The divestment dilemma

November 24, 2020 / Engagement and Advocacy

Blurred lines

A first step is to decide what types of firms qualify for divestment. Should divestment focus on those that produce fossil fuels? Or firms that burn them, releasing global warming gases into the atmosphere? Are firms that support the fossil fuel supply chain in or out? Coal ports? Gas pipelines? Roadside retailers of petrol (“gas”)?

Burning fossil fuels is a major part of industries as diverse as energy generation, steelmaking and aviation. Are these all candidates for divestment too? Many of the largest organisations involved in fossil fuels are governments; should countries be divested too?

Are fossil fuels equal? Is coal burnt to make steel for wind turbines worse than lower-carbon oil to air freight fresh tropical fruit to temperate markets? Is it worse than food firms’ destruction of carbon sinks like The Amazon, for agricultural expansion? Is it worse for a firm to undermine climate action with propaganda? If so, some media companies are higher priorities for divestment than coal.

The good news is that a well-canvassed consensus on such questions is developing, as a result of the new EU taxonomy for “environmentally sustainable activities”. After long and fiercely contested debate, the EU converged on a sensibly functional framework: with a top-line focus on activities rather than industries, and clear guidance on which activities these count as “climate-mitigating”. A framework for activities that harm climate mitigation is still underway.

Digging deeper

To avoid being paralysed by the possibilities, I recommend that clients stay focussed on their rationale.
A well-founded rationale for considering divestment makes many of the confounding complexities recede and is a ready-reckoner for whether (and which) divestments would deliver the desired result.

For some investors, divestment is about wielding capital responsibly; they see withholding capital from fossil fuel businesses as a way to deny them support. However for mature, publicly traded companies; divestment involves one investor selling shares to another, and these transactions are dwarfed by the volumes of shares that trade on any day. The financial position of a fossil fuel company may be unaffected by divestment decisions made by equity investors.

For others, divestment is more akin to a boycott; a protest expressed through refusal of fossil fuel-based returns. This has historical precedents, for instance the “disinvestment” of companies operating in South Africa in protest of Apartheid, as part of a sustained global campaign that also included a UN resolution, trade sanctions, and boycotts of the country by consumer, sporting, academic and cultural groups. Isolation of fossil fuels, in contrast, is nearly impossible as they are entangled in everything from agricultural production to defence. Even most climate-action oriented investors would struggle to back their divestment with a boycott of fossil fuel use.

Hammer and nails

Systemic problems like climate change require system interventions. Focussing on a single investment portfolio could be viewed as myopic in this context; perhaps a case of “when all you have is a hammer, everything looks like a nail”.

In fact, the divestment ‘hammer’ is far from the only tool in the kit. Investors who prioritise climate (versus portfolio) objectives often use other, more powerful tools.

Stewardship initiatives – in which investors use influence for climate action – have gained momentum, and are getting results. Examples include victories claimed by the Climate Action 100+ coalition which
co-ordinates many institutional investors to secure climate commitments from the world’s largest corporate emitters; including fossil fuel companies.

Investor stewardship at times goes further; electing directors, putting resolutions forward, or stipulating conditions to be met before agreeing to roll over debt. Reining in fossil fuel company influence on government carbon policy or appointing corporate leaders committed to decarbonisation are among the ambitious climate outcomes investors have pursued.

Direct advocacy with regulators, industry bodies and governments, is a further avenue that should not be neglected. Pricing carbon pollution, removing fossil fuel subsidies, and supporting institutional R&D are all in the interests of diversified investors. Investors can at a minimum check that they don’t support climate inaction, directly or through third parties, for example via support of business groups, political parties, or public communication platforms that obstruct, diminish or delay climate action.

Also effective is well-targeted catalytic investment. Early investors (for instance in energy storage technology) helped spawn whole industries (like electric vehicles) now transforming the world’s reliance on burning fossil fuels.

Know when to hold them, (know when to fold them)

None of the above means divestment should not be considered; indeed many investors divest when they believe that markets have failed. This includes investors who believe many fossil fuel assets are ‘stranded’, and think this is not well reflected in their price. It also includes those who think fossil fuel liability risks are not worth taking. Or those simply seeing more attractive opportunities elsewhere.

This last of these highlights the unspoken assumption that investors default to holding all available shares. For active investors, ‘divestment’ is superfluous: they hold only the assets they have explicitly chosen to own.

These investors are also better placed to pursue climate action through stewardship, without this being compromised by their continuing interest in good returns from fossil fuels. Indeed this may be one of the better reasons for investors to divest: to free them from ambivalence about the fortunes of fossil fuels, and thus empower them to be more assertive in global decarbonisation to protect their broader more enduring investments.

 

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