand pensions which want to reduce their carbon footprint and think this makes a lot of sense over the long run.

The Caisse has set targets to reduce its portfolio's carbon footprint 25% by 2025 and others are not setting public targets but necessarily moving in that direction because laws are changing and they're taking climate change seriously.

In fact, the Caisse and Ontario Teachers' Pension Plan are leading the G7 global investor initiative to unite global investors and focus is on three initiatives:
  1. Enhancing expertise in infrastructure financing and development in emerging and frontier economies;
  2. Opening opportunities for women in finance and investment worldwide; and
  3. Speeding up the implementation of uniform and comparable climate-related disclosures under the FSB-TCFD framework.
One of the pensions which is part of this global initiative is OPTrust and it's taking climate change seriously, delving deep into its portfolio to see the impact of climate change across all asset classes.

OPTrust's approach to climate change is rooted in its investment beliefs and strategy, which recognize that environmental, social and governance (ESG) factors will impact the fund's investment risk and return, decades in the future.

But it's important to note all of Canada's large pensions are taking climate change seriously, they don't have a choice. The world is changing, consumers are demanding it and laws are changing too which puts pressure on pensions to reduce their carbon footprint.

Still, it's one thing being cognizant about climate change and how is poses real long-term risks across all portfolios and another blindly divesting out of fossil fuels.

OPTrust and other large Canadian pensions take responsible investing seriously but none of them are openly talking about divesting out of fossil fuels.

Why? Because their fiduciary duty is such that they need to put their members' best interests first, lowering the cost of the plan. I articulated this point in a comment comparing BCI to OPTrust on climate change but I admit I was a bit irritated by the topic and may have done a lousy job.

I sent the article at the top of this comment to a blog reader out in Vancouver who was kind enough to share this with me:
Trustees have a fiduciary duty to act in the economic best interests of the beneficiaries – full stop. They have no fiduciary duty to “re-examine their commitments to” any particular holdings, except to the extent such re-examination is required to discharge their fiduciary duty. It’s a subtle but important point: the fiduciary duty is a macro duty, and there are all sorts of micro actions that are taken to discharge that duty, but the duty itself does not dictate any particular micro action.

If the trustees judge energy investments to be inconsistent with the best economic interests of the beneficiaries, they must divest. Environmental considerations are irrelevant except to the extent, and only to the extent, that they bear on the economics of the investment. A trustee that places his or her environmental preferences ahead of the economic interests of beneficiaries is surely in breach of his or her fiduciary duty.

Some of the arguments cited in the note (above) are therefore breathtaking. If the law is that in discharging their fiduciary duties trustees must comply, or may comply, with their own subjective view of what’s ethical (which is what the arguments imply), how could courts ever determine whether they are in breach? The fiduciary standard would become potentially unenforceable by virtue of having become subjective.

As for the argument that divestment is recommended by the fact that the fossil fuel industry is dying, witness the attached chart showing the performance of Altria (MO) while its industry was dying (click on image).

Now, he showed me a chart of Altria to prove a point, not because he's personally invested in tobacco stocks.

The point is this, pension trustees have a fiduciary duty to properly diversify their holdings across many sectors in order to improve their portfolio's overall risk-ajusted returns.

HOOPP's CEO, Jim Keohane, was telling me how in the 1990s, a lot of pensions were divesting out of sectors and it forced them to overweight the tech sector and when that crashed, they realized they made a huge blunder (too late).

More recently, have a look at the returns of the S&P 500 Energy sector (XLE) since bottoming in early 2016 (click on image):


Not too shabby and even though I'm not bullish on energy and other cyclicals in the near term (read my comment on the flattening yield curve for details), I'm not recommending any pension divest out of fosssil fuels. That would be a breach of their fiduciary duty in my opinion.

What about the report, The Financial Case for Fossil Fuel Divestment, which is available here? It's alright but it’s heavily biased and has many holes in it and lots of data mining going on there to make their biased case for divesting from fossil fuels.

I don't know, call me a skeptic but in a low rate, low return environment, I'd rather pensions have more not less degrees of freedom to properly diversify across all sectors at all times.

Below, Jim Auck, treasurer of the Corona Police Officers Association told CalPERS' board in a meeting last year that his union opposes divesting out of certain industries like tobacco and fossil fuels.

Indeed, many public sector workers in California are worried about their pensions being sustainable in the future but there is increasing pressure on CalPERS and CalSTRS to divest from fossil fuels.

I'm against divestment, think it's a breach of fiduciary duty but we do need to take climate change seriously and lower the carbon footprint at all pensions while maintaining the focus on returns and lowering the cost of pension plans for all stakeholders.


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