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What Can Anyone Do About Climate Change?

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Rising temperatures around the globe are a reality, and so too is the primary cause: Energy-related CO2 emissions caused by human-beings. Long term energy analysis by the highly respected International Energy Agency (IEA) shows the world traveling down an unsustainable track. Very unsustainable. In 2012, CO2 emissions grew by 1.4% to a record high. Looking ahead, in its 'business as usual' scenario, the IEA shows energy-related CO2 emissions growing 1/3rd by 2035 and doubling by 2050, while global temperatures increase by up to 5.3 degrees Centigrade to 2100.

Recent disasters around the globe illustrate the growing problem with a warming planet: rising sea levels, changing rainfall patterns, more droughts, floods and heat waves, all adversely affecting ecosystems, food production and water resources. Unless large restrictions on carbon emissions are established around the globe, but particularly in the world's two top emitters, China and the US, scientists predict ocean level rises of three to six feet in this century, triggering massive evacuations. What's worse, we know scientists systematically understate the case -- repeatedly discovering the globe's climate system is more, not less, sensitive to man-made assault.

So, what's the world doing about this existential peril to our planet? It's not just resting in neutral. Having put the car in reverse, it is picking up speed as it heads towards the cliff. As the IEA put it less colorfully: "climate change is slipping down the policy agenda, even as the scientific evidence continues to accumulate."

In 2011, across the globe, fossil fuel subsidies increased by 30%, to $523 billion. This is equivalent to an incentive of $110 for every ton of CO2 dumped in the air. Subsidies for renewables that year were a pitiful $88 billion. Just a few weeks ago, for the first time in millions of years, CO2 in the atmosphere exceeded 400 parts per million -- a flashing red warning.

The IEA reports that meeting the emission goals currently pledged by countries under the UN Framework Convention still leaves the world some 13.7 billion tons of CO2 -- or 60% -- above the top level permitted if the globe is to remain on track with the widely accepted target of 2 Degrees Centigrade from pre-industrial times.

Why aren't Governments acting? Jeremy Grantham, the investment guru turned passionate environmentalist, answered that question in his April Quarterly Letter: "Aversion to bad news."

"Historians have pointed out the bias against the need for change: there are always clear beneficiaries of the current state of affairs but the benefits of a changed world in contrast will look vague and uncertain to the likely beneficiaries. ... What is less common ... is what we have today: the near complete control of government by the powerful beneficiaries of the current system."

And who are these beneficiaries? The giant oil, gas and mining companies.

So, hope -- real hope -- for global action now, before it becomes too late -- rests with the private sector. To save the planet, we need to create a global movement of ordinary people demanding action now. The people, young and old, rich and poor, must seize power over global policy by taking control away from the fossil fuel companies who now wield it. I just googled Arlo Guthrie to remind myself of his 1967 masterpiece, "Alice's Restaurant," a song in which he disclosed the formula for creating a Movement. It's worth listening to.

For investors, particularly institutional investors required to act as fiduciaries with informed care and caution, the present state of the planet in regard to climate change poses serious portfolio risks that grow daily.

Consider the top 200 publicly listed oil and gas and mining companies. They carry on their balance sheets fossil fuels equal to some 20-40% of the world's proven reserves. The IEA calculates that, to avoid a rise in global temperature over the danger threshold of 2 Degrees Centigrade to 2050, only 20% of total fossil fuel reserves can be burned. Assuming a pro-rata allowance for the 200 companies, this means that 60% to 80% of the reserves of these 200 are unburnable -- stranded assets as the Carbon Tracker Initiative describes them.

Assuming governments finally get their act together -- which is nothing more than a bet on the Darwinian drive of human beings to survive -- these companies are severely mispricing their assets and misleading the investing public about their future prospects. Analysts at HSBC, in a recent report, reckoned the current market value of these companies -- $4 trillion -- would fall by 40% -60% should Governments succeed in holding temperatures below the 2 degree bound.

The mispricing risk for the securities of the 200 resulting from a stranding of their carbon-bearing assets grows more severe when one considers how these companies are spending free cash flow. Last year, they allocated some $674 billion to finding and developing new reserves and new ways of extracting them. Here they follow the conventional business model of recycling fossil fuel revenues into replacing reserves. But, considered against the facts just presented, this business model is broken. To search for more fossil fuels is to waste capital. This absurd situation could offer opportunity for a promising shareholder derivative suit against the directors of these companies for committing corporate waste.

But, beyond show trials, what can the private sector do? What should institutional investors do? Particularly fiduciaries of college and university endowments, on campuses where growing student engagement with the issue is bound to create pressure. Here are some ideas, briefly sketched.

1. Join the divestment movement being led by Bill McKibben through 350.org. Unlike the divestment project initiated against companies doing business in South Africa during the apartheid era, this project can rest not alone on grounds of morality or an investor's chartered purpose, but on financial grounds as well. This gives the divestment movement aimed at fossil fuel companies a huge advantage. The South Africa-free project had to contend with the fact that some of the best corporations in America were doing business in South Africa and were not willing to withdraw. Thus, the divestment argument had to overcome the possible, even likely, portfolio costs of ceasing to own those corporations. The State of New Jersey's South Africa free pension fund was tracked annually by a frustrated Treasurer, who proved, year after year, how costly the Legislature's decision was to the portfolio.

Despite this kind of problem, which for some institutional investors proved insuperable, the South Africa-free movement was, according to close and well informed observers, including Nelson Mandela, an important contributing factor in ending apartheid. The facts pertaining to fossil fuel companies are dramatically different, making it possible for divestment to rest comfortably, and alone, on the financial grounds of due care and caution.

Assuming the science is correct and the Darwinian moment occurs, an informed market will discover the stock prices of extractive industry companies to be vastly overpriced. A correction will occur, one that smart fiduciaries will want to get ahead of.

There is another scenario. What happens if the science is correct, but the Darwinian moment fails to materialize? Won't these companies be severely punished in the market for the damage they have caused? Won't they suffer - belatedly to be sure - at the hands of Governments trying to reset the planet's climate system, even if it is too late to stop what had, by then, become an irreversible trend? (Piling on after the fact is a favorite pastime of our Congress).

This analysis suggests that, again assuming the science is correct, under either scenario the pricing of fossil fuel companies is grossly out of line with the risks.

As interest in divestment grows, one can predict that mutual fund families will create "fossil-fuel free funds, designed to attract investors concerned about mispriced extractive industry stocks.

2. Adopt a goal of requiring, or persuading, fossil fuel companies to disclose in their 10Ks and other filings the amount of carbon held for ultimate release on the asset side of their balance sheets, and the range of possible outcomes to their business if some of those assets are stranded. There are various ways to pursue this goal:

(a) Petition the SEC for a rule requiring fossil fuel companies to disclose all carbon-related risks to asset values and revenues, to quantify a range of possible outcomes, and to show the consequences of each outcome for their asset values, revenues, income, capex business plans and capital market pricing for securities. Regulators have the power and the tools to compel these companies to disclose the risks they face under various scenarios. And the SEC is not alone in possessing such powers. There is the FASB, which could accomplish the needed disclosure through the accounting rules it announces. And many states, through their Attorney Generals, have powers similar to those of the SEC. Indeed, in recent years, New York's Attorney General used its powers under the Martin Act with force and creativity to compel unprecedented climate change disclosures by three very large public utilities.

These types of disclosure, of course, embody uncertainties. But there are at least two important precedents for compelling this kind of risk analysis. One is the FASB order in Statement No. 33 (issued in 1979), which required public companies to provide detailed quantitative analysis of the impact of continuing hyper-inflation on their businesses. The second is the SEC's release issued in 1998, requiring public companies to make the same sort of disclosure regarding the possible impacts of Y2K on their businesses.

(b) Petition company managements, through shareholder proposals carried in company proxy statements, boycotts of their products or those of their suppliers (such as banks) or other means of bringing pressure to bear, in order to achieve voluntary disclosures ( with the hope that by getting some enlightened management sensitive to their own children's future to become the first "olive out of bottle", widely followed guild standards will in time evolve).

Shareholder proposals find their way to the desks of the top fiduciaries of institutional funds and there they are -- because as a matter of fiduciary law they must be -- taken seriously and voted on with the requisite level of care and caution required of all decisions by fiduciaries affecting their rights as shareholders. As such, these carbon-related disclosure proposals will challenge the trustees and managers of pension funds, foundations, universities and colleges to explain how holding equity in the extractive industry is consistent with their duties.

At some point down the road towards the red light of 2 Degrees Centigrade, it is entirely plausible, even predictable, that holding such equities will be ruled negligence. Here a powerful 2nd Circuit decision by the famous jurist, Learned Hand, decided in 1932, becomes relevant. In that case, The T.J. Hooper, tug boat owners were found liable for loss of cargoes in a nor'easter because they hadn't issued to operators what were then newly developed short-wave receivers. At the time, this newfangled device was a rarity on tugs. Had the operators possessed them, they surely would have picked up weather reports warning of a storm and sought refuge on the inland waterway.

Here's the crucial finding of this great judge:

"Indeed in most cases reasonable prudence is in fact common prudence; but strictly it is never its measure; a whole calling may have unduly lagged in the adoption of new and available devices. It never may set its own tests, however persuasive be its usages. Courts must in the end say what is required; there are precautions so imperative that even their universal disregard will not excuse their omission."

(c) Many institutional investors don't use separate accounts to hold their securities. If they did so, of course, voting proxies would be a simple matter of directing their portfolio managers to forward the proxies to them for that purpose. Instead, increasingly, institutional investors own underlying securities through pooled investment vehicles, such as registered mutual funds. In that case, the managers of those funds will not yield to a particular investor's desires regarding proxy voting, due to the duty it owes to the mutual fund itself, and all of its investors, viewed collectively.

Some institutions have expressed frustration over this situation. In my opinion, it is entirely feasible, under the Investment Company Act, for a mutual fund to obtain an exemptive order from the SEC creating a separate class of stock with pass-thru voting by shareholders of all proxies received from companies whose stock is held in the fund. In other respects, that class of stock would be identical to the common stock. Given the SEC's perennial eagerness to allow more voice for mutual fund shareholders, it is not hard to imagine an exemptive order being granted to a mutual fund family seeking it - and through it, seeking to attract institutional investors desiring to control the voting franchise of stock owned indirectly. Working on this project could prove valuable as the issue of climate change grows in the minds of investors seeking to use their voting power to influence management.

(d) Finally, for the really aggressive in the audience, there is Exxon-Mobil's recent energy report, titled The Outlook for Energy: A View to 2040. It's a dazzling vision of the world, as seen by this giant. One can easily come away from a close reading of this upbeat analysis with the belief that it contains serious omissions that a court would find it necessary for E-M to have included in order to make its contents, taken as a whole, not materially misleading to the reader. Here, the project would be to obtain an independent review of the E-M Report by respected scientists to determine, by an overlay on the predictions made by E-M, what science shows the world will actually look like in 2040 if E-M's predictions about energy exploration and usage prove true. Depending on the outcome, such a project could have outsized results in shaping the public mind.

[This post is drawn from a talk given on June 19, 2013 in Washington, DC at a Green Business Roundtable Symposium on Management of University & College Endowments in an Era of Global Climate Change.]

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