The divestment of fossil fuel assets is a big statement. Its impact, however, is murkier. Selling an asset requires someone else to buy it, which, in the case of fossil fuels, can mean pumping new capital into the exact assets companies are trying to squeeze out. But there is another approach: sinking these assets into the ground. By retaining fossil fuel assets, investors can resist efforts to improve their production and extend their lifespan. By planning to terminate these assets, they maintain control and can ultimately have more impact than if they simply washed their hands and emptied these investments from their books.
Committing to divest from fossil fuels seems like a profound pro-climate statement. Selling fossil fuel investments, the logic goes, will choke the capital of fossil fuel companies and make it more difficult for them to operate. Eventually, divestment will lead to the demise of the sector and create a better environment to accelerate renewable energy efforts. By getting money out of fossil fuel investments, companies can demonstrate how they are taking an important step towards a more sustainable world.
Unfortunately, what looks good on paper is often insufficient in practice. There is a major problem with divestment: selling an asset requires someone to buy it. In other words, for you to divest, someone else has to invest. As a result, divestment could end up breathing new life into fossil fuel assets – the exact opposite of what is expected.
So what should a climate-conscious company do?
Divestment box work, but it has to be part of a larger liquidation strategy. Think of this holistic approach as taking fossil fuel investments as “shoving it into the ground,” like you would an old car. Buying a new car adds one to the roads, while using the old one until it is unusable delays the additional effect. To make an impact – not just a statement – companies should plan to end fossil fuel investments at the end of their useful life rather than shifting the blame to someone who might try to make them productive again. Here’s how.
What is divestment?
Fossil fuel divestment is a simple concept: the owner of a fossil fuel asset agrees to sell it to demonstrate adherence to sustainable finance practices and climate risk management. Divestment aims to withdraw capital from companies that threaten the environment, making divestment a tangible act of “voting with your dollars”. The objective is to create constraints on the capital available in the fossil fuel sector, which should hinder the operations of companies in the target sector and limit returns to shareholders, making the category less attractive to investors. Ultimately, divestment aims to make fossil fuel companies so unattractive that they will struggle to survive.
The fossil fuel sector is not the primary target of divestment campaigns. The classic example is the targeting of companies in South Africa in the 1980s. Driven by opposition to apartheid, the divestment gained favorable perception and was meant to generate global awareness and sentiment against the South African government. Closer examination, however, reveals that divestment never really politics influenced. Other divestment campaigns have had even less impact. All the benefits of the tobacco divestment campaign in the 1990s, similar to South Africa and the fossil fuel campaigns, but with much less fanfare, for example, would have been obscured by effects of litigation.
Despite the meager track record of divestment, it’s easy to argue that the campaign against the fossil fuel sector is different, if only because of its scale. Fossil fuel divestment is widely believed to have become the the most successful such campaign in history. More … than $40 trillion in assets pledged to divest, i.e. nearly two-thirds of all global pension fund assets under management ($56 trillion). And it represents 1,550 institutional investors, including AXA Investment Managementthe Ford Foundationthe Norwegian sovereign wealth fundand Harvard University.
Nevertheless, many still question how well divestment works, even for fossil fuels. Specifically, there have been no clear links to the real realignment of capital flows away from fossil fuels, and in fact the fundraising environment appears to have improved, growth from $234 billion in 2000 to around $700 million in 2015. If history is any guide, past divestment efforts suggest limited future success at best, with the availability of capital accentuating this forecast.
Why doesn’t divestment work?
The effectiveness of divestment campaigns depends on perspective. From the perspective of the transferring party, is very effective. Fossil fuel asset sellers vote with their dollars and publicly proclaim their positions – and $40 trillion is a jaw-dropping commitment. Sellers can remove unwanted assets from their portfolios, freeing up capital to allocate to cleaner or otherwise more preferable investment opportunities. On the other hand, capital to the dirtiest parts of the energy sector continues to flow. Divestment by one party implies investment by another, which results in more capital flowing into the fossil fuel sector, in violation of the seller’s objectives.
However, the issue is more important than “money goes out, money comes in”. The real problem is that the new buyer has a primary interest in making this asset work and generate returns. This often means improving the overall productivity of the fossil fuel investment, including promoting increased production through longer useful life. Thus, that the divestment work in such a situation comes down to how the climate benefits of the reallocation of the surrendering party versus the asset improvements made by the buying party.
Let’s take an example. The selling asset manager sells an oil refinery and reallocates its capital to renewable energy assets. The party that buys the refinery invests in improvements. To assess the benefits of divestment, the climate benefits of the renewable energy portfolio are expected to exceed those of the upgraded refinery. Even attempting to calculate this would be a difficult exercise, requiring both parties to commit to the effort, the engagement of a qualified independent party, and even agreement on definitions and methodology (itself a nest of hornets in sustainable finance).
Fossil fuel divestment certainly has some value as a promotional and advocacy tool, and in general, the move by asset managers to divert capital away from fossil fuels is laudable. However, it requires near-total adoption to be truly effective, and without this penetration, divestment could have the unintended negative consequences described above. For greater effect than symbolism or public discourse, alternatives to the sale of fossil assets should be considered.
What’s better than a divestment?
Run-off strategies are poised to succeed where divestment campaigns fail. As illustrated above, divesting is built on an inherently contradictory and counterproductive dynamic, in which the divested asset could become more negatively effective. On the other hand, selling an asset instead of selling it simply means holding onto it until it can be terminated. For example, this could mean holding a fossil fuel company’s debt until maturity and not renewing or extending another loan, or it could mean operating a physical asset (like a refinery) until that it is no longer useful, including resisting investments in improvements that would make the asset more productive and more durable. Instead of extending the useful life of a fossil fuel asset or otherwise improving it, runoff involves setting a time horizon for ending its productivity.
The run-off, of course, lacks the immediacy of the divestment. Selling an asset today – or committing to it – is easy to communicate: I get that off my books now. This makes a great line in a letter to investors. Explaining a fossil fuel runoff strategy requires complexity, nuance, and patience. In the long run, it’s worth it. And, runoff can even be associated with divestment. Divesting an asset to a party that agrees to dispose of it puts the asset on a runoff path. While the run-off hasn’t received as much attention as the divestment, the strategy is already in use. The 2% position in fossil fuel investments that survived Harvard University’s endowment surrender commitments is in fossil fuel investments at flee.
The path of least resistance can also be the path of least outcome. Depleting fossil fuel assets may take longer and seemingly require more capital than divestment, but the strategy has teeth. Divestment, on the other hand, is easy to achieve and scale. Ultimately, divestment can only work if paired with long-term action, and that’s where trickle-down can help. The disposal of fossil fuel assets overcomes the fatal flaw of disposal and tends to remove fossil fuel assets from the market. Yes, the second round lacks immediacy and we lack patience. Instead of viewing runoff – or divestment or whatever – as a discrete solution to climate change, consider it in a broader context of climate risk mitigation tools. Run-off should not exist in a vacuum, and asset managers should consider a wide range of sustainable funding strategies for their portfolios.
Divestment allows for a better press release. Runoff makes the world a better place.