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Fossil Fuel Divestment Report for the Seattle City Employees Retirement System

22 Pages

Fossil Fuel Divestment Report for the Seattle City Employees Retirement System

Fossil Fuel Divestment Report for the Seattle City Employees Retirement System

Profile image of Alex LenfernaAlex Lenferna

This report serves to aid the city of Seattle's Employees Retirement System (SCERS) in deliberations as to whether it will be the first pension fund in the US to divest from fossil fuels. It provides an overview of the growing literature on fossil fuel divestment, and concludes that divestment can be consistent with fiduciary duty as fossil fuels are becoming an increasingly financially and ethically irresponsible investment for a number of different yet reinforcing reasons. Those include but are not limited to considerations of the carbon bubble, the rapid decrease of alternative energy costs, increasing costs of fossil fuel extraction, increases in energy efficiency, changing social norms, increased environmental regulation, and suppressed growth in key economies.

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Divest from the Carbon Bubble? Reviewing the Implications and Limitations of Fossil Fuel Divestment for Institutional Investors

Justin Ritchie, Hadi Dowlatabadi

Climate change policies that rapidly curtail fossil fuel consumption will lead to structural adjustments in the business operations of the energy industry. Due to an uncertain global climate and energy policy framework, it is difficult to determine the magnitude of fossil energy reserves that could remain unused. This ambiguity has the potential to create losses for investors holding securities associated with any aspects of the fossil fuel industry. Carbon bubble risk is understood as financial exposure to fossil fuel companies that would experience impairments from assets stranded by policy, economics or innovation. A grassroots divestment campaign is pressuring institutions sell their fossil fuel company holdings. By September 2014, investors had responded by pledging to divest US $50 billion of portfolios. Though divestment campaigns are primarily focused on a moral and political rationale, they also regularly frame divesting as a strategy for mitigating stranded asset risk. We review aspects of the divestment movement alongside the context of carbon bubble risk. Several common hypotheses on reducing stranded carbon asset exposure through divestment are critically examined. We find that institutional investors are limited in their ability to reduce exposure to carbon through divesting and that the financial sector is likely to absorb many ‘fossil free’ funds.

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Oxford Research Encyclopedia of Climate Science

Communicating about Fossil Fuel Divestment

2017 •

Jill Hopke

Divestment is a socially responsible investing tactic to remove assets from a sector or industry based on moral objections to its business practices. It has historical roots in the anti-apartheid movement in South Africa. The early-21st-century fossil fuel divestment movement began with climate activist and 350.org co-founder Bill McKibben’s Rolling Stone article, “Global Warming’s Terrifying New Math.” McKibben’s argument centers on three numbers. The first is 2°C, the international target for limiting global warming that was agreed upon at the United Nations Framework Convention on Climate Change 2009 Copenhagen conference of parties (COP). The second is 565 Gigatons, the estimated upper limit of carbon dioxide that the world population can put into the atmosphere and reasonably expect to stay below 2°C. The third number is 2,795 Gigatons, which is the amount of proven fossil fuel reserves. That the amount of proven reserves is five times that which is allowable within the 2°C limit forms the basis for calls to divest. The aggregation of individual divestment campaigns constitutes a movement with shared goals. Divestment can also function as “tactic” to indirectly apply pressure to targets of a movement, such as in the case of the movement to stop the Dakota Access Pipeline in the United States. Since 2012, the fossil fuel divestment movement has been gaining traction, first in the United States and United Kingdom, with student-led organizing focused on pressuring universities to divest endowment assets on moral grounds. In partnership with 350.org, The Guardian launched its Keep it in the Ground campaign in March 2015 at the behest of outgoing editor-in-chief Alan Rusbridger. Within its first year, the digital campaign garnered support from more than a quarter-million online petitioners and won a “campaign of the year” award in the Press Gazette’s British Journalism Awards. Since the launch of The Guardian’s campaign, “keep it in the ground” has become a dominant frame used by fossil fuel divestment activists. Divestment campaigns seek to stigmatize the fossil fuel industry. The rationale for divestment rests on the idea that fossil fuel companies are financially valued based on their resource reserves and will not be able to extract these reserves with a 2°C or lower climate target. Thus, their valuation will be reduced and the financial holdings become “stranded assets.” Critics of divestment have cited the costs and risks to institutional endowments that divestment would entail, arguing that to divest would go against their fiduciary responsibility. Critics have also argued that divesting from fossil fuel assets would have little or no impact on the industry. Some higher education institutions, including Princeton and Harvard, have objected to divestment as a politicization of their endowments. Divestment advocates have responded to this concern by pointing out that not divesting is not a politically neutral act—it is, in fact, choosing the side of fossil fuel corporations.

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Fossil Fuel Divestment: Reviewing Arguments, Implications & Policy Opportunities

Hadi Dowlatabadi, Justin Ritchie

If countries around the world implemented climate policies consistent with the science of limiting global average surface temperature warming to 2 ̊C, the current business models of conventional energy companies would face deep structural changes. In particular, such policies would render large volumes of known coal, oil and gas reserves ‘unburnable’, lest the inevitable greenhouse gas (ghg) emissions they produced when burned would push warming above the 2 ̊ ceiling target. while such climate policy has been slow to materialize, grassroot campaigners have started asking institutions and individuals to divest their financial holdings in fossil fuel companies. Though many have dismissed the strategy, since 2012 investors around the globe managing nearly $50 billion (US) in combined assets have committed to divest or are starting to review their options for removing their holdings in fossil fuel companies. If divestment campaigns were successful in moving large volumes of holdings out of fossil fuel companies, would climate change be effec- tively addressed? This paper first evaluates three core assumptions of fossil fuel divestment campaigns: firstly, that divestment can protect investors from ‘unburnable carbon risk’ or a ‘carbon bubble’ whereby stocks lose value due to fossil fuel reserves becoming too expensive to extract because of climate policies or market conditions. Secondly, that divesting from publicly listed energy companies will keep fossil fuels in the ground. And thirdly that ‘green’ energy stocks can be substituted for fossil fuel companies in the portfolios of institutional investors. These assumptions are shown to be unfounded, or effects shown to be small. The University of british Columbia’s (UbC) endowment is evaluated in the context of the ongo- ing campus divestment campaign. we estimate the greenhouse gas emissions exposure – or “carbon shadow” of UbC’s endowment returns and evaluate several paths for reducing that expo- sure. Overall, we find that substituting renewable energy companies for all oil and gas company equities in UbC’s endowment (which represent approximately 10 percent of the portfolio) would likely reduce its ghg exposure or “carbon shadow” by around 3 per cent. while this effect is not negligible, this result is lower than expected given these company holdings represent the heaviest carbon emitters among the portfolio’s assets and that renewable energy companies are generally viewed as low or zero carbon investment opportunities. Though divestment will likely have limited quantitative success in directly reducing ghg emis- sions or a fund’s immediate exposure to unburnable carbon, it may gain momentum as a symbolic gesture that could change social expectations for investment practices. Divestment would be effective when funds are reinvested away from fossil fuel and its associated infrastructure into investments that actively seek to create a low carbon economy. without a concerted effort, we suggest that the most likely recipient of divested funds will be banks and financial institutions as they output a low amount of carbon per dollar of investor earnings. In this case, at least a portion of the divested funds would be reinvested in projects that perpetuate fossil fuel use, through less direct means. As more institutions consider and commit to divestment, there is a window for effective policy to create a safe home for investors who are seeking such funds. with this potential shift in mind, we offer the following recommendations to bC provincial & municipal policy makers, institutions considering divestment, and divestment campaigns themselves:  Provincial & municipal policy makers 1. Establish a public finance entity: Consider creating an ‘energy transition bank’, similar to the Clean Energy finance and Investment Authority in Connecticut or existing programs in Massachusetts and Ontario. Such a bank could offer bonds and other financial tools to projects that seek to create a low carbon economy. This institution could also support the development of bC’s green tech sector. 2. Review tax incentives: A low-carbon-transition investment tax credit could attract private capital to domestic investments in a low carbon economy along the lines of energy, transportation and housing, similar to the 1996 Small business Venture Capital Act, which provides 30 per cent cash-back refundable tax credits when investing in a qualifying value- added sector of the bC economy. 3. Assess risk: Review bC’s exposure to unburnable carbon risk. Support public fund managers in their potential decisions to invest in a low carbon transition. This may include revised language on risk consideration. Universities and other institutions 1. Begin an open conversation: Commitments to divestment or action on carbon risk can be issued along a timeline set by the institution as part of a thorough review. 2. Review: Review sustainability goals and harmonize with other objectives. Revise the mandate of fund managers on how they screen investments to meet environmental, social and governance targets in order to report a portfolio’s carbon intensity and exposure to unburnable carbon. Re-evaluating benchmarks, such as those analyzed by leading financial studies on potential carbon bubble risks, can place current returns in a new context. Consider establishing positions on green funds or bonds. 3. Research: Engage and leverage on-campus expertise, such as that in business schools, to assess and research strategies for dealing with unburnable carbon risk. Issuing a detailed accounting of the specific services and initiatives supported by investment revenues could help to place earnings from fossil energy investments in context. Divestment campaigns 1. Propose a parallel endowment: Consider working with the university to launch a separate low-carbon or fossil free endowment fund, creating the opportunity for comparing returns. Students could engage in alternative portfolio construction. Returns would be favorable in energy bear markets. 2. Contribute: launch crowdfunding campaigns that allows students, faculty and/or staff to donate toward a fossil-free endowment to demonstrate support. These funds could be withheld from the target university or institution until further action had been taken. 3. Plan: Advance dialogue by developing a tangible timeline of divestment components, such as how to proceed after a statement that discloses oil, gas and coal investments would be received. Explore how investment returns fit into broader campus sustainability goals. Don’t shy away from emphasizing that at the current moment, divestment would primarily be a symbolic action.

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Climate Change & International Relations (eds. G. Sosa-Nunez & E. Atkins)

Fossil Fuel Divestment Movement within Universities

2016 •

Leehi Yona, Alex Lenferna

The climate change movement has seen a dramatic shake up in recent years with the birth of a primarily student- and youth-led movement to remove investments in the fossil fuel industry. This book chapter explores the movement to divest from fossil fuels on university campuses and the effects it is having on global efforts to tackle climate change.

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Resilience

Investing in Climate Failure: The Ethics & Economics of Fossil Fuel Divestment

Alex Lenferna

Institutions considering whether to divest from fossil fuel companies are faced with a seemingly difficult moral and financial choice. In order to unpack the elements of this choice this paper explores the prospective decision of whether to divest from the perspective of a university endowment fund. In order to attempt to artificially separate the questions of ethics and economics, I provide two separate analyses of the choice faced by universities considering whether to divest. One analysis shall be strictly economic and shall assume that university endowment funds can be legitimately considered to driven solely by the pursuit of profit. The second analyses will focus on the university endowment as an institution answerable to the dictates of morality, and will argue that if we see an endowment as such that it has a moral responsibility to divest in order to: ensure its integrity as an institution; show moral leadership; and prevent harm caused as a result of its investment policies. I draw substantially from rational choice theory, game theory and discussions of the tragedy of the commons, in order to provide an ethical and economic analysis of the choice faced by universities.

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The Case for the Bill and Melinda Gates Foundation’s Divestment from Fossil Fuels

Alex Lenferna

As part of the campaign to get the Gates Foundation divested from fossil fuels, this report was drawn up to make the case for divestment. It examines the financial, political, and moral case for divestment. It was co-authored by Alec Connon and Alex Lenferna

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Are We Exceptional? The Case for Queen’s University Belfast to Divest from Fossil Fuels

Christina Kelly, Ben Christman, Paul Loughran

This report sets out the case for Queen’s University Belfast to divest from fossil fuels – it aims to influence QUB to divest from companies involved in the extraction and/or production of fossil fuels. Section 1 introduces the concept of divestment, explains its aims and sets out a brief history of divestment as it has been used in relation to fossil fuels and against apartheid in South Africa. Section 2 situates the divestment argument in the context of QUB. It discusses the extent to which QUB currently invests in the fossil fuel industry, analyses QUB’s ethical investment policy and discusses the conflicts between QUB’s values and its current investments in fossil fuels. Sections 3 explains the ethical argument for divestment. This concerns the adverse implications of climate change, and the need to keep the majority of the world’s remaining fossil fuel reserves in the ground to keep climate change below the internationally agreed safe threshold of two degrees. By investing in, and profiting from the fossil fuel industry, QUB is implicated in social and environmental injustice – such as the impacts of climate change on the human rights to life, shelter, food and water. Section 4 outlines the financial argument for divestment. Due to the climate imperative to keep most of the remaining fossil fuels in the ground, fossil fuel companies are currently vastly overvalued. Investment in the fossil fuel industry represents a highly risky investment which may result in significant financial losses for QUB. In addition, the empirical evidence suggests that divestment can be done with little effect on investment returns or risk. Section 5 counters the main arguments against divestment. Section 6 concludes and summarises the report.

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Fossil fuel divestment: implications for the future of sustainability discourse and action within higher education (Local Environment)

Noel Healy, Jessica Debski

This paper provides a critical overview and analysis of the student-led fossil fuel divestment (FFD) movement and its impact on sustainability discourse and actions within US higher education. Analysing higher education institutes’ (HEIs) divestment press releases and news reports shows how institutional alignment with cultures of sustainability and social justice efforts played key roles in HEIs’ decisions to divest from fossil fuels. Key stated reasons for rejection were: minimal or unknown impact of divestment, risk to the endowment, and fiduciary duty. Participant observation and interviews with protagonists reveal the intricate power structures and vested business interests that influence boardroom divestment decision-making. While some HEIs embrace transformative climate actions, we contend that higher education largely embraces a business-as-usual sustainability framework characterised by a reformist green-economy discourse and a reluctance to move beyond businessinterest responses to climate politics. Nonetheless, the FFD movement is pushing HEIs to move from compliance-oriented sustainability behaviour towards a more proactive and highly politicised focus on HEIs’ stance in the modern fossil fuel economy. We offer conceptual approaches and practical directions for reorienting sustainability within HEIs to prioritise the intergenerational equity of its students and recognise climate change as a social justice issue. Fully integrating sustainability into the core business of HEIs requires leadership to address fundamental moral questions of both equity and responsibility for endowment investments. We contend that HEIs must re-evaluate their role in averting catastrophic climate change, and extend their influence in catalysing public climate discourse and actions through a broader range of external channels, approaches, and actors.

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Climate Justice and the Economy: Social mobilization, knowledge and the political (ed. Stefan Jacobsen)

Divestment as Climate Justice: Weighing the Power of the Fossil Fuel Divestment Movement

2018 •

Alex Lenferna

Fossil fuel divestment has become a powerful tactic in the broader movement for climate justice. This chapter offers a sympathetic yet critical appraisal of the fossil fuel divestment movement, critically surveying relevant literature to understand both the power and limitations of the movement. It argues that the divestment movement has been successful in stigmatizing and exposing the injustices of the fossil fuel industry; raising broad awareness of the financially and ecologically unsustainable nature of the fossil fuel industry business model; shifting financial norms and financial capital; elevating morality and justice in the climate change discourse; and helping build a broader more powerful climate justice movement. The piece discusses why shareholder engagement is too limited a strategy to affect the sort of change needed of the fossil fuel industry. The paper then considers some of the divestment movement’s limitations and argues that the movement can leverage the power it has built, and improve upon some of its limitations through: an increased focus on direct financiers of fossil fuels, like banks; pushing for regulations of the financial sector and the fossil fuel industry; and wielding the political power created by the divestment movement to pursue policy changes and more politically engaged activism.

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Fossil fuel divestment in US higher education: student-led organising for climate justice

Jess Grady-Benson

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Fossil Fuel Divestment Report for the Seattle City Employees’ Retirement System Lead Author: Alex Lenferna On Behalf of 350Seattle & Divest UW October 2014 lenferna@uw.edu alexlenferna.wordpress.com 1 Executive Summary For institutional investors concerned with both the financial performance of their investments and their environmental and social impacts, it is becoming increasingly clear that divesting from fossil fuels is a prudent and sound decision to address the risk associated with carbon intensive industries. As this report highlights, due to a rapidly changing socio-economic and environmental landscape, the fossil fuel industry is becoming a high risk investment with tens of trillions of dollars of potential near term losses at stake. Furthermore, the industry represents an ethically dubious investment, given that if its business model is carried out, the world will experience catastrophic runaway climate change far surpassing internationally agreed upon targets and threatening the global economy, human civilization and life as we know it. Recognizing this, a growing number of institutions representing over $50 billion of investments have committed to divest from fossil fuels citing both financial and ethical reasons. The Carbon Bubble: Jointly the fossil fuel industry owns up to five times more carbon than can be burnt if the world is to keep to the internationally agreed upon target of keeping climate change below two degrees Celsius. This means that up to 80% of their reserves could become stranded assets, which translates into potential losses for the fossil fuel industry estimated to be as high as $28 trillion in just the next two decades (Lewis, 2014a). Hoping for High Fossil Fuel Demand: The fossil fuel industry is gambling trillions of dollars on new investments in high-capital low-return projects, which depend on high oil prices to remain financially viable. However, the fossil fuel industry’s bullish projections of high prices and increased demand are not materializing due to a combination of economic factors, including the rapid decrease of alternative energy costs, increasing costs of fossil fuel extraction, increases in energy efficiency, changing social norms, increased environmental regulation, and suppressed growth in key economies. The fossil fuel industry’s rosy demand projections are also counter to a growing number of investment analyst reports that indicate deteriorating fundamentals for the industry. Financial Underperformance: The fossil fuel industry is already underperforming relative to the market despite weak and limited climate regulation and awareness of the carbon bubble only just being realized. For instance, analysis by Standard & Poors showed that if a $1 billion endowment had divested 10 years ago their endowment would have grown by an extra $0.12 billion when compared to if it had not divested . Doubly-Wise Investing: Divesting from fossil fuels is one important means SCERS has to protect itself from the risks associated with the fossil fuel industry, and uphold its fiduciary duty to participants. By divesting, SCERS can also make a strong moral, political and financial statement that fossil fuels are an irresponsible and financially risky investment. Divesting may thus be a doubly-wise decision representing both financially sound decisionmaking and environmentally and socially responsible investment. October 2014 2 Pathways to Divestment: SCERS is well-positioned to join over 180 institutions - including philanthropies, religious organizations, pension funds and local governments - as well as hundreds of wealthy individual investors who have already committed to divest. Various different tools and pathways exist which SCERS can use to divest from fossil fuels. While SCERS may want to determine its own path forward, 350 Seattle and Divest UW recommend the following steps forward. 1. Determine Portfolio’s Carbon Risk. Instruct financial advisors to assess direct holdings & commingled funds 2. Commit to divest and at what level. The typical target for divestment involves removing direct holdings in the Carbon Underground 200 (CU 200), which consists of the top 100 public coal companies globally and the largest 100 public oil and gas companies globally, ranked by the potential carbon emissions content of their reported reserves. Many pension funds are also focusing on the fossil fuels that are most capital and carbon-intensive such as coal and tar sands, as they are both the most environmentally harmful and the most financially risky fossil fuel ‘assets’. We also recommend re-investing in fossil free indexes and cleantech mutual funds, as appropriate for your portfolio risk tolerance and goals. There is an increase of available indexes, including Seattle-based Parametric, which manages over $100 billion, and offers an index free of the CU 200. Black Rock has also launched a similar index in partnership with the FTSE Group and the NRDC. It is also possible to develop custom-made fossil-free products from a number of providers. It is also possible to take a deeper approach to carbon risk by screening out greenhouse gas intensive companies other than fossil fuel companies, and include different levels of re-investment in low-carbon investments more broadly (cf. Humphreys, 2013). 3. Make a plan to divest, instruct advisors to do so and determine a timeline. Following the example of other institutions, we recommend a five year timeline, which allows for a flexible and manageable approach that does not incur penalties, and can minimized any transaction costs. It is quite straightforward to instruct asset managers to stop making new direct investments in fossil fuel companies and then to gradually shift existing fossil fuel holdings out of the portfolios through regular reallocation, portfolio rebalancing and fund procurement. For example, the Rockefeller Brothers Fund began by selling off holdings in coal and oil sands and is gradually expanding to the broader fossil fuel industry. As this report examines, divesting from fossil fuels does not necessarily involve taking a return penalty and has provided equal if not better returns when compared to portfolios invested in fossil fuels. Furthermore, as increased regulation responsive to climate change is enacted, which restricts the business of fossil fuel industry and carbon intensive companies, then fossil free investing may well continue to bring about better returns in the future. Fossil fuel divestment thus represents an opportunity to possibly achieve improved financial results while addressing climate change. During the housing bubble the SCER’s portfolio lost roughly one third of its value. By divesting, SCER’s can potentially protect itself from the increasing financial risks associated with fossil fuel investments, fulfill its fiduciary responsibility, keep its investments clear of this ethically problematic industry, and help to galvanize a meaningful response to the intertwined carbon bubble and climate crisis. October 2014 3 Contents Executive Summary ........................................................ 1 Contents ......................................................................... 3 The Carbon Bubble & the Decline of Fossil Fuels ........... 4 Underestimating Risk: The Case of Exxon ...................... 7 Insignificant Risks & Potential Gains from Fossil Free Investing .................... 8 Fiduciary Duty ............................................................... 12 The Fossil Fuel Divestment Movement ........................ 14 Case Study: The Rockefeller Foundation....................... 15 Case Study: Storebrand Pension Fund .......................... 15 The Positive Effects of Fossil Fuel Divestment and Reinvestment ................... 16 Conclusion .................................................................... 17 Bibliography .................................................................. 18 Disclaimer: The author is not an investment adviser, and makes no representation regarding the advisability of investing in any particular company or investment fund or other vehicle. The aim of this report is merely to inform the SCERS board about some of the ethical and financial aspects of continued investment in fossil fuels, so that they may come to their own independent conclusion regarding fossil fuel divestment. Thus, a decision to invest in any investment fund or other entity should not be made solely in reliance on any of the statements set forth in this publication. While the author has obtained information believed to be reliable, he shall not be liable for any claims or losses of any nature in connection with information contained in this document, including but not limited to, lost profits or punitive or consequential damages. Acknowledgments: Thanks to the many individuals who provided feedback and input to this report – including but not limited to members of 350.org, the Mayor’s Innovation Project, & a number of financial advisers whose useful input and wording I have borrowed at times. October 2014 4 The Carbon Bubble & the Decline of Fossil Fuels The pioneering work of the Carbon Tracker Initiative (CTI), the Oxford University Stranded Assets Programme (OUSAP), and other institutions, have identified and defined the concept of carbon asset risk, colloquially referred to as the ‘carbon bubble’. This concept refers to the fact that fossil fuel reserves reported by listed companies and those held by governmentsare are jointly much greater than can be burnt if people are to limit global warming below the internationally agreed upon 2°C target. If all the listed fossil fuel reserves are burnt, we will be unable to maintain a 2°C limit and instead will be on a path to a catastrophic climate change scenario of 5-6°C. Contrary to fossil fuel companies’ business models, governments will, and have begun, to regulate fossil fuels in response to climate change. Thus many of the reserves that fossil fuel companies count as assets on their balance sheet will potentially not be monetized. The reserves that will not be able to be burned are called potentially “stranded assets” (or toxic assets, for those of us that recall the 2007-8 recession). As Carbon Tracker calculates, “60 - 80% of coal, oil and gas reserves of listed firms are unburnable [to stand a 50% and 80% chance of adhering to the 2°C target].” (CTI, 2013, p. 4). Furthermore, not only are fossil fuel companies valued based on their current reserves which may not all be burnable, they are also expending great amounts of capital, approximately 1% of global GDP, on developing new reserves – ironically about the same percentage of global GDP that the International Energy Agency (2014a) concluded is required to invest in the clean economy in order to stay below the 2°C target. If the fossil fuel industry continues as such, and if the assumption of stranded assets holds true, then through investing in capital expenditure (CAPEX) for new reserves over $6 trillion could be wasted on new potentially stranded fossil fuel investments over the next decade alone, with around $670 billion being spent to develop new yet potentially unburnable reserves in 2012 alone (2013). While the potential for stranded assets are a regular and necessary feature of dynamic economic systems, in the case of the fossil fuel industry the potential for stranded assets represents a significant, deep threat to global markets. Indeed, the contradiction between the 2°C target and fossil free industry growth assumptions is “so large it represents a systemic global financial risk”, which dwarfs previous bubbles (Gilding, 2013). October 2014 5 While estimates vary, according to John Fullerton’s calculations the current market value of the fossil fuel reserves that stand to be potentially stranded represents $22 trillion, as illustrated in the adjacent diagram. More recently and comprehensively, Kepler-Chevereux’s renowned energy analyst Mark Lewis (2014a), estimated $28 trillion in potential lost revenue in the next two decades, with the oil industry accounting for USD19.3trn, gas USD4trn, and coal USD4.9trn. Loss in revenues may cause many fossil fuel investments to decline in value, posing significant risk for those still invested in the fossil fuel industry. As Nathaniel Bullard highlights in Bloomberg New Energy Finance’s Report Fossil Fuel divestment: A $5 Trillion Challenge, “oil, gas and coal companies make up one of the world’s largest liquid asset classes, with a combined stock market valuation of nearly $5trn. The current value of the 1,469 listed oil and gas firms is $4.65trn; 275 coal firms are worth $233bn” (Bullard, 2014, p. 7). For comparison, the debt overhang from the recent housing bubble has been estimated to be around $4 trillion (cf. Russell Sage Foundation, 2012). Like the deterioration of the coal market, which many investors have incidentally divested from based on poor performance alone, the oil industry is showing distressing signs of market weakness. The oil industry is in a quandary; they are paying more to extract oil in increasingly remote locations, as ‘easy to find oil’ has peaked. Oil is now being extracted in remote, dangerous, locations; war zones; deepwater sites. Further, the oil that is extracted was not only more expensive to get out of the ground, but also lower quality, like tar sands, and requires more processing to be commercial, again increasing costs. So while costs of extraction are increasing, demand is flat and falling in developed nations, counter to oil company projections. Finally, oil companies are finding that they cannot sell this more expensive oil to consumers at high prices without driving their customers to the many existing alternatives that currently exist, such as hybrids, EVs, and other alternatives. As a result of higher supply side costs & lower returns, oil companies are experiencing missed revenue targets, widespread cash shortfalls, and are taking out massive, landmark levels of debt to cover the difference. “The world’s leading oil and gas companies are taking on debt and selling assets on an unprecedented scale to cover a shortfall in cash, calling into question the long-term viability of large parts of the industry” (EvansPritchard, 2014). Despite this cash shortfall, oil and gas companies are still paying dividends, maintaining the illusion of normalcy for investors. The illusion is thin, for as the US Energy Information Agency recently highlighted, oil and gas companies took on $110 billion more in debt than they received in revenue returned during the last financial year (Barron, 2014). This trend may not slow, as rather than taking steps to respond to October 2014 6 the problems with their business model and secure their companies’ futures, fossil fuel companies are instead ‘throwing good money after bad’, investing capital into more high cost, low return projects, such as oil sands and Arctic oil; bets made on potentially phantom future demand. According to Carbon Tracker analysis oil companies will are set to spend approximately $1.1 trillion dollars of CAPEX into projects that won’t see a return if oil prices drop below $95 in the next decade (CTI, 2014a). At the same time, the International Energy Agency, which tends to be bullish on oil and gas forecasts, predicts that the oil industry will reach global peak in demand by 2020, resulting in lower future demand and possibly stranding the current CAPEX exploration investments (IEA, 2014b). Similarly, a recent report by Carbon Tracker (2014b) shows that much of the already beleaguered coal industry is “gambling on survival in the hope that prices will somehow recover”. However, as the report highlights, such a gamble will potentially prove a bad one, as it is likely that “future demand and price levels may not meet current industry expectations”. In response the argument is made that carbon asset risk is not a real problem because laws won’t come about to regulate climate change. People making this argument ignore history and the broader risk facing the fossil fuel industry. It’s in this volatile, deteriorating market environment that regulatory risk is a true threat. With poor market performance, bizarre managerial decision making, and extensive industry denial of existential threats to its own business, it will arguably require little regulatory pressure to potentially destabilize the oil industry. We have seen this in the coal industry which --- crushed by natural gas and renewable alternatives--- arguably has little hope of recovery now that the EPA has passed a weak rule. Furthermore, as the figure below from Caldecott and Robins (2014) points out, the risks for fossil fuel companies are numerous and not limited to increasingly forthcoming climate regulation. The fossil fuel industry is already vulnerable and the risks posed to it are multiple; however, in failing to respond to the changing realities of their own industry, and continuing to double down on business as usual despite significant evidence to change course, fossil fuel companies may have effectively stranded their own assets. October 2014 7 Underestimating Risk: The Case of Exxon While the understanding of how individual fossil fuel companies are vulnerable to risk from carbon asset and other environmental risks is still in its infancy, a few reports have been released which attempt to understand how they might be affected. This case study examines the latest analysis available, provided by a Carbon Tracker analysis of Exxon Mobil (CTI, 2014d). According to the report, Exxon is “significantly underestimating the risks to its business model from investments in higher cost, higher carbon reserves; increasing national and subnational climate regulation; competition from renewables; and demand stagnation.” What’s more, the risks to Exxon’s business are not a distant worry; rather they are already playing out. Exxon Mobil and the fossil fuel industry in general, are beginning to significantly underperform relative to the broader stock market and have seen a decline in return on their investments. Drawing on Exxon’s own analysis, if you invested in Exxon stock in 2009, your returns would be just 60 percent what you could’ve earned by investing in the S&P Index. This decrease in performance is arguably a potent omen of the unfurling carbon bubble and an incredible sign of the times. Carbon Tracker argues that Exxon’s underpeformance is partly a result of Exxon taking on more and more high cost and low return projects such as oil sands, Arctic oil, and heavy oil. This represents an ongoing trend whereby Exxon and other oil companies have been steadily replacing low cost high return production with high cost, low return and generally high carbon production. However, instead of internalizing the risk that oil prices may not be as high, Exxon is putting increasingly more capital investments into oil projects which rely on a high price to break even. As the Carbon Tracker report highlights, out of Exxon's $286 billion in potential upstream oil capex from 2014---2025, $103 billion (36%) is for projects requiring a market price above $95/bbl. Another worrying sign is that for a number of problematic reasons Exxon does not really consider serious action on climate change and goes so far as to base its plans and projections on an International Energy Agency scenario that assumes no new climate policy. Not only would such a path lead us to disastrous climate change of 3.7 – 4.8°C rise (IPCC, 2013). Furthermore, betting on such a future seems an incredibly bad bet, given a surge in new local climate policies as well as a global climate change deal due in 2015, which is set to see a suite of new and more ambitious climate commitments come into place (cf. Jacoby & Chen, 2014). What’s more, as opposed to projections by companies like Exxon who are betting on the world providing 4% of its energy from wind and solar by 2040 (cf. Muttitt, 2014), 80% of global energy industry experts believe that the electricity system can be 70% renewable by 2050, and almost half of them believe that we can achieve 70% in just 15 years (Hill, 2015). The Carbon Tracker report highlights that Exxon’s future plans are based on their own highly favourable assumptions and definitions, along with quite ‘creative’ use of data. While Exxon’s projections paint a businessas-usual picture that shows them continuing profitably into the future, the likelihood of that picture turning out to be true is increasingly slim given the rapidly changing market and regulatory landscape. Thus, as Carbon Tracker’s latest analysis of one of the fossil fuel industry’s titan’s makes clear, the times are rapidly changing, and the continued profitability of investing in fossil fuels is no longer a given. October 2014 8 Insignificant Risks & Potential Gains from Fossil Free Investing One of the main challenges to fossil fuel divestment has been the inaccurate but widely perceived danger that because excluding fossil fuels limits the investment universe that it therefore leads to significant increases in risk and a loss of returns. This fear has been underpinned by studies commissioned by the American Petroleum Institute, which have misrepresented the risks associated with fossil fuel divestment (Shapiro & Pham, 2012). Fortunately, counter to the skewed American Petroleum Institute research, numerous studies have now shown that divestment can occur with potentially little added risk and often results in gains in return. One of the first attempts to work out the risk of fossil fuel divestment was released by the Aperio Investment Group in the form of a widely cited report entitled Do the Investment Math (Geddes, 2013). The report debunked the idea that divestment would cause substantial risks to an endowment’s portfolio by analyzing the risks when excluding all fossil-fuel companies altogether relative to a broad U.S benchmark, the Russell 3000. The Aperio group did a historical backtest of the Russell 3000 and the fossil free portfolio from 1997 – 2012 and found that the fossil free portfolio had higher returns 73% of the time, meaning that the fossil free portfolio would have been a better investment. Furthermore, the risk from divestment of the fossil fuel industry worked out to be 0.0101%. Statistically, that figure was “basically noise”, according to Patrick Geddes, the Aperio Group chief investment officer (Gardner, 2013). More recently, another study by the Aperio Group further confirmed their earlier results, this time not only looking at the U.S. markets but Canadian, Australian and global markets too. On a global scale a carbon-free tracking portfolio, which is reweighted to track an index, received higher annualized returns from 1997-2013 than a non-carbon free portfolio, and incurred only a very slightly higher tracking error. Similar results were found for the US, Canada and Australia analyses. The report thus concluded that “the data does not support the skeptics’ view that screening negatively affects an index tracking portfolio’s return. The data also shows that the impact on risk may be far less than presumed” (Geddes et al, 2014, p. 8). Fossil Free Indexes US Index and S&P500, 2004 - July 2014 (Source: Fossil Free Indexes, Bloomberg) October 2014 9 IMPAX Asset Management (2013) also analysed the potential benefits of fossil fuel divestment using the MSCI index from 2008-2013 to compare four different fossil free investment strategies with varying aggressiveness towards investing in clean energy and environmental opportunities. Each one of the strategies did better than the fossil fuelled portfolio, showing that “removing the fossil fuel sector in its entirety & replacing it with ‘fossil free’ portfolios of energy efficiency, renewable energy, and other alternative energy stocks, either on a passively managed or actively managed basis would have improved returns with limited tracking error” (2013, p. 4). Likewise, MSCI performed a study to determine the effects of fossil fuel divestment. Over 1-, 3- and 5-year periods, the fossil fuel screened portfolio they constructed slightly outperformed the unscreened portfolio" (MSCI, 2013, p. 6). The 10-year period did involve an under-performance of the fossil fuel screened portfolio. However, as the report highlights the ten-year performance was the result of unusually high oil prices at the beginning of the period. Thus the ten-year trend is not necessarily an indication that investing in fossil fuels is a sound investment strategy because there is good reason to think that either we shouldn’t expect high oil prices looking forward, or that if we do receive high oil prices that renewable energy will undercut fossil fuel performance. The fossil fuel industry is caught in a bind: if fossil fuel prices go up they are increasingly undercut by competition from cheap renewable energy prices; alternatively if fossil fuel prices go down the industry cannot adequately recoup costs, and even with low fossil fuel prices, renewable energy is still cheaper and undercutting their market share (cf. Lewis, 2014b). (Since initially publishing this report, oil prices have tumbled causing 100s of billions of losses for investors, illustrating the latter worry (cf. Loder, 2015)). Current trends are already indicating declining fossil fuel industry dominance, and under-performance relative to the broader stock market. For example, if you invested in Exxon in 2009, your returns would be just 60 percent what you could have earned by investing in the S&P Index (CTI, 2014d). Likewise, coal, which is the canary in the coal mine for the carbon bubble, is having a rather dismal time as the graph below suggests. Showing similar trends the Market Vector Coal ETF, a coal index fund, has performed horribly during the last 5 years and has reduced in value by -44.35% while the S&P 500 has increased by 74.57% (Google Finance, 2014). More broadly speaking a rough analysis done by Standard & Poors showed that if an institution with a $1 billion endowment had divested from fossil fuels 10 years ago their endowment would have grown by an extra $0.12 billion compared to if they had not divested (Begos & Loviglio, 2013). Similarly analysis shows (as graphed above), that the S&P 500 screened against the CU200 outperforms the standard S&P 500 (the gold standard of benchmarks) by approximately 30 basis points over the previous 10 years (Fossil Free Indexes, 2014). Some might still argue that divestment restricts the ‘investment universe’. Arguments about restricting the investment universe are often associated with a financial theory called Modern Portfolio Theory (MPT), which argues that the best way to reduce risk is by spreading one’s investments across a range of asset classes, so as to have a more diversified portfolio. On this line of thinking removing investments in fossil fuels increases risk by reducing diversity, and thus should not be done. However, MPT is just one financial October 2014 10 theory which might seem strong in theory, is more complex in practice. What appeals to MPT overlook is, firstly, the empirical studies illustrating that fossil fuel divestment does not significantly increase risk. It also overlooks that the risk associated with staying invested in fossil fuels might outweigh the risk of excluding fossil fuels. Thirdly, as Herbert and Lenferna (2015) point out, “the entire process of investment management is one of narrowing one’s investment universe and deciding (through the methodical application of various and sundry criteria) not to invest in certain companies or asset categories”. No one takes MPT to its extreme by owning every security in the marketplace in order to diversify; rather tools like asset substitution and portfolio optimization are routinely used to create a viable portfolio allocation and to avoid prohibitively risky investments. Managers constantly restrict the investment universe by theme- small cap, large cap, emerging markets. Fossil fuel divestment is arguably no more significant than the usual screens managers apply to funds every day, and is an increasingly financially sound screen given the risks associated with the fossil fuel industry. Related to MPT is the claim that because fossil fuels have done well in past times of high inflation we should hedge against high inflation by staying invested in fossil fuels. While a prudent financial manager arguably needs to employ a strategy for dealing with high inflation periods, it's not clear that staying invested in fossil fuels and incurring the potential losses they may well feel (and currently are feeling) is the best way to hedge against inflation. Perhaps a sounder strategy might involve investing in other industries that have historically done well in times of inflation, such as construction and engineering, aerospace, and machinery, or, as Yale’s David Swensen suggests, one can invest in inflation protected Treasuries (Wee, 2009). Ignoring the increasingly real risks of stranded carbon assets and instead organizing an investment strategy around the fact that fossil fuels did well in times of high inflation in the 1980's when energy markets were much different than today seems like a risky strategy. Furthermore, times of high inflation are rare and thus to use fossil fuels as a hedge against a relatively low probability occurrence when the same assets face significant risk from a potentially higher probability and more devastating eventuality seems like a risky investment strategy when other inflation hedges are available. Recent history shows that the fossil fuel industry is already underperforming relative to the broader market and growing evidence suggests that underperformance will deepen moving forward. In the words of Paul Humphreys of the Teller Institute, “analysts and investors are beginning to grapple with the prospect that the historical outperformance of fossil-fuel companies may be as illusory as the tech boom of the 1990s and the housing bubble at the beginning of this century” (2013, p. 3). The examples highlighted above are examples of the growing evidence that remaining invested in fossil fuels is risky, and will likely result in foreseeable, near- and long-term, negative consequences. A corollary of that point is that divesting from fossil fuels is not the risky endeavour the fossil fuel industry has attempted to paint it as. What’s more, these studies were done in a time when the carbon bubble is a concept that is only just coming to the fore, and the implications of which are only beginning to ripple through the financial industry and thus the underperformance may well deepen moving forward. The carbon bubble and associated risks are in many ways unprecedented forward looking risk factors, and as such past performance may not be a very good guide to future performance, especially as we are entering a potentially radically different future with renewable energy costs rapidly declining while fossil fuel costs continue to rise. October 2014 11 When the entire fossil fuel industry has been underperforming the market for years and the National Bank of Abu Dhabi commissions studies arguing that renewables are the future for the Middle East as they are already cheaper and more reliable than oil, then we are arguably already living in a fundamentally different world, even if the fossil fuel industry may not have realized it yet (University of Cambridge & PwC, 2015). It is for this reason that studies, such as Daniel Fischel’s (2015) Independent Petroleum Association of America funded study, that claims divesting fossil fuels is a bad investment strategy because fossil fuels performed well over the past fifty and even twenty years, are akin to thinking that Blockbuster is the future of home entertainment. Both claims simply don’t recognize that the world has changed as the above graph from Mitchel (2015) powerfully illustrates. As Cleveland and Reibstein (2015, p. 32) point out, “multiple independent studies and the observation of actual investment patterns are unequivocal [on] one point: the cost of onshore wind power in many regions of the world is now in a competitive range with base load electricity generation from coal, natural gas, and nuclear sources, even when subsidies are excluded”. Similarly, as a Deutsche Bank analysis has shown, solar energy is set to be costcompetitive with coal power in 80% of the world by 2017. The world is changing and while the costs of renewables continue to plummet the cost of fossil fuel extraction continues to rise as we move increasingly to unconventional and expensive extraction methods. Before closing this section it is worth considering another problematic assumption often employed by financial consultants to claim that fossil fuel stocks are not overvalued because the market has already priced in stranded assets. This argument is often associated with reliance on a financial theory called efficient market theory (cf. Lenferna, 2014). Efficient market theory assumes that market participants have all the necessary information about the market, information which is supposed used efficiently, such that all shares are properly valued. Financial bubbles, however, form because shares are erroneously over-valued which means that markets do not always act in accordance with efficient market theory. The reasons for this are many, but two predominant reasons are important to consider. Firstly, markets do not have always have access to the requisite information to act upon. Secondly, markets may not act very efficiently on information either, thus they have often been described as weakly efficient. In some cases, particularly in the case of bubbles, markets do not work very efficiently at all, as “investors are prone to over-optimism, systematic biases and ‘timid choices and bold forecasts’” (Ansar, Caldecott, & Tilbury, 2013, p. 21). When markets are betting on a future where we burn up to five times more fossil fuels than the governments of the world have agreed to burn, and are continuing to pour 100s of billions of dollars into developing even more new unburnable and arguably prohibitively expensive reserves, we may wonder how collectively rational they are. Apart from the obvious contradiction posed by the carbon bubble there are a few other good reasons to think efficient market theory does not hold, and that it is thus irresponsible to dismiss the carbon bubble by way of appeal to it. Consider that the Asset Owners Disclosure Project’s (2014) Global Climate Index Report found that just under 80% of asset-owners are failing to properly manage climate risks, making them vulnerable to the October 2014 12 risks of the carbon bubble among other climate risks. Compounding this, a recent CTI (2014c) report revealed that the 'wisdom' of the collective market is limited by the fact that only 7% of coal, oil and gas companies have checked their projects are consistent with limiting dangerous global warming, and many companies who have are simply betting on a 4 degree (or worse) world (cf. Exxon and Shell). Because markets can only be efficient if they have access to the relevant information, such studies should warn against assuming efficiency. If the market pays more attention and it becomes clearer that the fossil fuel industry will not be able to capitalize on all of their reserves this could lead to a significant loss in value for fossil fuel companies. A scenario made more likely by the fact that major players like the Bank of England and the G20 are beginning to recognize, analyze and act on the carbon bubble (cf. Carrington, 2014). For long term investors it is important to keep in mind, as the Carbon Tracker team points out, that “in the context of a declining carbon budget, [current] valuation models provide an inadequate guide for investors and need to be recalibrated… [as] the markets appear unable to factor in the long-term shift to a low carbon economy into valuations and capital allocation”(CTI, 2013, p. 5). In the long-term the likelihood of the carbon bubble causing significant revaluations of fossil fuel assets poses considerable risks to those who continue to invest in the fossil fuel industry, especially in those industries that are most capital- and carbon-intensive, such a coal and tar sands. What’s more is that “although we cannot, and should not, abandon the world’s current energy infrastructure overnight, investors who equate the transition with drawn-out, incremental change do so at their own peril as the stranding of carbon assets may occur at unforeseen rates and at an unpredictable scale” (Generation Foundation, 2013, p. 20). Coupled with the broader risks to the fossil fuel industry and deepening trends of underperformance, concerns about the carbon bubble make it increasingly clear that divesting from fossil fuels is an increasingly sound investment strategy. Of course, direct investments which are actively and skilfully managed could still make some profit riding the ups and downs as the fossil fuel market fluctuates. However, the volatility of fossil fuels makes such a strategy quite risky as illustrated by the recent oil price crash which wiped out 100s of billions for investors (cf. Loder, 2015). When it comes to passively managed investments, such as index funds, it seems the case for excluding fossil fuels is quite strong given their deepening underperformance and potentially bleak future. Fiduciary Duty If the purpose of an endowment or fund is to provide long-term returns then it is becoming increasingly clear that fossil fuel divestment is at least consistent with fiduciary duty and the duty of care, if not a requirement thereof. As former SEC Commissioner Bevis Longstreth points out, fiduciaries of endowments are charged with a duty of care, which is outlined in the American Law Institute's 1991 Restatement of Trusts, Third, Section 227 as such: "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 endowment]" (Longstreth, 2013). “An understanding of the standard of care generally applicable to fiduciaries leads easily to the conclusion that divestment of fossil fuel companies on the basis of the financial considerations outlined above is a permissible option.” As Longstreth went on to argue “betting against the stranding risk [of the carbon bubble] materializing is arguably an irresponsible, hard-to-defend, position for a fiduciary, who will have to demonstrate a sound basis for doing so, something that seems hard to do”. October 2014 13 Far from climate change and environmental concerns being extraneous to fiduciary duty, a report by the UN Principles of Responsible Investment and United Nations Environmental Programme Financial Initiative demonstrated that it is in the financial interest of fund beneficiaries that large diversified institutional investors such as pension funds, mutual funds and insurance companies address the environmental impacts of investments to reduce exposure to externalities (UN PRI, 2010). Likewise researchers from Oxford University’s Stranded Assets Programme point out that: “The lack of a mandate for companies to integrate ESG factors in decision-making, undertake materiality assessments or disclose environment-related risks hinders both consistent understanding of the issues and the ability to mitigate risks… The interpretation of fiduciary duty has evolved significantly over time and must continue to evolve to adjust to changing social and economic realities. Fiduciary duty is often cited as an obstacle to incorporating ESG factors into the investment process. The argument that ESG-inclusive investing is inconsistent with fiduciary duty is based on the premise that including ESG factors in investment decision-making would compromise returns to achieve extraneous social or environmental objectives” (Caldecott & McDaniels, 2014, p. 7). As we’ve seen though, that premise is turning out to be increasingly false, especially when it comes to the fossil fuel industry. Thus incorporating ESG factors into investment decisions is no longer just an ethical obligation, but increasingly a fiduciary duty, especially when it comes to the fossil fuel industry. Similarly, a report by Mercer concluded that “given the risks and opportunities presented by climate change and the rapid introduction of carbon pricing regimes across multiple jurisdictions, trustees have a clear duty to consider climate change risks and relevant laws and policies in making investment decisions when such matters prove to be material” (Mercer, 2013a, p. 4). The report lists two reasons divestment fits within the obligations of fiduciary responsibility. First, it cites a report entitled A Legal Framework For The Integration of Environmental, Social and Governance Issues Into Institutional Investment, which concluded that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions” (Freshfields Bruckhaus Deringer, 2005). Secondly it cites that many investors already consider it their fiduciary duty to incorporate climate change concerns into their investment decisions. Australian law firm, Baker & McKenzie’s reported that “most surveys have shown that the majority of Australian trustees now believe that addressing climate change risk is part of their fiduciary duty.” Similarly, the perception around investments in fossil fuel stocks in the U.S. is starting to shift. Already in 2013, First Affirmative Financial Network surveyed 500 industry professionals, and the findings of the survey showed that 77% see growing risks associated with fossil-fuel company holdings and 67% thought that 2013 was the time for investors to reconsider investing in traditional energy companies (Financial Advisor Staff, 2013). Likewise Mercer (2013b) conducted a survey of the investment practices of 37 asset owners and 47 asset managers which found that 53% of asset managers have decided to divest or not invest based on climate change concerns. October 2014 14 However, despite the importance of incorporating environmental risks into investment decisions, “asset owners have so far failed to systematically integrate environmental externalities and risks into their mandates” (Caldecott, Derricks, & McDaniels, 2014, p. 5). That was the conclusion of the recently concluded inaugural forum on Stranded Assets, organized by the Oxford University Smith School of Business and the Environment’s Stranded Assets Programme (SAP), which brought together sixty global leaders and experts to discuss the disruptive impacts of the shift to a low-carbon economy. Thus given that environmental related risk considerations have not been systematically integrated into asset management, even though they pose significant financial risks to asset managers, fossil fuel divestment represents one pathway to address the shortfall of systematic integration of carbon risk and in doing so fulfill fiduciary duty. In summary, it seems clear that divesting from fossil fuels is consistent with fiduciary duty and can be seen as a proper fulfillment thereof. Indeed, as this report highlights, the carbon bubble and related environmental risks pose a systemic financial risk, and it would entail serious neglect of fiduciary duty not to address those risks. The Fossil Fuel Divestment Movement The increasing numbers of people trying to get investments out of the fossil fuel industry represents the fastest growing movement of its kind in history, the fossil fuel divestment movement (cf. Ansar et al., 2013). The movement was inspired by students calling for their institutional endowment investment decisions to match their institutional values. This movement is modelled after the successful movement to divest from South Africa in response to Apartheid. In the last two years, the movement has Map of Active Fossil Fuel Divestment Campaigns rapidly expanded with growing concerns about the climate crisis and the risk of a carbon bubble. The common demand is to freeze any new investment in the 200 publically traded fossil-fuel companies with highest amount of reported carbon reserves, and to remove their current investments in the fossil fuel industry through divesting from direct ownership of fossil fuel stocks and any commingled funds that include fossil-fuel public equities and corporate bonds. Beginning in 2011 with just a few campuses the movement now consists of 100’s of different active campaigns. Over 400 colleges have active campaigns, and in recent years, 180 institutions - including philanthropies, religious organizations, pension funds and local governments - as well as hundreds of wealthy individual investors have pledged to sell assets tied to fossil fuel companies from their portfolios and to invest in cleaner alternatives. On Monday the 22nd of September over 700 investors representing $50 billion committed to divest from fossil fuels. Stanford University has committed to divest from coal and 14 other universities have committed to divest from fossil fuels. 29 cities, 2 counties, and over 30 churches, have all divested. Hesta Australia, a health care industry retirement fund worth $26 billion, announced in September 2014 that it would get out of coal. Norwegian pension fund, Storebrand divested from companies with high exposure to coal and oil October 2014 15 sands in 2013. The growth and rate of divestment is growing, and not only is the fossil fuel divestment movement leading on this important issue, but furthermore, it is exposing the carbon bubble and the unsustainable nature of fossil fuel investments, arguably making it wise to get out of fossil fuel investments before the recognition of the carbon bubble becomes more widely known, and devaluations of fossil fuel companies becomes more commonplace in the market. Case Study: The Rockefeller Brothers Fund The Rockefeller Brothers Fund representing $800 million of investment committed to divesting completely from fossil fuels on Monday the 22nd of September. It has already sold off all of its direct holding in oil sands and coal, and is increasing investments in alternative energy. It is now working gradually to divest its broader holdings from fossil fuels. It also allows itself to hold small investments in fossil fuel companies in order to engage in shareholder advocacy. Should SCERS also be interested in doing so they could retain $2,000 worth of stock in such companies, which enables them to introduce resolutions (Collins, 2013). The Rockefeller Brothers Fund in its moves to divest cited both economic and moral grounds for their divesting: they see it as a good investment move both financially and morally speaking. Case Study: Storebrand Pension Fund Already pension funds are starting to react to both the carbon bubble and concerns about the decline of fossil fuels. In 2013, Storebrand, a Norwegian pension fund, began divesting from companies with a high exposure to coal and oil sands. In 2014 they expanded their divestment even further to include even more coal companies. The reasoning behind the divestment was both financial and sustainability oriented. In the words of their head of sustainable investment Christine Tøklep Meisingset: as “climate goals become reality, these resources are worthless financially, but it is also true that they do not contribute to sustainable development in the extent and the pace we want”. Meisingset later went on to say that as “a savings and pension provider our goal is to ensure long-term positive return for our customers. Part of that goal is achieved by reducing the risk in our portfolios, and climate change is the most comprehensive risk to sustainability” (in Malone, 2014). When other pension funds are already beginning to divest and a global movement is drawing attention to the financial risks associated with the carbon bubble and the decline of fossil fuels, then ignorance or inability is no longer an excuse available to pension fund managers. SCERS retirees have already suffered enough from financial losses associated with irresponsible industries and it would be sad to see history repeat itself when the warning signs are becoming increasingly clear that the fossil fuels industry is an ethically and financially irresponsible investment. October 2014 16 The Positive Effects of Fossil Fuel Divestment and Reinvestment “Divesting from fossil fuels is an integral piece to aligning the financial sector with a 2 degree climate scenario. The [International Energy Agency] estimates in their 2 degree scenario reductions in fossil fuel investments of $4.9 trillion (~26% of total estimated investment) and additional divestment away from power transmission and distribution of $1.2 trillion (~7%)” (2° Investing Initiative, 2013, p. 9). Likewise the latest Intergovernmental Panel on Climate Change (IPCC, 2013) report highlights the need to reduce annual investment in fossil fuels by at least $30 billion dollars per year over the coming decades, and for annual investment in low carbon electricity supply to grow $147 billion a year if we are to achieve the internationally agreed upon two degree target. Impacts of fossil fuels held by pension funds are not insignificant. A recent study done by Fossil Free Indexes on the investments held by CalPERS, the California Public Employees Retirement system with $300 billion dollars invested, 7.3% of which was in the Carbon Underground Top 200 in 2013 (Connolly, Francis, Griep, & Palmieri, 2014). The report showed that the financed emissions supported by CalPERS’ oil and gas holdings would be equivalent to the emissions embedded in reserves held by 55th largest oil and gas company, and the 88th largest coal company. While not all pension funds are as large as CalPERS, the more funds that divest the closer we get to the needed reductions in fossil fuel investments. SCERS leadership on divestment would demonstrate to other municipalities that divestment is both feasible and necessary. When a growing number of investors begin to align their investments with a 2 degree world, collectively they can shift the capital required. Apart from divestment’s direct impacts, perhaps more importantly, are many of the indirect impacts. Divestment campaigns are triggering a process of stigmatization of fossil fuel companies. As Oxford University’s Stranded Assets Programme researchers argue, “we find that even if the direct impacts of divestment outflows are limited in the short term, the campaigns will cause neutral equity and/or debt investors to lower their expectations of fossil fuel companies’ net cash flows in the long term. The process by which uncertainty surrounding the future of fossil fuel industry will increase is through stigmatization. In particular, the fossil fuel divestment campaign will increase legislative uncertainty and potentially also lead to multiples’ compression causing more permanent damage to the companies’ enterprise values… Indirectly, by triggering a process of stigmatisation, the divestment campaign is likely to make the operating and legislative environment more challenging. Greater uncertainty over future cash flows can permanently depress the valuation of fossil fuel companies, e.g. by compressing the price/earnings multiples.” (Ansar et al, 2013). As Nobel Prize-winning economists Robert Shiller and George Akerlof (2009) argue, our economies and financial systems are significantly driven by our emotions and psychology which determines market sentiment. The importance of divestment in this context is that it shifts market sentiment and perceptions and in doing so drives investments out of fossil fuels and increasingly into clean energy. Combined with the other direct and indirect effects, divestment is beginning to deflate the carbon bubble, and drive some of the capital reallocation needed to bring our investments in line with a two degree world. Apart from financial impacts, divestment also has much broader societal impacts and helps to shift the moral and social discourse around fossil fuels by bringing to the fore the deeply problematic nature of the fossil fuel industry’s business model alongside its stranglehold on political and social solutions to the crisis we jointly face (cf. Douglass, 2014; Lenferna, 2015; Supran & Achakulwisut, 2014). Thus, by divesting SCERS can protect itself against the increasing financial risks associated with fossil fuel investments, keep its investments clear of this ethically problematic industry, and help to galvanize a meaningful societal response to the carbon bubble. October 2014 17 Conclusion As this report outlines, divestment from fossil fuels is a decision that is supported by a number of reinforcing motivations. It is not merely an ethically laudable decision which could help to tackle the climate crisis and deflate the carbon bubble. It may also be a financially prudent decision which can help SCERS to protect its stakeholders from potentially devastating financial losses associated with an industry that is arguably in decline yet remains for the large part unwilling to countenance the steps needed to responsibly manage that decline. Not only is the fossil fuel industry failing to adequately countenance what climate change means for its bottomline, and in doing so ignoring tens of trillions of dollar worth of risk. Furthermore, it is not recognizing broader economic trends which spell significant danger for its business model. Coupled with other trends, the rapid decline in the costs of renewable energy is undercutting the business model of the fossil fuel industry. The costs of fossil fuels, on the other hand, are rising as fossil fuel reserves become more remote, difficult to access, expensive, carbon-intensive and financially risky. The fossil fuel industry is already underperforming and the broad array of risks that it faces leaves it particularly vulnerable to increasing climate legislation, which may prove to be a crippling blow for an industry that may already be in decline. The continuing decline of the coal industry serves as an important omen of times to come for the broader fossil fuel industry as coal is largely recognized to be the canary in the coal mine for the carbon bubble. Following the canary, even the broader fossil fuel industry is underperforming, and yet it continues to take on high cost, lower return investments, which are adding to a rapidly growing amount of debt. Both the near and long-term future of the fossil fuel industry holds worrying signs, with the industry set to potentially take on tens of trillions of dollars in losses in just the next two decades. As a long-term investor SCERS has a financial and fiduciary duty to protect itself from the financial losses and risks associated with fossil fuel industry; risks and losses which are already taking hold, and which have arguably already translated into significant losses for SCERS. By divesting from fossil fuels or thoroughly incorporating carbon risk into its investment approach SCERS can show itself to be a responsible asset manager, while helping to galvanize a meaningful response to the intertwined climate crisis and carbon bubble. In this report we have highlighted why we believe that fossil fuel divestment is a sound decision, and we hope that SCERS will heed the warning signs and appropriately respond. The alternative involves SCERS continuing to expose itself to massive potential risks and financial losses so that it can continue to invest in an industry committed to devastating climate change. October 2014 18 Bibliography 2° Investing Initiative. (2013). From Financed Emissions to Long Term Investing Metrics: State of the Art Review of GHG Emissions Accounting for the Financial Sector. Retrieved from http://www.trucost.com/publishedresearch/112/2i financed emissions report Ansar, A., Caldecott, B., & Tilbury, J. (2013). 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Retrieved from http://www.smithschool.ox.ac.uk/research-programmes/strandedassets/Greening China%27s Financial Markets - Risks and Opportunities from Stranded Assets.pdf Carrington, D. (2014, December 1). Bank of England investigating risk of “carbon bubble.” The Guardian. Retrieved from http://www.theguardian.com/environment/2014/dec/01/bank-of-england-investigatingrisk-of-carbon-bubble Cleveland, C. J., & Reibstein, R. (2015). The Path to Fossil Fuel Divestment for Universities: Climate Responsible Investment. Boston, MA. Collins, C. (2013). 11 Reasons To Divest From The Fossil Fuel Industry. Counter Currents. Retrieved from http://www.countercurrents.org/collins240713.htm Connolly, L., Francis, T., Griep, C., & Palmieri, M. (2014). The CalPERS Portfolio and Fossil Fuel Reserve-related CO2 Emissions 2004-2013. Retrieved from http://fossilfreeindexes.com/research/calpers-portofliofinanced-co2-emissions/ October 2014 19 CTI. (2013). Unburnable Carbon 2013: Wasted capital and stranded assets. London. Retrieved from http://www.carbontracker.org/wastedcapital CTI. (2014a). Carbon supply cost curves: Evaluating financial risk to oil capital expenditures. London. Retrieved from http://www.carbontracker.org/wp-content/uploads/2014/05/CTI_Oil_Report_Oil_May_2014_1305.pdf CTI. (2014b). Carbon supply cost curves: Evaluating financial risks to coal capital expenditures. London. Retrieved from http://www.carbontracker.org/wp-content/uploads/2014/09/CTI-Coal-report-Sept-2014WEB1.pdf CTI. (2014c). Recognising Risk, Perpetuating Uncertainty: A baseline survey of climate disclosures by fossil fuel companies. London. Retrieved from http://www.carbontracker.org/report/climateriskdisclosures/ CTI. (2014d). Responding to Exxon - A Strategic Perspective. London. Retrieved from http://www.carbontracker.org/report/response-to-exxon-an-analytical-perspective/ Douglass, E. (2014). 2014: Riding a Rocket, Divestment Movement Gains Momentum. Inside Climate News. Retrieved from http://insideclimatenews.org/news/20141222/2014-riding-rocket-divestmentmovement-gains-momentum Evans-Pritchard, A. (2014). Oil and gas company debt soars to danger levels to cover shortfall in cash. The Telegraph. Retrieved from http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/11024845/Oil-and-gas-companydebt-soars-to-danger-levels-to-cover-shortfall-in-cash.html Financial Advisor Staff. (2013). Skepticism Grows About Investing In Fossil-Fuel Companies, Survey Says. Financial Advisor. Retrieved from http://www.fa-mag.com/news/skepticism-grows-about-investing-infossil-fuel-companies--survey-says-14300.html Fischel, D. R. (2015). Fossil Fuel Divestment: A Costly and Ineffective Investment Strategy. Retrieved from http://divestmentfacts.com/pdf/Fischel_Report.pdf Fossil Free Indexes. (2014). Fossil Free Indexes US (FFIUS): Performance Analysis. Retrieved from http://fossilfreeindexes.com/wp-content/uploads/2014/06/FFIUS-Performance-June30ud.pdf Freshfields Bruckhaus Deringer. (2005). A Legal Framework For The Integration of Environmental, Social and Governance Issues Into Institutional Investment. Retrieved from http://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf Gardner, L. (2013). Divesting from Fossil Fuels is Unlikely to Harm Endowments. The Chronicle of Higher Education. Retrieved from http://chronicle.com/blogs/bottomline/divesting-in-fossil-fuels-shouldntharm-endowments-report-finds/ Geddes, P. (2013). Do the Investment Math: Building a Carbon-Free Portfolio. Sausalito CA. Retrieved from http://www.aperiogroup.com/system/files/documents/building_a_carbon_free_portfolio.pdf Geddes, P., Goldberg, L., Tymoczko, R., & Branch, M. (2014). Building a Carbon-Free Equity Portfolio. Sausalito CA. Retrieved from https://www.aperiogroup.com/system/files/documents/aperio_group__building_a_carbon-free_equity_portfolio.pdf October 2014 20 Generation Foundation. (2013). Stranded Carbon Assets: Why and How Carbon Risks Should Be Incorporated in Investment Analysis. New York. Retrieved from http://genfound.org/media/pdf-generation-foundationstranded-carbon-assets-v1.pdf Gilding, P. (2013). Victory at Hand for the Climate Movement? Renew Economy. Retrieved from http://reneweconomy.com.au/2013/victory-at-hand-for-the-climate-movement-99405 Google Finance. (2014). Market Vectors – Coal ETF. Retrieved from https://www.google.com/finance?q=NYSEARCA:KOL&ei=AvMiVKiWEMu68gbmwIDwBQ Herbert, B., & Lenferna, G. A. (2015). Critique of NEPC reports on Divestment to the City of Seattle SCERS committee. Seattle. Retrieved from http://bit.ly/1CKKMn0 Hill, J. (2015, March 23). Industry experts say 70% renewables possible across globe within 15 years. Clean Technica. 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(2014). Carbon Blind: Lessons from 350Seattle’s Struggle Against a Flawed Divestment Report. GoFossilFree.org. Retrieved from http://gofossilfree.org/carbon-blind-lessons-from-350seattles-struggleagainst-a-flawed-divestment-report/ Lenferna, G. A. (2015). Divest-Invest: A Moral, Financial and Economic Case for Fossil Fuel Divestment. Retrieved from http://bit.ly/AMoralEndowment Lewis, M. C. (2014a). Stranded assets, fossilised revenues. Retrieved from http://www.keplercheuvreux.com/pdf/research/EG_EG_253208.pdf Lewis, M. C. (2014b). Toil for Oil Spells Danger for Majors: Unsustainable Dynamics Mean Oil Majors Should Become Energy Majors. Boston Carbon Risk Forum. Kepler Cheuvreux. Retrieved from http://www.mayorsinnovation.org/images/uploads/pdf/Lewis.pdf Loder, A. (2015, January 29). Cheap Oil Burns $390 Billion Hole in Investors’ Pockets. Bloomberg Business. 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