19 February 2018

Fossil fuel divestment doesn’t damage oil firms, just pension funds


In recent years there has been a campaign to compel investment managers with responsibility for British university endowments to divest themselves of any assets (eg, pension fund investments or shares in particular firms) associated with the mining or refinement of oil, gas, coal or other fossil fuels, often replacing them with investments in renewable energy or in communities most affected by climate change. This strategy has come to be known as “fossil fuel divestment”.

There are a number of fairly obvious objections to a fossil fuel divestment strategy. Proponents frame the campaign as a means to combat climate change and reduce emissions. But fossil fuel divestment would appear to be both an ineffective and expensive means to seek to achieve that end.

The fundamental determinants of the value of fossil fuel companies are the costs of extracting and processing fossil fuels and the demand for those fuels. Selling your fossil fuel stocks simply because you don’t want them, not because you have obtained some new information that suggests their value is lower than the market price, will not in itself make them worth any less.

You could, perhaps, make them worth less if you persuaded those that would be unusually efficient and effective owners of fossil fuel companies (say, by ensuring they were managed particularly well) not to own them. But it’s hard to see how the cause of mitigating climate change would be advanced by fossil fuel companies being run less efficiently, even in the implausible event that that could somehow be achieved.

Indeed, if you could coordinate such a large volume of the world’s capital behind your strategy that it would have any impact on fossil fuel companies at all, the more natural strategy is surely the opposite: to deliberately acquire controlling stakes in fossil fuel companies and then see that they are managed in the ways you would want — perhaps by investing heavily in alternative energy sources, in fuel efficiency improvements or in carbon capture systems; things many energy companies already do.

In practical terms, a refusal to invest in fossil fuel stocks acts almost solely as a signal of disapproval — a signal that comes at significant expense. At Europe Economics we have previously modelled the cost to investors of boycotting fossil fuels in their portfolios, through inefficient “diversification” (ie, avoiding the “putting all your eggs in one basket” problem). There are important situations in which fossil fuel stocks will be doing better precisely when other kinds of investments are doing worse, allowing investors to balance with gains on the swings what they lost on the roundabouts. So by refusing to invest in fossil fuel stocks, investors will be taking more risk if they leave their other investments in place. They could reduce their risks back to their preferred level if they reduced the riskiness of those other investments, as well, but that would come at a cost of lower returns.

The Europe Economics study found that from 2002 to mid-2015, if they did not want to accept lower returns, investors following the recommendation of the fossil fuel divestment campaign to exclude fossil fuels would have had to take more than 20 per cent extra risk on their investments. Alternatively, to keep the riskiness of their portfolios no higher, despite not using fossil fuel stocks, they would have sacrificed the equivalent of an annual return of 0.68 percentage points (68 bps).

To put that in perspective, if you invest £1,000 for 20 years at an 11 per cent annual return you would end up with about £8,000. If you reduce that rate of return by 68 basis points, then you would end up with about £7,000. Scale that up to the level of a university pension fund, and you would be putting a significant dent in people’s retirement plans.

Perhaps some university employees would be happy to have lower pensions in order to signal that they disapprove of fossil fuels. But universities need to attract talented staff, many of whom will not want to sacrifice one-eighth of their pensions on virtue-signalling. What’s more, it is not unknown for university lecturers and researchers to call for additional public money to be provided for their salaries. A cynic might suggest that some university staff would not be expecting their own salaries to drop but would, instead, hope to secure additional public funds to pay for their own choices. But will taxpayers really be willing to pay for university staff unnecessarily to cut their remuneration in order to have no practical impact on fossil fuel companies at all?

Andrew Lilico is an economist and political writer