This post is adapted from my talk to SF Pension Trustees
In 2010, at Cancun, the world's nations set 3.5 degrees F as the permissible increase in global temperature to 2050. Beyond that was catastrophe. Since Cancun, the dangers of climate change have grown and become palpable in myriad ways with which you are all familiar. And, yet, nations have made little progress. In fact, having put the car in reverse, they are accelerating in the wrong direction. Thus, the IEA reports our current trend-line will take the planet by 2050 to 7 degrees F, twice the level set in Cancun. Carbon emissions increased by 1.5 percent per year from 1980 to 2000. But, then, that rate doubled to 3 percent per year through 2012. The IEA just reported that the cost to de-carbonize by 2050 was $44 trillion, up from $36 trillion just two years ago, and climbing. The cause is an increase in coal usage that exceeds the increase in renewables.
So, the planet has a big problem. I'm here to suggest divestment from fossil fuel companies as an important strategy for the Trustees of the SF public pension plan to pursue. Here's why.
Purpose of Divestment
Financial Reasons -- Risk reduction. Risk from Stranded assets ("unburnable carbon"). Let me explain. To hold to the 3.5 degree goal, there is a limit on how much carbon can be emitted to 2050. It's called the Carbon Budget and its reckoned through science.
The level is 886 Gigatons of CO2 from 2000-2050. Subtracting what's been emitted to date since 2000 (121 Gt) leaves 565 Gt left to emit. But just reserves proven on the books of public and private companies equal 2795 Gt of potential emissions, meaning that proven reserves are about five times what nations can allow to be emitted to 2050, if we are to avoid planetary catastrophe. So the rest is at risk of being stranded -- unburnable -- if nations, as they must, have a Darwinian moment and act. If this happens, of course, it means current market prices for fossil fuel companies are hugely overvalued.
And consider the risk to the $21 trillion of CAPEX by Big Oil that is planned for expenditure in the near term to develop unconventional oil projects. And, the risks from rising prices (need $95/bbl or more to break even) for oil and limits on consumer price tolerance.
And, overall, the risks from multiple problems facing the fossil fuels complex, including faltering productivity, falling profits, poor economics, environmental disasters and increasing competition from power plants and automobiles running on free fuel.
There are growing risks of stranding in the grid power sector. Barclays recently down-graded high-grade corp. bonds across the entire US utility sector, citing the energy threat of solar power and storage. Base load power sources like coal and nuclear are being replaced by renewables, and in time the grid will become obsolete. In Europe, growth in renewables was the primary reason the top 20 utilities lost $600 billion in market value over the past five years.
And I'm sure you know the losses in market value experienced by the coal industry over the past three years, down 61 percent against the S&P 500, up 47 percent. By the way, coal is the canary in the oil well, to coin a phrase.
Conventional oil peaked in 2005. Oil and gas production by Chevron, Exxon-Mobil and Shell declined over the past 5 years, even as they spent $500 billion in CAPEX on new projects.
Despite the recent surging flows of tight oil and shale gas in the US, the country is waking up to the fact of the huge decline rates of the sources for these products.
Renewable energy supplies 23 percent of global electricity generation today. Its capacity doubled from 2000-2012. Solar is now growing at a 30 percent rate/year. And is rapidly becoming cost competitive with fossil fuels.
There's an old saw: How did you go bankrupt? "Two ways: slowly at first; then all at once." In financial markets today, too few consider climate change an investment risk at all. Too many of those who do imagine it to be merely a remote tail risk, barely worth noting. But change in energy is coming at a gallop. It's happened before. Consider, not long ago, when we used whales for light; horses for power; coal for steam for locomotion; now coal again for electricity. We need to disenthrall ourselves from old business models. And listen to the wise and well-informed. Like Sheikh Yamani, Saudi Arabia's powerful Minister of Oil from 1962 to 1986. He famously said: "The Stone Age didn't end because we ran out of stones, and the age of oil won't end because we run out of oil."
Moral Imperative -- particularly pertinent for a pension fund like yours, so importantly affected with the public interest.
This pension fund can't avoid having a large leadership role, and not just for the city and state, but for the country and, indeed, for the world. Given the Gargantuan existential risk of climate change to the planet, those in positions of leadership who fail to take reasonable steps to stop carbon emissions from rising become the moral equivalent of those seeking to deny the science and brush away the problem. As Galileo did by recanting to save his life. Divestment is a reasonable step for pension trustees to take.
What does divestment accomplish? It avoids the ugly picture of trustees seeking to profit from emissions of carbon through the sale and burning of fossil fuel reserves and from the massive use of shareholder funds to search for more fossil fuels to sell and burn. Such behavior violates the most basic norms of a civilized society.
Divestment by any group, but particularly by thought leaders such as those responsible for this pension fund, helps to stigmatize the oil, gas and coal giants as repugnant social pariahs and rogue political forces bent on profit at whatever cost to the planet and its people. Don't underestimate the power of being able to create pariahs. These companies fear stigmatization. It hurts in hiring, employee morale and motivation, shareholder satisfaction and equity valuations. And it hurts when leaders of these companies go home to face their children and grandchildren.
Do these companies deserve stigmatization? Consider, e.g., Exxon-Mobil and Shell reports to shareholders on stranding. Despite each company's acceptance of the science, they smack their gauntlets across the collective face of humanity by asserting that no government restrictions will restrain them. Here, e.g., is E-M's statement:
"We are confident that none of our hydrocarbon reserves are now or will become stranded. ... Further, the company does not believe current investments in new reserves [which it intends to discover and develop in quantities at least equal to current proven reserves] are exposed to the risk of stranded assets, given the rising global need for energy..."
Divestment by leaders like you will help awaken us to the peril of inaction. Collectively, we are like the frog resting comfortably in a pot of cold water being heated to boiling.The SF Pension Trustees can be among the first in the nation to shake this frog from the deadly comfort zone in which it rests.
Your Fiduciary Duty
As Trustees, you are fiduciaries charged with the duty of care. Here's how the American Law Institute's Restatement of Trusts describes that duty (in section 227):
"This standard requires the exercise of reasonable care, skill and caution, and is applied to investments not in isolation but in the context of the ... portfolio and as a part of an overall investment strategy, which should incorporate risk and return objectives reasonably suitable to the [purposes of the pension]."
Based on an informed view of all climate change factors, including those I've just outlined, it is easy to conclude divestment on the basis of financial considerations alone is a permissible option. And the moral dimension makes this conclusion even more powerful.
Whether divestment is compelled by the duty of care is, at this time, a more difficult question to answer. Anticipatory divestment in recognition that at some unknown and unknowable point down the road, markets will suddenly adjust equity prices downward to reflect swiftly changing prospects for fossil fuel companies, however wise today, is probably not yet compelled in the exercise of due care.
Whether your portfolio will under or outperform after divestment is unknowable. Looking back in time, results vary depending on the measuring period and assumptions about how proceeds are reinvested. But past is not prologue here. And, in any case, fiduciaries need not worry about short-term results. Anticipatory investment should be viewed as having unknown short-term consequences. In the long run, those results are unimportant. A decision to divest rests on the claim that fossil fuel companies will prove to be bad investments over the long-term and, therefore, with foresight that anticipates this result, should be removed from the pension fund before the strengthening and foreseeable likelihood of this result becomes commonplace in the market. I hope that, very soon, you will make that decision.
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