Frequently Asked Questions

The Fossil Fuel Divestment Discussion

 

⊕Goals

The goals of fossil fuel divestment are:

What fossil fuel divestment won’t do:

⊕The Basics

Q: What is divestment?

Q: What are fossil fuels?

Q: What is the Greenhouse Effect?

Q: Where’s the best place to find the science of global warming?

⊕Fossil Fuels have a Short Future

Q: What’s the problem?

Q: When do we need to stop burning fossil fuels?

Q: But, what if we don’t go carbon-neutral?  Suppose the world just keeps burning fuel?

Q: But, we can fix it later, can’t we?   We can capture carbon from the atmosphere and remove any excess CO2, right?

Q: But, we can fix it later, can’t we?   We can use plants to remove excess CO2, right?

Q: But, we can fix it later, can’t we?   We can do geoengineering to keep the Earth from getting too hot, right?

⊕What a Zero-Carbon Economy Means to Fossil Fuel Companies

Q: What will fossil fuel companies do when we (nearly) stop burning carbon?

Q: But prices of fossil fuel stocks have fallen by (10% or 20% or 30%) already.  Surely, they will go back up, and when they do, anyone who has divested will lose money?

Q: Why will these companies become worthless?

Q: What is the Carbon Bubble?

Q: But surely, the price of oil will go back up.

⊕Why Divest?

Q: Why divest?  It doesn’t harm the company.  As John Silber observed “once a stock issue has been made, the corporation doesn’t care whether you sell it, burn it, or anything else, because they’ve already got all the money they’re ever going to get from that stock. So they don’t care.”

Q: But, isn’t it better to engage with these companies in the hopes of changing them?  As a large activist shareholder, Pittsburgh might have influence.

Q: Should we divest from all fossil fuels or just coal?  Coal is the “dirtiest”, in terms of CO2 released per unit energy.

Q: But the free market is supposed to do the best possible job of pricing stocks.  Theoretically, it should already have taken global warming into account.

Q: The free market will solve global warming.

Q: How will divestment change the pension fund’s return on investment?

Q: If it is immoral to own stock in fossil fuel companies, how can it be moral to sell that stock to someone else?

Q: It seems that divestment does not help solve the underlying problem, which is the consumer demand for fossil fuel.  Also, it does not help push research and production of new energy and infrastructure.

⊕Financial Details of Divestment

Q: Doesn’t the 1974 ERISA act says that pension funds need to be operated strictly for the maximum immediate financial return, and minimum immediate risk.

Q: Doesn’t ERISA require the fiduciary to minimize risk, and to diversify?

Q: But Modern Portfolio Theory (MPT) says that the lowest risk portfolio is the one that is broadly invested across the entire market.

Q: Are there carbon-free mutual funds?

Q: Are we going to get lower short term returns without fossil fuels?

Q: What is the pension fund?

⊕Related Links

⊕Goals

The goals of fossil fuel divestment are:

  • Economic: Divestment insulates public funds from the risks of the fossil fuel industry.  Over the term of a typical pension fund (e.g. 25 years), the fossil fuel industry is almost certain to decline and largely disappear.  Why invest in an industry that is going away?
  • Moral:  We do not wish to contribute to the slow-motion disaster of climate change, and it is wrong to profit from the disaster we are inflicting on future generations.
  • Political: To limit Earth’s temperature rise, we will need to gradually shut down fossil fuel companies.  Divestment makes it clear that these industries are working on borrowed time.
  • Economic: Divestment is a way of getting Wall Street’s attention.  Solving (and adapting to) the climate change problem will be a huge undertaking, and will not be possible unless the financial system provides support.
  • Overall: We want to push the economy away from unsustainable fossil fuel energy sources, and towards better and safer ways of providing the energy we need.

 

What fossil fuel divestment won’t do:

  • Cause fossil fuel companies to go bankrupt.
  • Dramatically reduce their share prices.
  • Reduce us to living in unheated cabins.

 

⊕The Basics

Q: What is divestment?

A: Divestment means asking the pension fund to sell its stock in fossil fuel companies and to invest the proceeds in something else.  Somewhat less than 10% of the portfolio is invested in fossil fuel companies, as of early 2016.

 

Q: What are fossil fuels?

A: Coal, oil, and natural gas.  Fuels brought up from underground.

 

Q: What is the Greenhouse Effect?

A: When we burn fossil fuels, and release carbon dioxide, or CO2, the CO2 traps heat.  This effect was first understood by Svante Arrhenius, in 1897, and he correctly predicted global warming.  There are many explanations of this effect available online.

 

Q: Where’s the best place to find the science of global warming?

A: In the IPCC report.  But be aware that there’s a lot of it to read.

 

⊕Fossil Fuels have a Short Future

Q: What’s the problem?

A: We have discovered more fossil fuels than we can safely burn.  To avoid dangerous global warming, and to avoid acidifying the oceans, we will need to leave about 80% of the discovered fossil fuels in the ground.  This requires political resolve, because unless something is done, companies aren’t likely to stop drilling and selling.

 

Q: When do we need to stop burning fossil fuels?

A: As soon as possible.  We have a global carbon budget that amounts to less than 25 years of our current burn rate to keep temperature rise below 2 degrees Celsius and a carbon budget of 12 years for the preferred 1.5 degree Celsius rise.

If we start from the over-optimistic assumption that the world will ramp down fossil fuel use starting this year, our burn rate would have to hit zero in 2040  to keep temperatures below 1.5 C or 2065 to stay below 2 C.  But, realistically, we’re not ready to start ramping these industries down yet, especially in places like India.  Even in the US, assuming the new EPA rules for power plants pass court challenges, we don’t plan to start ramping down until 2022, and that only covers CO2 pollution to make electricity.

So, with a slow US start, and with India and China burning more carbon for a few years, to meet to global carbon budget, we’ll need to ramp down faster once we start. We’ll need to reach zero burn rate between 2030 and 2050.  So, the fossil fuel industry might operate as usual until 2022, but from then on, it must shrink until it disappears some time around 2040.

That schedule is well within the time horizon of pension funds.  An employee who is 41 years old in 2016 will be 65 years old in 2040 and will be ready to start collecting a pension, just about the time that stocks in fossil fuel companies will become valueless.

 

Q: But, what if we don’t go carbon-neutral?  Suppose the world just keeps burning fuel?

A: We must, because the alternatives are too dire.  Over time, the effects of climate change will become more and more obvious, and we will cease to use fossil fuels out of self-preservation.

A: There are two basic problems: climate change (or global warming) and ocean acidification.  Both of these problems will worsen as long as we continue burning fossil fuels and adding carbon dioxide to the atmosphere. [Summary, NASA summary, NCAR, IPCC detailed report]

Global warming will cause the oceans to rise as the Earth’s ice caps melt; and it will bring tropical weather and diseases to the United States.  Over time, many of our major cities will be flooded and lost to the waves; the periodic flooding of Miami is an early example.

Climate change caused by burning fossil fuels may eventually turn much of the United States into desert, and will certainly force us to move our farms.  In some parts of the world, natural disasters, failure of farms and stress may lead to the collapse of governments, leading to wars and refugees.

If we are persistent enough in burning fossil fuels, we may be refugees, competing for living space in the North of Canada.  It’s really a case of “how bad do we want it to be?”

Another risk is ocean acidification, as the carbon dioxide we release makes the oceans more and more acidic.  The chemistry of this is simple and extremely predictable, but the ecological effects are not yet well understood.  What we know is that the acidic ocean water will either dissolve the shells of  shellfish and plankton, or force those plants and animals to spend substantially more energy to maintain their shells.  We see these effects already in the declining productivity of oysters, but the effect on the plankton species that form the base of the ocean’s food chain may be large.  Fisheries and fish farming may collapse, if nothing worse.

 

Q: But, we can fix it later, can’t we?   We can capture carbon from the atmosphere and remove any excess CO2, right?

A: Not enough.

Carbon capture and storage only makes sense when it’s done right at the smokestack of the power plant, and even then it is fairly expensive.  The process use lots of energy (about 30% of the energy from a power plant would be used to capture its CO2).  The process also produces quantities of waste (i.e. used chemicals) that need disposal, and the huge quantities of CO2 that it captures then need to be safely shipped and injected into deep wells.

“Air capture” — removing CO2 from the air — is dramatically more expensive.  The laws of Thermodynamics state that you need to pay an extra cost to separate the CO2 out of the air, after it mixed with the atmosphere.  You can think of it as the cost to inspect thousands of air molecules to find a single CO2 molecule.  This cost (called “entropy”) can be calculated precisely, and it’s not subject to technological improvement.  It’s fixed by the laws of nature.

The American Physical Society has evaluated the process and concludes: “High-carbon energy sources are not viable options for powering [air capture] systems, because their CO2 emissions may exceed the CO2 captured.”  In other words, to capture the CO2 from a coal fired power plant, it takes more power than the plant produces.  This is a losing proposition.

 

Q: But, we can fix it later, can’t we?   We can use plants to remove excess CO2, right?

A: Not enough.    [Nontechnical article, formal IPCC report]

It takes a lot of trees to absorb a billion tons of CO2, and we produce about 40 billion tons per year.  We simply cannot plant enough trees; there is simply not enough suitable land.

Likewise, soil carbon management is a useful technique, though not sufficient.  The idea is that carbon in soil is stable for centuries if properly treated, so if we can change agricultural practices or add biochar to the soil, we can pull a substantial amount of carbon out of the atmosphere.

We can also artificially add carbon to the soil by creating biochar and burying it.  The idea behind biochar is that you grow plants or collect household waste, partially burn it to yield black carbon, and then bury the solid carbon.

Soil carbon management has the promise of removing some carbon from the atmosphere.  The idea behind soil carbon management is that soils contain more carbon than the atmosphere does, and that we have degraded our soils, releasing carbon.  If we put carbon back into the soils and treat them right, they will store carbon for centuries.

These are all fine techniques, but none of them are especially easy, and they take much land, or they require us to change agricultural practices over large areas.  Most importantly, though, the soil cannot absorb carbon as fast as we would like to burn it.  These methods can store away about 1 billion tons of carbon per year, which is fairly small compared to our current burn rate of about 40 billion tons per year.  So, again, our only option is to reduce our burn rate dramatically.

Overall, plant-based solutions simply cannot capture CO2 fast enough.  They can remove about 1 billion tons per year, but we are currently burning about 40 billion tons per year.  Again, these approaches will be useful once we’ve eliminated at least 90% of our CO2 production, but there is no alternative to switching to a (nearly) carbon-free economy, where all of our energy comes from renewables (and maybe some from nuclear or fusion energy).

 

Q: But, we can fix it later, can’t we?   We can do geoengineering to keep the Earth from getting too hot, right?

A:  We don’t know enough about geoengineering yet, and that should be a red flag.  We don’t know practical methods, and we don’t have a good understanding of likely side-effects.  What if we plan for it and it doesn’t suffice?

Geo-engineering is essentially the art of controlled pollution.  The idea is to introduce stuff (like sulfate dust) into the upper atmosphere; that dust would then scatter some of the sunlight back to space before it has a chance to warm the Earth.

It’s hard to really understand and predict the effects of geo-engineering for the simple reason that we have only one Earth, so there’s no way to do a laboratory experiment on a spare planet.  If we try it, we will be experimenting over our own heads, and there will be no going back if it goes wrong. 

But, even if geo-engineering works and keeps the Earth cooler, we still need to stop producing CO2.   That’s because of ocean acidification.  Geoengineering won’t keep CO2 out of the oceans, so it won’t keep the ocean from getting more acidic.

Ocean acidification is the unknown twin sister of global warming.  Essentially, excess CO2 in the atmosphere dissolves in the ocean, and reacts with the water to form dilute carbonic acid.   This acidic ocean dissolves the shells of a wide variety of sea creatures, notably plankton, coral, and shellfish.  As a result, the ocean ecology will change dramatically if we keep burning fossil fuels.  At the moment, we don’t know enough to predict the details, but we can compare it to some of Earth’s great extinction events.  It is disturbing that we have increased the ocean’s acidity one-seventh of the way to what it was during Earth’s greatest mass extinction event.

As with all the other mitigation strategies, geoengineering may be a useful tool to have, but it cannot help us unless we get to an economy that produces no more than a small amount of CO2.  There is no substitute for a (nearly) carbon-free economy.

 

⊕What a Zero-Carbon Economy Means to Fossil Fuel Companies

Q: What will fossil fuel companies do when we (nearly) stop burning carbon?

A: They will shrink; some may go out of business; the rest will become worth much less than they are today.  What else can they do?  They will be selling much less of their product.

 

Q: But prices of fossil fuel stocks have fallen by (10% or 20% or 30%) already.  Surely, they will go back up, and when they do, anyone who has divested will lose money?

A: Ultimately, the price of any fossil fuel company is expected to go to zero, so there is lots of room for further declines.  While we don’t expect them to go to zero immediately, and they may well go up and down in the mean-time, the long-term trend should be downward.

  • Why should their price go to zero?  It boils down to this: we need to get to net-zero emissions, and capturing CO2 is uneconomical.  Put those together and you see that we will need to stop burning fossil fuels.
  • If we stop burning fossil fuels, the companies that extract them will have no value.
  • Why net-zero CO2?  Because about 1/4 of the CO2 we emit will stay in the atmosphere for thousands of years.  If we keep producing net CO2 even at a small rate, it will accumulate and we will have continuing warming and a long-term climate disaster.
  • Why can’t we extract CO2 from the atmosphere?  Once we release a molecule of CO2 into the atmosphere and it mixes with all the air, it takes an unreasonably large amount of energy to find it and pull it back out.  Even capturing the CO2 from a power plant where it is easiest and cheapest (at the smokestack) is still expensive, using about ¼ of the energy produced by burning the fuel.  (And, then what do you do with all the excess CO2 that would be captured?  While CO2 has some uses, we don’t have a need for the huge quantities that would be produced.)

 

A: Financial markets are becoming aware that fossil fuel companies may not be viable long-term investments.  For instance, HSBC warned clients that investors who stay in fossil fuels “may one day be seen to be late movers, on the ‘wrong side of history’”.  Also, the Governor of the Bank of England has warned that investors face huge climate change risks.  These warnings suggest that financial experts think that fossil fuel companies will not do well over the coming decades.

 

Q: Why will these companies become worthless?

A: Let’s use Exxon as an example fossil fuel company, just to be concrete, but the same analysis applies to all of them.

A share of stock gives you the right to Exxon’s future earnings and dividends.  Now, suppose the world were going to be carbon-neutral at the beginning of 2040.  How much future earnings there be on the last day?   Zero, because Exxon wouldn’t have any time left to sell oil.   So, the rational stock price would be zero on December 31, 2039.

So, as we approach the carbon-neutral date, the stock price should go down, because there will be less and less future earnings, simply because Exxon would be running out of future.

The same thing happens to the value of Exxon’s oil reserves.  On December 31, 2039, any reserves in the ground would be worth nothing, because there isn’t time to pump them out and sell them.  Again, as we approach the carbon-neutral deadline, the book value of in-ground reserves should decline towards zero.

Of course, the situation is more complex than that. No one (yet) knows exactly when these companies will be shut down, so there isn’t a firm endpoint.  Also, their earnings are not directly tied to how much carbon these companies sell: the price of coal, oil, and gas may fluctuate wildly in the next 25 years.  So, maybe, for a while, the earnings will go up even as the amount of carbon sold goes down.   But, once we stop burning carbon, it’s hard to imagine that there will be much in the way of earnings.

All-in-all, the end-game is clear, even though it may be an interesting route to get there.

 

Q: What is the Carbon Bubble?

A: Another reason the price of fossil fuel companies will go down dramatically  is because we are in the midst of a “carbon bubble”.  We know that we must leave at least 70% or 80% of known fossil fuel reserves in the ground to avoid dangerous climate change.  But we don’t know which reserves will be sold, and which will be left underground.

Human nature being what it is, no  company — yet — wants to officially recognize that fact.  Each company is hoping that they will be able to sell all of their reserves, and hoping that the coming restrictions will apply to someone else.  So, they all keep all of their reserves on the books at full value.  Right now, there are about five times more fossil fuel reserves on the books than anyone will ever be able to sell.

But, sooner or later, the carbon bubble will pop: the market will adopt a more realistic value for the reserves.  When that happens, most companies will need to take huge write-downs on the book value of their assets, and their stock price will also drop.

That’s why Divest Pittsburgh’s legislation gives financial managers the flexibility to do time their exit or gradually spread divestment over five years of market fluctuations.  We want to give the market professionals the freedom to do their job.

 

Q: But surely, the price of oil will go back up.

A: Maybe, or maybe not.  If the capacity of renewable power grows fast enough, the demand for oil might drop below the supply, and stay there.

A: If you were a company or country with a large supply of oil, and you began to believe that there was a global carbon budget and that it would be enforced, what would be the rational thing to do?

If you truly believed that 80% of the existing fossil fuels would need to be left in the ground (which is the case), then you would try to sell your oil fast.  If you (instead) tried to keep the price high, sell slowly and wait, then someone else will sell their reserves first, and you will be left with reserves in the ground that you cannot sell.  So, a rational oil company will try to sell early, even if it means selling at a low price.

It is, again, the tragedy of the commons.  Individually, it is to the advantage of each oil company to sell as fast as possible, because they know that there are a limited number of barrels of oil to sell, and that if they don’t someone else will.  As a consequence, one would expect prices to go down — and perhaps stay down — until governments shut down the fossil fuel industry.

 

⊕Why Divest?

Q: Why divest?  It doesn’t harm the company.  As John Silber observed “once a stock issue has been made, the corporation doesn’t care whether you sell it, burn it, or anything else, because they’ve already got all the money they’re ever going to get from that stock. So they don’t care.”

A: Our intent is not to harm the companies, but rather to help start an orderly transition away from fossil fuels.  Divestment is a way for people to demonstrate to each other and to the financial system that they are serious about climate change and the future of the planet.

 

A: John Silber’s statement only applies to companies that will never again issue stock and do not care about their public image.  Yes, the company has gotten their money from the last time they issued stock, but divestment can affect the next time they wish to sell shares.  And, selling new shares is a common event: for example, Facebook issued new shares 28 times between May 2012 and the end of 2015, and three of those sales exceeded $100M.

 

Q: But, isn’t it better to engage with these companies in the hopes of changing them?  As a large activist shareholder, Pittsburgh might have influence.

A: Pittsburgh isn’t that big a shareholder of these companies.  Our $660M pension fund holds only a few million dollars of even the largest fossil fuel companies; and these are multi-billion dollar companies (BP’s stock is worth about $110 billion dollars).  So, we could twist BP’s arm with perhaps 0.01% of their shares; that’s not enough to get much attention.

 

A: Even if we got BP’s attention and spoke to the CEO, and convinced him, what could he do?  Converting an oil company like BP into (for example) a solar energy company is a daunting task.  The company doesn’t know much about making or installing solar PV panels.  There would need to be a huge amount of re-education of engineers and managers, and many mistakes would doubtless be made.  Meanwhile, profits would disappear and be needed to build new factories; shareholders would revolt.

Historically, large companies often do not survive a major change in their industry.  So, even if engagement were a total success, we might lose our investment.   In fact, if engagement is a success, we would be very likely to lose at least part of our investment while the company re-tools.  And, we would also be likely to lose the remainder, if the new company cannot win against its competitors.

Suppose that after 5 years, Pittsburgh convinces BP to change to a solar photovoltaic company.  Why would one expect BP to win against entrenched competitors?  There is certainly no guarantee.

(One solution is to split the company into fossil fuel and renewable halves, like E.ON has recently done.   Each half can then pursue its own strategy without compromise.  But, that approach sets up the fossil fuel half for eventual shrinkage and disappearance.)


A: Real “Engagement” amounts to walking into a shareholder meeting and proposing a resolution that the company shall voluntarily leave 80% of its potential profits in the ground.  (Perhaps to be picked up by the competitors.)  Such a resolution would, realistically, never pass.

 

Q: Should we divest from all fossil fuels or just coal?  Coal is the “dirtiest”, in terms of CO2 released per unit energy.

A: We need to move towards an economy that has net-zero carbon.  Consequently, we cannot burn coal, oil, or gas.  None of them are carbon-free.

If this were still the 1990s, maybe we could have just divested from coal, but that didn’t happen and we need to make up for lost time.  If we invest in new gas-fired power plants, now in 2016, we will be shutting them down before the end of their useful lifetime.   (Recall that power plants last 50 years or so, and we need to stop burning all fossil fuels by about 2040, in about 25 years.)  So, investment in fossil fuels is becoming economically wasteful.  We are reaching the point where anything that we build that depends on fossil fuels will have to be rebuilt before it wears out.

 

A: Gas leaks release methane, a powerful greenhouse gas, and gas leaks are common.  So, there appears to be enough leaks so that natural gas — when the full production process is considered — causes as much climate change as coal.

 

A: There is no trajectory where human civilization has a reasonable chance of comfortable survival if we burn all of our fossil fuels.  We need to switch to a zero-carbon economy, and we might as well start by divesting all fossil fuels.

 

Q: But the free market is supposed to do the best possible job of pricing stocks.  Theoretically, it should already have taken global warming into account.

A: The free market is made of people.   And, for people to do a good job of pricing stocks, we need more than a collection of scientific papers.  There are several reasons why the market could be (at least temporarily) giving a bad pricing signal.

  1. Free markets can’t account for the damage caused by pollution unless someone actually measures the cost of pollution.  Right now, we do not have good numbers for the economic costs of CO2 pollution and global warming.  The market doesn’t have the information it needs.  We need ground rules that force  the market to pay attention to ecological damage or the risk that we may cause our own civilization to collapse.  If they did, the financial markets would probably have already moved us away from fossil fuels.
  2. Modern media and the internet make filter bubbles where many people only hear opinions that they want to hear.  So, some people probably never have read a coherent presentation of the evidence for climate change.
  3. Climate change is psychologically difficult to accept.  It’s a big change; it disrupts business-as-usual, and it requires cooperative action, and it’s a slow threat, so it’s easy to put off to another day.  We note that the American Psychological Association and the Association for Psychological Science have published papers explaining why it is so difficult for people to act on climate change.
  4. Fossil fuel companies have muddied the waters, running a disinformation campaign, intentionally confusing people.
  5. Many 401(k) plans do not support carbon-free investment options; so many people cannot act, even if they wish to divest.  Similarly, cheap carbon-free and low-carbon mutual funds have only been available recently and are not widely publicized.  Many people cannot divest, or do not realize that they can divest.
  6. Pension plans move slowly because of fiduciary responsibility, politics, and the need to build a consensus.  There is a lot of uncommitted money in pension plans as of now; the market does not yet know what they will do.
  7. Some people are unwilling to act on their knowledge because they think it would be “market timing” or “going against the market.”  They believe that the best action is always to passively own shares of everything in the market.  (Needless to say, if everyone invested passively, the market couldn’t possibly respond to new information.)

If you put these problems together, as of January 2016 there are still a lot of people who haven’t yet acted to move the market, therefore, the market’s prices still (partially) reflect the old world, before global warming was recognized.  In other words, we are saying that the market is not (yet?) efficient for fossil fuel stocks: it has not acted on all the available information; it has not yet popped the carbon bubble.  

That’s where divestment comes in. Communities across the planet are making it impossible for Wall Street to ignore the carbon bubble by forcing themselves into the pricing conversation.  There is a growing grass-roots coalition ready to take on climate change with responsible and bold action.

 

Q: The free market will solve global warming.

A: As far as we know, the only way to solve global warming is to cease burning carbon and building a carbon-neutral economy.  So, if the free market is going to do it, it will presumably have to start by driving fossil fuel companies out of business.

 

A: We also think it will do most of the work, but it hasn’t yet realized what needs to be done and how to make a dollar while doing it.  We shall need to rebuild the global economy to run on renewables.  This will be history’s largest engineering project, and it will need massive investment, and support from existing companies, financial institutions and governments.  We’re just here to get the ball rolling.

 

Q: How will divestment change the pension fund’s return on investment?

A: We expect that divestment will have a positive impact over the long-term as the fossil fuel industry shrinks.

After the Paris agreement, it is clear that the value of fossil fuel companies must dramatically fall in the coming 25 years because their value is based on the fossil fuel reserves they can extract and sell. There is now a global recognition that these very reserves must be left in the ground: to limit warming to a relatively safe level, 70-80% of fossil fuel reserves must remain unburned. As renewable technologies improve and governments begin to regulate, these reserves will become impossible to sell, and the stock prices are expected to fall.

Pension funds care about long-term investing.  Remember, 2040 isn’t the distant future for a pension fund; it’s only 25 years away, and 25 years is less than a typical career.  There are people working for the city right now who will be retiring in 2040.  Does it make sense to invest in fossil fuel stocks that will (likely) be valueless by the time those employees retire?  It does not.

 

A: Recall that fossil fuel companies make up less than 10% of Pittsburgh’s investment, so the impact of divestment cannot be more than 10% in either the best-case or worst-case scenario.

 

A: For 2010-2015, fossil fuel companies have had a lower rate of return than the market as a whole.  More importantly, at the beginning of 2016, we stand at a dividing line between the old fossil-fuel economy and the future zero-carbon economy.  There is no rational reason to expect that fossil fuel companies will give especially good returns in the future.

 

A: For 5-year investment periods ending December 2010 – December 2015, fossil fuels outperformed the broader market on 3 of 11 periods, and underperformed on 8 periods.

 

Q: If it is immoral to own stock in fossil fuel companies, how can it be moral to sell that stock to someone else?

 

A: The goal of divestment is not a game of moral hot potato, but an attempt to help shift the economy to less damaging energy sources.  Divestment is a moral call to action, and it intends to demonstrate to policy makers that we are ready for and demand action on climate change.  Divestment will help build a political coalition to build towards the real change we need.

 

A: There are not very many moral imperatives that we all share; presumably, the buyers of our stock will feel that they are acting acceptably.  They are adults and have the right to make their own moral judgments.

 

Q: It seems that divestment does not help solve the underlying problem, which is the consumer demand for fossil fuel.  Also, it does not help push research and production of new energy and infrastructure.

A: Divestment is just one of many things we should be doing.  And, you are absolutely right that divestment is only a part of a solution, and an indirect part at that.

Consumers don’t really demand fossil fuels.  They (and we) demand products and energy to make life easier.  We want the heat, the light, and the ability to travel, but we don’t really care whether those come from fossil fuels or solar power and batteries.  Because of that, the divestment movement is pushing on the energy supply side of the equation.  We intend to replace the energy sources that our economy depends on.

But, rebuilding the economy is a huge project, and cannot be done without cooperation of the government, industry, the financial sector, and the public.

The first goal is to make people aware of it and build a consensus that we need to ramp down the fossil fuel industry.  If that can be accomplished, everything else will follow.  And divestment raises public awareness of climate change and puts political and economic pressure on the government, and corporate powers. And incidentally strengthens the pension fund’s investments by removing it from a volatile and shrinking industry.

 

⊕Financial Details of Divestment

Q: Doesn’t the 1974 ERISA act says that pension funds need to be operated strictly for the maximum immediate financial return, and minimum immediate risk.

A: Not quite.  The fund must be invested prudently; and the fiduciary should try to avoid the risk of large losses.  But a long-term view is allowed, and perhaps required: a prudent person would probably invest their retirement savings in long-term investments.  [ERISA summary]


A:  Courts have not required strict optimization of either risk or return.  They are willing to leave those trade-offs largely to the fiduciary.

 

Q: Doesn’t ERISA require the fiduciary to minimize risk, and to diversify?

A: ERISA requires some diversification specifically “to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.”  In the language of the law, diversification is primarily a means of minimizing risk.

At the current time, we believe it is not prudent to invest in the fossil fuel industry, because of the very real risk of large losses.  We know that about 80% of known fossil fuel reserves must be left in the ground; when the decision is finally made about which reserves will or will not be tapped, many companies will need to recognize large losses.  In other words, the risk is minimized by divesting.

 

A: The ERISA law and related case law is largely silent on how much diversity of investment is required, beyond the obvious requirement that you don’t want a large fraction of your portfolio in a single investment, or invested in a single geographic region.

 

Q: But Modern Portfolio Theory (MPT) says that the lowest risk portfolio is the one that is broadly invested across the entire market.

A: Risk in investing is divided up into Systematic Risk (when all stocks move together, as in a stock market crash) and Unsystematic Risk (your stock wobbles around the market average).  You can’t get rid of Systematic Risk, and studies show that Unsystematic Risk is negligibly small even with a modest amount of diversification.  NASDAQ says “you cannot significantly reduce your risk by spreading your investments over 1000 stocks instead of 500.”

 

A: The actual statement that Modern Portfolio Theory makes is quite a bit more nuanced.  There are two equivalent ways of computing MPT; one that assumes you (somehow) know the future performance of stocks, and the second that assumes that the market is perfectly efficient.

If future returns are known: As you can see from this example MPT computation, the optimal MPT portfolio can have a zero quantity of many stocks.   This is a mathematical way of saying that if you know in advance that a stock will under-perform the market, or if you know that the stock’s yield would be very uncertain, you should not invest in it.

We contend that (as of January 2016), fossil fuel stocks will substantially under-perform the market over the next 25 years, and that a MPT computation done on that assumption would show they should not be included in the portfolio.

Using the Efficient Market Hypothesis: If you assume that the market has correctly priced in all future knowledge into the current prices of all stocks (which we do not: see above), then MPT says that risk can be minimized by owning all of the market.  However divesting 10% or less of a large portfolio makes very little difference to the total risk, because the Systematic Risk dominates.

 

A: A reasonable discussion of the limits of Modern Portfolio Theory in the real world can be found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1840734

 

Q: Are there carbon-free mutual funds?

A: Up until recently, low-carbon mutual funds were specialized and expensive.  But in late 2014, the exchange-traded funds LOWC and CRBN launched; in late 2015 SPYX appeared.  These are all broad-based funds that have reasonably low expense ratios.  As time goes on, there will be more such funds.

 

A: Some brokers, like Vanguard, offer ETFs and funds that track various sectors of the market.  Using these, one can divest by purchasing every slice except the energy and utility sectors.  This can lead to a portfolio with an even smaller carbon footprint than the existing low-carbon mutual funds (above).

 

A: Large brokerage houses like Vanguard offer dozens of industry specific funds; they have automated the process of creating and running mutual funds.  For large customers (like a city pension fund), they will design a mutual fund to a particular divestment specification.

 

Q: Are we going to get lower short term returns without fossil fuels?

A: There is no evidence that short-term returns are reduced without fossil fuels, but there are a lot of reasons to believe long-term returns will be higher without them.

 

Q: What is the pension fund?

A: The pension fund is a cooperative venture between the City and the employees. It is controlled by a board representing the City, unions, and non-union employees.

 

⊕Related Links

 

This work is licensed under the Creative Commons Attribution 4.0 International License. To view a copy of this license, visit http://creativecommons.org/licenses/by/4.0/.