STEVEN HEINTZ, PRESIDENT, ROCKEFELLER BROS FUND, ON DISINVESTING FROM FOSSIL FUELS, 30 SEPTEMBER 2014
A CLEAR understanding of the science of climate change has allowed the development of a carbon budget. Essentially, the calculation involves estimating how much atmospheric carbon will risk pushing average global surface temperatures 2°C or more above the pre-industrial average—a ‘guardrail’ that governments worldwide have agreed should not be exceeded.
The bottom line of the carbon budget is simple: to have a 75 per cent chance of avoiding more than 2°C of warming, over the first half of this century humanity can emit no more than 1000 gigatonnes of CO2. That sounds like a lot, but by 2012 only 672 gigatonnes remained.1 At the rate we’re burning fossil fuels, we’ll have used up the entire carbon budget by 2028—just over halfway into the budget period.
A big problem arises when we compare our remaining carbon budget with the world’s valued reserves of fossil fuels (that is, those listed on stock exchanges worldwide). It turns out that if we burn all of the valued fossil fuel reserves, we’d release around 3000 gigatonnes of CO2 into the atmosphere. As of 2015, our remaining budget is about 600 gigatonnes, which means that, if humanity is to have a fair chance of a decent future, about 80 per cent of the world’s valued fossil fuel reserves must be left in the ground.2 These excess fossil fuel reserves constitute ‘the carbon bubble’. Some countries have larger ‘bubbles’ than others. Australia’s known coal reserves, for example, represent about one-twelfth of the world’s allowable carbon budget, a large part of which lies in the Galilee Basin.3
The recognition that fossil-fuel companies are fundamentally overvalued, because most of their assets cannot be used if we are to have a stable climate, has led to investors selling off their shares in various fossil fuel–based industries. Divestment started in the US in 2011, as a student movement on college campuses. It was given momentum by writer and activist Bill McKibben, the founder and leader of the protest movement 350.org, who took a speaking tour of the US in 2012 selling a simple message: ‘If it is wrong to wreck the climate, then it is wrong to profit from that wreckage.’ 4 In 2013, divestment gained significant global momentum with the publication, by the think tank Carbon Tracker, of a key report: Unburnable Carbon: Are the World’s Financial Markets Carrying a Carbon Bubble?5 It explains many of the key concepts behind the idea that stocks in fossil-fuel companies are overvalued because much of their asset base is unusable. Reviewing the material, oil majors Shell and BP agreed that the burning of the world’s fossil fuels would lead to temperature increases pushing past the 2°C limit, and investors worldwide began to take the issue seriously.6
Six colleges, 17 cities and 12 religious institutions have already committed to selling their stock holdings in fossil fuels, and, as of October 2014, divestment campaigns continue at another 308 colleges and universities in 105 cities and states and at six religious institutions across the US. By September 2014, 181 institutions and local governments in the US and 656 individuals representing more than US$50 billion of funds had pledged to disinvest.7 Their pledges were presented to UN Secretary General Ban Ki Moon as 120 heads of government (that’s nearly two-thirds of all government heads) met in New York on 23 September 2014 to discuss climate change.8 Among the disinvestors is the US$860-million Rockefeller Brothers Fund, which was built on the Standard Oil fortune. Their announcement resonated around the world.
The push to divestment has now gone global. In October 2014, the Australian National University announced its own disinvestment program, a move that sparked unprecedented criticism by members of the conservative Abbott government, including the treasurer, Joe Hockey. Investors, however, pushed back, saying that governments had no right to dictate how investors chose to deploy their funds. Much larger divestment plays will occur in years to come. In early 2014, the Norwegian government announced a review of investment strategies of its pension funds, and on 27 May 2015 Norway’s parliament proposed rules to direct its largest pension fund to sell its assets in companies that earn at least 30 per cent of their revenue from coal. The rules gained bipartisan support and are expected to become law, with the sell-off beginning in 2016.9 As of 30 June 2014, the total value of the fund, known as the Government Pension Fund Global, is US$889.1 billion. That’s 1 per cent of global equity markets.10
During the first half of 2015, the global divestment movement grew spectacularly. The Church of England announced that it would not invest in companies dealing with fossil fuels, and 10,000 people signed a petition urging the Dutch pension fund ABP to disinvest. Asset managers claim there is a growing demand for investment products that have little or no fossil-fuel components. It is difficult to know just how much money is being invested in such strategies, but Gordon Morrison, a managing director at FTSE International, believes that about 80 per cent of institutional investors, including pension funds, are considering some sort of divestment.11
The latest research on carbon budgets attempted to establish just what types of fossil-fuel resources are unusable, and which countries they’re located in.12 It found that more than 80 per cent of known coal reserves, about 33 per cent of oil and 50 per cent of gas reserves must stay in the ground if we are to remain within budget. Analysing viability on a cost and location basis, the report found that the enormous coal reserves of China, Russia and the US must not be mined. Nor should the natural gas reserves of the Middle East, or any oil that may exist in the Arctic. Nearly three quarters of Canada’s tar sands must also stay in the ground.13
The fossil-fuels industry asserts that investors simply selling shares in their companies does them no harm. But as a means of highlighting public disquiet about increasing carbon pollution, divestment is effective. It’s arguably the most powerful challenge to the fossil-fuel industry’s social licence to operate we’ve seen to date. The movement is spreading swiftly, and a corporation’s ‘carbon risk’ is being taken seriously by more and more investors. As financial services company Standard & Poor’s noted in May 2014:
Investors are paying increasing attention to the impact of carbon and climate risk on corporate credit quality, yet their focus has largely been on regulated liabilities that reflect direct risks from regulations such as emissions trading schemes and other carbon pricing mechanisms. Outside of highly polluting industries, however, few companies recognise or account for the cost of carbon on their operations.14
Among the carbon risks that companies face are inflated values caused by including carbon resources as assets, when in fact the carbon resources can’t be burned if we’re to have a safe climate. They also include risks of increased carbon pricing, legal risks from health-related and other actions and reputational risk—for example, for banks that finance new coalmines and associated infrastructure.
In light of the new environment generated in part by disinvestment, Standard & Poor’s recommend that each investor should ‘examine the impact of carbon pricing on corporate credit from four risk aspects: environmental regulations, emissions market pricing, business risk across the value chain, and financial risk on profitability, cash flow, and asset and liability valuation’.15
There is a prospect that even fossil fuels once regarded as relatively green, such as gas, will be affected by carbon risk. As noted in June 2014 by Fatih Birol of the International Energy Agency, because the global energy-generation assets are getting greener as more wind and solar is built, unless carbon capture and storage is deployed to sequester CO2 from gas-fired plants, by 2025 gas-fired plants will have higher than the average carbon intensity.16
Take addressing carbon risk a step further and you end up in green investment. Consulting firm McKinsey notes in a recent report that ‘the quality and availability of sustainability data has improved’ to the point where investors are able to go beyond simply not investing in polluting companies or industries, and that better returns can be had by investing in industries with the best sustainability practices.17 They quote the research of three economists that suggest that sustainability initiatives can improve financial performance:
The researchers examined two matched groups of 90 companies. The companies operated in the same sectors, were of similar size, and also had similar capital structures, operating performance, and growth opportunities. The only significant difference: one group had created governance structures related to sustainability and made substantive, long-term investments; the other group had not. According to the authors’ calculations, an investment of $1 at the beginning of 1993 in a value-weighted portfolio of high-sustainability companies would have grown to $22.60 by the end of 2010, compared with $15.40 for the portfolio of low-sustainability companies. The high-sustainability companies also did better with respect to return on assets (34 per cent) and return on equity (16 per cent).18
Green bonds provide another avenue for investors. They are a way of raising finance to help solve environmental problems, including the climate problem. The funds are used solely for the stated purpose, and the loan repaid with either a fixed or variable rate of return. They are particularly attractive to institutional investors such as superannuation funds. The World Bank has issued more than US$3.5 billion in green bonds for climate-change-related matters since becoming the first organisation to provide the bonds in 2008.19 The issuing of green bonds is expanding swiftly, and is likely to stand at $40 billion for 2014—a 20-fold jump from 2012.20
Whatever the fossil-fuel industry is saying about divestment, politicians in countries with abundant fossil-fuel resources are now taking the matter seriously. In March 2014, the UK government’s Environmental Audit Committee voiced its concerns that the carbon bubble might be a threat to equity markets. The committee’s chair, Joan Walley, told the BBC that:
The UK Government and Bank of England must not be complacent about the risks of carbon exposure in the world economy. Financial stability could be threatened if shares in fossil fuel companies turn out to be overvalued because the bulk of their oil, coal and gas reserves cannot be burnt without further destabilising the climate.21
The concern is essentially that if fossil-fuel companies, being so very large, continue to be overvalued because of inclusion of unusable assets on their books, the economic shock of a mass devaluation may destabilise the economy. With the Paris climate meeting looming, the issue of the carbon bubble is becoming more urgent. As the UN’s climate chief, Christiana Figueres, said early in 2014:
Those corporations that continue to invest in new fossil fuel exploration, new fossil fuel exploitation, are really in flagrant breach of their fiduciary duty because the science is abundantly clear that this is something we can no longer do.22
If this is in fact the case, an orderly process of asset devaluation for unusable reserves of oil, coal and gas is clearly in the best interests of economic stability.