This post is a reprint of a speech to fiduciaries on fossil fuel divestment at the Boston Carbon Risk Forum, Harvard Law School, September 29, 2014
Preface
In 2010, at Cancun, nations of the world set 3.6 degrees F as the permissible increase in global temperature over the pre-industrial level. Beyond that was catastrophe. Since Cancun, the dangers of climate change have grown and become palpable in myriad ways with which you all are familiar. And, yet, nations have made little progress. In fact, having put the car in reverse, they are accelerating in the wrong direction. Thus, the IEA reports our current trend-line will take the planet by 2050 to 7 degrees F, twice the level set in Cancun. Carbon emissions increased by 1.5% per year from 1980 to 2000. But, then, that rate almost doubled to 2.5 % per year through 2012. And in 2013, emissions jumped 2.3% to record levels. The IEA recently reported that the cost to de-carbonize by 2050 was $44 trillion, up from $36 trillion just two years ago, and climbing. The cause? An increase in coal usage that exceeds the increase in renewables.
The planet has already warmed by 1.5 degrees F since the pre-industrial era. On our present trajectory, we will blow by the 3.6 degree F level, reaching as much as 10 degrees F above the pre-industrial era by 2100. By then, civilization and its current residence will have become unrecognizable.
So, the planet has a big problem. I'm here to argue that divestment from fossil fuel companies is an important strategy for fiduciaries of all types to pursue. Here's why.
Purpose of Divestment
The argument for divestment clusters around two ideas: financial and moral.
Financial Reasons - Here the argument is reduction of risk to your portfolio. The risks are many and growing. Consider a few:
The very serious, yet hardly recognized, risk from "stranded assets", in particular "unburnable carbon". Let me explain. To hold to the 3.5 degree goal, there is a limit on how much carbon can be emitted to 2050. It's called the Carbon Budget and its reckoned through science.
The level is 886 Gigatons of CO2 from 2000-2050. Subtracting what's been emitted to date since 2000 (121 Gt) leaves 565 Gt left to emit. But just reserves proven on the books of public and private companies equal 2795 Gt of potential emissions, meaning that proven reserves are about five times what nations can allow to be emitted to 2050, if we are to avoid planetary catastrophe. So the rest is at risk of being stranded -- unburnable - if nations have a Darwinian moment and act. As they must. If this happens, of course, it means current market prices for fossil fuel companies are hugely overvalued.
And consider the risk to the $21 trillion of CAPEX by Big Oil that is planned for expenditure in the near term to develop unconventional oil projects.
And, the risk that, given the plummeting prices for solar and wind energy, oil prices will not remain high enough to profit from the sale of newly discovered reserves, which generally need at least $95 per barrel to break even.
And, overall, the risks from multiple problems facing the fossil fuels complex, including faltering productivity, falling profits, poor economics, environmental disasters and increasing competition from power plants and automobiles running on free fuel.
There are growing risks of stranding in the grid power sector. Barclays recently down-graded high-grade corp. bonds across the entire US utility sector, citing the energy threat of solar power and storage. Baseload power sources like coal and nuclear are being replaced by renewables, and in time the grid will become obsolete. In Europe, growth in renewables was the primary reason that the top 20 utilities lost $600 billion in market value over the past five years.
And I'm sure you know the losses in market value experienced by the coal industry over the past three years, down 61% against the S&P 500, up 47%. By the way, coal is the canary in the oil well, to coin a phrase.
Conventional oil peaked in 2005. Oil and gas production by Chevron, Exxon-Mobil and Shell declined over the past 5 years, even as they spent $500 billion in CAPEX on new projects - that's shareholder wealth that will potentially vanish down very expensive holes drilled in the earth.
Despite the recent surging flows of tight oil and shale gas in the US, the country is waking up to the fact of the huge decline rates of the sources for these products.
Renewable energy supplies at least 23% of global electricity generation today. Its capacity doubled from 2000-2012. Solar is now growing at a 30% rate/year. And is rapidly becoming cost competitive with fossil fuels.
Finally, consider that government subsidies for fossil fuels are some $600 billion per year, compared to just $90 billion for clean energy -- a public perfidy whose days are numbered -- a global outrage that soon will end. As it must.
There's an old saw: How did you go bankrupt? "Two ways: slowly at first; then all at once." In financial markets today, too few consider climate change an investment risk at all. Too many of those who do imagine it to be merely a tail risk, remote and barely worth noting. But change in energy is coming at a gallop. It's happened before. Consider, not long ago, when we used whales for light; horses for power; coal for steam to drive locomotion; now coal again for electricity. We need to disenthrall ourselves from old business models. And listen to the wise and well informed. Like Sheikh Yamani, Saudi Arabia's powerful Minister of Oil from 1962 to 1986. He famously said: "The Stone Age didn't end because we ran out of stones, and the age of oil won't end because we run out of oil."
Moral Imperative -this argument is particularly pertinent for public pension funds, so importantly affected with the public interest.
Given the Gargantuan existential risk of climate change to the planet, those in positions of leadership who fail to take reasonable steps to stop carbon emissions from rising become the moral equivalent of those seeking to deny the science and brush away the problem. As Galileo did by recanting to save his life. Divestment is a reasonable step for pension trustees to take.
What does divestment accomplish? It avoids the ugly picture of trustees seeking to profit from emissions of carbon through the sale and burning of fossil fuel reserves and especially through the massive use of shareholder funds to search for more fossil fuels to sell and burn. Such behavior violates the most basic norms of a civilized society.
I've tried to imagine how Homer, the great story-teller, would have described Big Oil. You'll have your own answer. Here's mine: "The lung-choking, ocean-poisoning, species-sickening pitiless scourge of humanity."
Divestment by any group, but particularly by thought leaders such as those responsible for public pension funds, helps to stigmatize the oil, gas and coal giants as repugnant social pariahs and rogue political forces bent on profit at whatever cost to the planet and its people. That is, the pitiless scourges of humanity.
Don't underestimate the power of being able to create pariahs. These companies fear stigmatization. It hurts in hiring, employee morale and motivation, shareholder satisfaction and equity valuations. And it hurts when leaders of these companies go home to face their children and grandchildren.
Do these companies deserve stigmatization? Consider, e.g., the Exxon-Mobil and Shell reports to shareholders on stranding. Despite each company's acceptance of the science, they smack their gauntlets across the collective face of humanity by asserting that no government restrictions will restrain them. Here, e.g., is E-M's statement:
"We are confident that none of our hydrocarbon reserves are now or will become stranded. ... Further, the company does not believe current investments in new reserves [which it intends to discover and develop in quantities at least equal to current proven reserves] are exposed to the risk of stranded assets, given the rising global need for energy..."
As the Carbon Tracker Initiative observes in its rebuttal to the Exxon-Mobil report, that company does not consider a low carbon scenario in its investment planning, which proceeds on a "business as usual" basis. Its projections are, without doubt, incompatible with meeting the 3.6 degree F goal. Studies show that the company's projections correspond with the IPCC's RCP 8.5 scenario, putting the planet on a pathway to about a 7 degree F increase from the pre-industrial era by 2050.
Divestment by leaders like you will help awaken us to the peril of inaction. Collectively, we are like the frog resting comfortably in a pot of cold water being heated to boiling. You can be among the first in the nation to shake this frog from the deadly comfort zone in which it rests.
Despite the success of the Peoples Climate March in New York City, even the most basic scientific arguments have not been settled. Consider, for example, in the NY Times of September 23, the comment of Freeman Dyson, distinguished and greatly admired theoretical physicist at the Institute for Advanced Study:
"What worries me is that many people, including scientists and politicians, believe a whole lot of dogmatic nonsense about climate change. The nonsense says that climate change is a terrible danger and that it is something we can do something about if we wanted to. The whole point is to scare people, and this has been done very successfully."
Dyson is wrong. Alas, not enough people have been scared. Too many are still slumbering frogs. Governments won't act until enough people -- call it a critical mass - have been scared by the foreseeability of the dire consequences that science tells us will follow inaction to demand their Governments to act, thereby driving down demand for fossil fuels and driving up demand for non-fossil fuel alternatives such as renewables, nuclear and efficiency. In fact, foreseeability is the key and every one of us holds that key in our hands. When a critical mass of people accept the foreseeability of dire consequences from inaction as being inescapably certain, nations will act to avert catastrophe. By educating ourselves and others as to this matter, each of us can help achieve the necessary level of certainty.
Consider the tragedy of the Titanic. It is a metaphor for the surpassing vanity of mankind and the indifferent brutality of nature. As such it can speak to us about the looming threat of climate change.
On that night in April, 1912, hundreds of human beings consciously, and with deliberation, chose to die as a matter of honor in order to save women and children. Men of privilege, such as Isidor Straus and Benjamin Guggenheim, refused places on the lifeboats, choosing to wait in deckchairs for death to come. Of course, the immediacy of death, the certain foreseeability of the ship sinking, is what makes that case different from the perils of doing nothing about carbon.
Although the sinking of the Titanic is high drama, I don't believe it is any more fraught than the planetary threat we face today. It's just far more compressed. Two and a half hours to sink instead of 35 or so years to reach 7 degrees and even more to experience the full catastrophe. Humans are simply not well designed to contemplate, fear and act in anticipation of events - however terrifying - that are way down the road.
Somehow, despite the time-line, the resting frog -- our collective self - must be awakened.
Your Fiduciary Duty
As Trustees, you are fiduciaries charged with the duty of care. Here's how the American Law Institute's Restatement of Trusts describes that duty (in section 227):
"This standard requires the exercise of reasonable care, skill and caution, and is applied to investments not in isolation but in the context of the ... portfolio and as a part of an overall investment strategy, which should incorporate risk and return objectives reasonably suitable to the [purposes of the pension]."
Based on an informed view of all climate change factors, including those I've just outlined, it is easy to conclude on the basis of financial considerations alone that divestment of fossil fuel company holdings is a permissible option. And the moral dimension makes this conclusion even more powerful.
Whether, at this time, divestment is compelled by the duty of care is a more difficult question to answer. Anticipatory divestment in recognition that, at some unknown and unknowable point down the road, markets will suddenly adjust equity prices downward to reflect swiftly changing prospects for fossil fuel companies, however wise as a prudent option today, is probably not yet compelled in the exercise of due care.
But here's the most important point: Whether your portfolio will under or outperform after divestment is unknowable. Looking back in time, results vary depending on the measuring period and assumptions about how proceeds are reinvested. But past is not prologue here. And, in any case, fiduciaries need not worry about short-term results. Anticipatory investment should be viewed as having unknown short-term consequences. In the long run, those results are unimportant. A decision to divest rests on the claim that fossil fuel companies will prove to be bad investments over the long term and, therefore, with foresight that anticipates this result, should be removed from the pension fund before the strengthening and foreseeable likelihood of this result becomes commonplace in the market. As it did with coal. I hope that, very soon, you will make that decision.
Preface
In 2010, at Cancun, nations of the world set 3.6 degrees F as the permissible increase in global temperature over the pre-industrial level. Beyond that was catastrophe. Since Cancun, the dangers of climate change have grown and become palpable in myriad ways with which you all are familiar. And, yet, nations have made little progress. In fact, having put the car in reverse, they are accelerating in the wrong direction. Thus, the IEA reports our current trend-line will take the planet by 2050 to 7 degrees F, twice the level set in Cancun. Carbon emissions increased by 1.5% per year from 1980 to 2000. But, then, that rate almost doubled to 2.5 % per year through 2012. And in 2013, emissions jumped 2.3% to record levels. The IEA recently reported that the cost to de-carbonize by 2050 was $44 trillion, up from $36 trillion just two years ago, and climbing. The cause? An increase in coal usage that exceeds the increase in renewables.
The planet has already warmed by 1.5 degrees F since the pre-industrial era. On our present trajectory, we will blow by the 3.6 degree F level, reaching as much as 10 degrees F above the pre-industrial era by 2100. By then, civilization and its current residence will have become unrecognizable.
So, the planet has a big problem. I'm here to argue that divestment from fossil fuel companies is an important strategy for fiduciaries of all types to pursue. Here's why.
Purpose of Divestment
The argument for divestment clusters around two ideas: financial and moral.
Financial Reasons - Here the argument is reduction of risk to your portfolio. The risks are many and growing. Consider a few:
The very serious, yet hardly recognized, risk from "stranded assets", in particular "unburnable carbon". Let me explain. To hold to the 3.5 degree goal, there is a limit on how much carbon can be emitted to 2050. It's called the Carbon Budget and its reckoned through science.
The level is 886 Gigatons of CO2 from 2000-2050. Subtracting what's been emitted to date since 2000 (121 Gt) leaves 565 Gt left to emit. But just reserves proven on the books of public and private companies equal 2795 Gt of potential emissions, meaning that proven reserves are about five times what nations can allow to be emitted to 2050, if we are to avoid planetary catastrophe. So the rest is at risk of being stranded -- unburnable - if nations have a Darwinian moment and act. As they must. If this happens, of course, it means current market prices for fossil fuel companies are hugely overvalued.
And consider the risk to the $21 trillion of CAPEX by Big Oil that is planned for expenditure in the near term to develop unconventional oil projects.
And, the risk that, given the plummeting prices for solar and wind energy, oil prices will not remain high enough to profit from the sale of newly discovered reserves, which generally need at least $95 per barrel to break even.
And, overall, the risks from multiple problems facing the fossil fuels complex, including faltering productivity, falling profits, poor economics, environmental disasters and increasing competition from power plants and automobiles running on free fuel.
There are growing risks of stranding in the grid power sector. Barclays recently down-graded high-grade corp. bonds across the entire US utility sector, citing the energy threat of solar power and storage. Baseload power sources like coal and nuclear are being replaced by renewables, and in time the grid will become obsolete. In Europe, growth in renewables was the primary reason that the top 20 utilities lost $600 billion in market value over the past five years.
And I'm sure you know the losses in market value experienced by the coal industry over the past three years, down 61% against the S&P 500, up 47%. By the way, coal is the canary in the oil well, to coin a phrase.
Conventional oil peaked in 2005. Oil and gas production by Chevron, Exxon-Mobil and Shell declined over the past 5 years, even as they spent $500 billion in CAPEX on new projects - that's shareholder wealth that will potentially vanish down very expensive holes drilled in the earth.
Despite the recent surging flows of tight oil and shale gas in the US, the country is waking up to the fact of the huge decline rates of the sources for these products.
Renewable energy supplies at least 23% of global electricity generation today. Its capacity doubled from 2000-2012. Solar is now growing at a 30% rate/year. And is rapidly becoming cost competitive with fossil fuels.
Finally, consider that government subsidies for fossil fuels are some $600 billion per year, compared to just $90 billion for clean energy -- a public perfidy whose days are numbered -- a global outrage that soon will end. As it must.
There's an old saw: How did you go bankrupt? "Two ways: slowly at first; then all at once." In financial markets today, too few consider climate change an investment risk at all. Too many of those who do imagine it to be merely a tail risk, remote and barely worth noting. But change in energy is coming at a gallop. It's happened before. Consider, not long ago, when we used whales for light; horses for power; coal for steam to drive locomotion; now coal again for electricity. We need to disenthrall ourselves from old business models. And listen to the wise and well informed. Like Sheikh Yamani, Saudi Arabia's powerful Minister of Oil from 1962 to 1986. He famously said: "The Stone Age didn't end because we ran out of stones, and the age of oil won't end because we run out of oil."
Moral Imperative -this argument is particularly pertinent for public pension funds, so importantly affected with the public interest.
Given the Gargantuan existential risk of climate change to the planet, those in positions of leadership who fail to take reasonable steps to stop carbon emissions from rising become the moral equivalent of those seeking to deny the science and brush away the problem. As Galileo did by recanting to save his life. Divestment is a reasonable step for pension trustees to take.
What does divestment accomplish? It avoids the ugly picture of trustees seeking to profit from emissions of carbon through the sale and burning of fossil fuel reserves and especially through the massive use of shareholder funds to search for more fossil fuels to sell and burn. Such behavior violates the most basic norms of a civilized society.
I've tried to imagine how Homer, the great story-teller, would have described Big Oil. You'll have your own answer. Here's mine: "The lung-choking, ocean-poisoning, species-sickening pitiless scourge of humanity."
Divestment by any group, but particularly by thought leaders such as those responsible for public pension funds, helps to stigmatize the oil, gas and coal giants as repugnant social pariahs and rogue political forces bent on profit at whatever cost to the planet and its people. That is, the pitiless scourges of humanity.
Don't underestimate the power of being able to create pariahs. These companies fear stigmatization. It hurts in hiring, employee morale and motivation, shareholder satisfaction and equity valuations. And it hurts when leaders of these companies go home to face their children and grandchildren.
Do these companies deserve stigmatization? Consider, e.g., the Exxon-Mobil and Shell reports to shareholders on stranding. Despite each company's acceptance of the science, they smack their gauntlets across the collective face of humanity by asserting that no government restrictions will restrain them. Here, e.g., is E-M's statement:
"We are confident that none of our hydrocarbon reserves are now or will become stranded. ... Further, the company does not believe current investments in new reserves [which it intends to discover and develop in quantities at least equal to current proven reserves] are exposed to the risk of stranded assets, given the rising global need for energy..."
As the Carbon Tracker Initiative observes in its rebuttal to the Exxon-Mobil report, that company does not consider a low carbon scenario in its investment planning, which proceeds on a "business as usual" basis. Its projections are, without doubt, incompatible with meeting the 3.6 degree F goal. Studies show that the company's projections correspond with the IPCC's RCP 8.5 scenario, putting the planet on a pathway to about a 7 degree F increase from the pre-industrial era by 2050.
Divestment by leaders like you will help awaken us to the peril of inaction. Collectively, we are like the frog resting comfortably in a pot of cold water being heated to boiling. You can be among the first in the nation to shake this frog from the deadly comfort zone in which it rests.
Despite the success of the Peoples Climate March in New York City, even the most basic scientific arguments have not been settled. Consider, for example, in the NY Times of September 23, the comment of Freeman Dyson, distinguished and greatly admired theoretical physicist at the Institute for Advanced Study:
"What worries me is that many people, including scientists and politicians, believe a whole lot of dogmatic nonsense about climate change. The nonsense says that climate change is a terrible danger and that it is something we can do something about if we wanted to. The whole point is to scare people, and this has been done very successfully."
Dyson is wrong. Alas, not enough people have been scared. Too many are still slumbering frogs. Governments won't act until enough people -- call it a critical mass - have been scared by the foreseeability of the dire consequences that science tells us will follow inaction to demand their Governments to act, thereby driving down demand for fossil fuels and driving up demand for non-fossil fuel alternatives such as renewables, nuclear and efficiency. In fact, foreseeability is the key and every one of us holds that key in our hands. When a critical mass of people accept the foreseeability of dire consequences from inaction as being inescapably certain, nations will act to avert catastrophe. By educating ourselves and others as to this matter, each of us can help achieve the necessary level of certainty.
Consider the tragedy of the Titanic. It is a metaphor for the surpassing vanity of mankind and the indifferent brutality of nature. As such it can speak to us about the looming threat of climate change.
On that night in April, 1912, hundreds of human beings consciously, and with deliberation, chose to die as a matter of honor in order to save women and children. Men of privilege, such as Isidor Straus and Benjamin Guggenheim, refused places on the lifeboats, choosing to wait in deckchairs for death to come. Of course, the immediacy of death, the certain foreseeability of the ship sinking, is what makes that case different from the perils of doing nothing about carbon.
Although the sinking of the Titanic is high drama, I don't believe it is any more fraught than the planetary threat we face today. It's just far more compressed. Two and a half hours to sink instead of 35 or so years to reach 7 degrees and even more to experience the full catastrophe. Humans are simply not well designed to contemplate, fear and act in anticipation of events - however terrifying - that are way down the road.
Somehow, despite the time-line, the resting frog -- our collective self - must be awakened.
Your Fiduciary Duty
As Trustees, you are fiduciaries charged with the duty of care. Here's how the American Law Institute's Restatement of Trusts describes that duty (in section 227):
"This standard requires the exercise of reasonable care, skill and caution, and is applied to investments not in isolation but in the context of the ... portfolio and as a part of an overall investment strategy, which should incorporate risk and return objectives reasonably suitable to the [purposes of the pension]."
Based on an informed view of all climate change factors, including those I've just outlined, it is easy to conclude on the basis of financial considerations alone that divestment of fossil fuel company holdings is a permissible option. And the moral dimension makes this conclusion even more powerful.
Whether, at this time, divestment is compelled by the duty of care is a more difficult question to answer. Anticipatory divestment in recognition that, at some unknown and unknowable point down the road, markets will suddenly adjust equity prices downward to reflect swiftly changing prospects for fossil fuel companies, however wise as a prudent option today, is probably not yet compelled in the exercise of due care.
But here's the most important point: Whether your portfolio will under or outperform after divestment is unknowable. Looking back in time, results vary depending on the measuring period and assumptions about how proceeds are reinvested. But past is not prologue here. And, in any case, fiduciaries need not worry about short-term results. Anticipatory investment should be viewed as having unknown short-term consequences. In the long run, those results are unimportant. A decision to divest rests on the claim that fossil fuel companies will prove to be bad investments over the long term and, therefore, with foresight that anticipates this result, should be removed from the pension fund before the strengthening and foreseeable likelihood of this result becomes commonplace in the market. As it did with coal. I hope that, very soon, you will make that decision.