23 April 2018

Divesting from oil companies is pointless posturing


Fossil fuel divestment has lately become big business. It began as a distinctly niche political movement, aiming to kick the finance-intensive oil and gas industry where it hurts by lobbying publicly-owned funds to divest. Now, it’s going fully mainstream. New York City’s $189bn public pension fund has recently announced that not only will it withdraw the $5 billion it has in fossil fuel investments, but the city will also sue the companies over their contribution to global warming.

The latest high-profile case is the University of Cambridge, which is under sustained pressure from some of its students and academics to divest its £6.3bn endowment fund of fossil fuels.

The apparent reluctance of the university to do so stems from worries about research funding – Cambridge has in the past received money from major oil companies, and is home to the BP Institute. But it is claimed that its continued investment in fossil fuels is contrary to its commitment to sustainability outlined in the university’s values statement. A decision on the matter is expected within days.

There is an undisputable link between fossil fuels and climate change, and all of its negative effects. The onus is on governments, universities and private companies all over the world to find commercially viable alternatives. The divestment debate touches on one aspect of this matter – scepticism of it does not reflect on others.

But there are good reasons to be sceptical – both in terms of whether divestment helps reduce consumption of fossil fuels and encouraging development of renewables, and secondly, whether any eventual financial losses incurred are a good price to pay.

Turning to the first point, the evidence does not inspire confidence. A study by Oxford’s Smith School for Enterprise and Management found that “direct impacts on equity or debt are likely to be limited”, and that “even if the maximum possible capital was divested from fossil fuel companies, their shares prices are unlikely to suffer precipitous declines over any length of time”. The reason is simply that the amounts which can be divested by funds potentially receptive to political pressure pale into insignificance compared to the huge market capitalisations of these companies.

Perhaps more importantly, the study also points out that the divested share is likely to simply be snapped up by investors not driven by ethical considerations wishing to increase their holdings, neutralising any negative effect the divestment had in the first place. This second phenomenon was also found to be the case in a study by economists Siew Hong Teoh, Ivo Welch, and C. Paul Wazzan who studied the impact of Apartheid boycott campaigns on South African stocks and on American stocks with South African exposure.

According to William MacAskill, an Oxford ethicist and one of the founders of the Effective Altruism movement, “if the aim of divestment campaigns is to reduce companies” profitability by directly reducing their share prices, then these campaigns are misguided’. As MacAskill illustrates:

“An example: suppose that the market price for a share in ExxonMobil is ten dollars, and that, as a result of a divestment campaign, a university decides to divest from ExxonMobil, and it sells the shares for nine dollars each. What happens then? Well, what happens is that someone who doesn’t have ethical concerns will snap up the bargain.

“They’ll buy the shares for nine dollars apiece, and then sell them for ten dollars to one of the other thousands of investors who don’t share the university’s moral scruples. The market price stays the same; the company loses no money and notices no difference.”

Then there is the question of costs to the taxpayer if the fund in question publicly-owned. The first priority of taxpayer-owned investments – such as public sector pensions – is to deliver the best returns they can. We rely on them to ease the financial impact of an ageing population on future generations.

If their performance suffers as a result, that matters because it means less money coming in to the Exchequer. It is therefore not a choice between doing the unequivocally good and virtuous (divest) and the unequivocally bad and unethical (not divest). It’s a trade-off, and – as demonstrated by the previous section – not a particularly good one.

In the case of public sector pensions the problem is particularly pronounced because so many of them are defined benefit and therefore the payouts they guarantee are independent of the returns generated by the underlying fund. The lesser the returns, the greater the gap which needs to be covered by the taxpayer. MPs arguing for divestment with regards to the parliamentary pension fund – a group which includes Jeremy Corbyn – ought to bear this in mind.

But there is one other aspect of this story worth mentioning. One of the reasons why the divestment campaign grew in prominence – and shows no signs of abating – is because increasingly, renewable energy stocks can offer attractive returns, though much of this is due to government subsidies which suggests the technology may not be there quite yet. At the same time, the market is growing weary of the notion of “stranded assets”, which is the risk of sudden regulatory or market changes tanking the price (and liquidity) of fossil fuels, “stranding” investors with them.

This means that it is very possible that trends exhibited in numerous studies comparing performance of divested and non-divested funds – unequivocally pointing to lower returns for those pursuing divestment – may not hold forever. When that happens, prioritisation of returns for taxpayer-backed funds will involve shunning fossil fuels. But until then, those running them need to remember that, firstly, evidence on the effectiveness of divestment is at best mixed, and secondly, that their primary obligation is to the taxpayers.

Jan Zeber is a Policy Analyst at the TaxPayers' Alliance.