by Dan Flannery, CFA
The Investment Case for Divestment
#1 Stranded Assets & the Carbon Budget Deficit
The Carbon Budget is intended to quantify the amount of fossil fuels that can be burned while remaining under a 2°C global warming target. Stranded Assets are current fossil fuel reserves that cannot be burned without exceeding the global carbon budget. How much of the current market value of fossil fuel companies is attributable to those reserves, and how much will they spend discovering new stranded assets?
Between 60-80% of coal, oil and gas reserves of publicly listed companies are ‘unburnable’ if the world is to have a chance of not exceeding global warming of 2°C
- The total coal, oil and gas reserves listed on the world’s stock exchanges equals 762GtCO2– approximately a quarter of the world’s total reserves;
- If you apply the same proportion to the global carbon budgets to have an 80% chance of limiting global warming to 2°C, their allocation of the carbon budget is between 125GtCO2and 225GtCO2, illustrating the scale of ‘unburnable carbon’;
– The Carbon Tracker Initiative, Unburnable carbon 2013: Wasted capital and Stranded Assets
#2 Carbon Costs & Regulation
As climate change continues to become more obvious and costly to society, more carbon taxes and cap and trade programs will be implemented. The effectiveness and feasibility of these schemes have already been demonstrated, so their growth appears certain. This will give less carbon-intensive companies and industries a cost advantage in the future.
#3 Alternative Energy
The greatest threat to fossil fuel companies isn’t regulation, it’s long-term weakness in demand as a result of displacement. Whether it takes 25 or 50 years, the economics of alternative energy keep getting better, while the economics of fossil fuel extraction only get worse. Who will want to extract, transport and pay for fossil fuels once solar and wind energy can be efficiently captured, stored and transported?
Practical Challenges of Divestment
#1 Limited Selection of Fossil Fuel Free Funds
Out of more than 10,000 U.S. Mutual Funds, fewer than 200 are considered socially responsible (Morningstar Direct), and only a handful of these are fossil fuel free. The lack of options can make it challenging to build a well-diversified fossil fuel free portfolio across a range of asset classes.
The limited selection also results in higher fees. The average annual expense ratio of all those socially responsible funds was .98% (Morningstar Direct), which is based on the lowest cost share class available for each fund. The minimums for many of these funds are $1,000,000. With less money to invest, the fees are generally even higher.
#2 Retirement Plan Limitations
With so much of the average person’s investments held in workplace retirement plans, almost none of which offer fossil fuel free options, there is a practical limitation to divesting within those assets. Retirement plan investment lineups should be reviewed regularly by an employer and their plan advisor, so voice your desire for fossil fuel free and/or sustainable investment options within your plan. If you are responsible for your company’s retirement plan, an advisor should certainly be able to help you add these options, or move you to a plan that permits them.
#3 Where to Reinvest?
- Everywhere else is a good place to start. It can be as simple as increasing allocations to all other industries rather than assigning previous fossil fuel investments to some specific new investment(s).
- Alternative energy companies that are positioned to build and maintain the new energy infrastructure. Energy storage and distributed generation technology.
- Opportunities in addressing the impact of climate change. Water resource companies for example, which could benefit as supplies are threatened by droughts.
- For greater impact and personal connection, consider allocating a small portion of your overall portfolio to local investment opportunities. These could be in clean energy or other investments consistent with your values.
#4 Often Misses the Opportunity Sustainable Reinvestment
Depending on the market index you use, energy companies represent approximately 7-9% of U.S. public market capitalization. That means 91%-93% of public equity investments are not impacted at all by divestment, even though these companies are major consumers of fossil fuels. A broader approach includes applying Environmental, Social and Governance (ESG) research, including factors such as the carbon intensity of companies’ operations. By shifting capital to more carbon-efficient companies, we lower their relative cost of capital and may also benefit by reducing exposure to future fossil fuel prices. This approach can be instituted alongside a fossil fuel free portfolio.
This presentation is intended to provide general information. It is not intended to offer investment, tax or legal advice. BRIA does not guarantee the accuracy of the information contained herein. The information, including any opinions expressed by BRIA, is of a general nature, provided solely for entertainment and educational purposes, and should not be construed as investment advice.