The financial case for fossil fuel divestment

There is a widespread assumption that divestment is a matter of sacrificing financial security in order to uphold an ethical position. In the case of fossil fuel corporations, this characterization is inaccurate. These have been underperforming investments, and the companies face major risks to their performance going forward. The source of the social injury described in chapter 2 of the brief – the massive reserves of coal, oil, and gas which these companies possess – are also the source of this financial risk. That risk arises, firstly, from the reality that governments are increasingly restricting the right to use the atmosphere as a dump for carbon pollution and, secondly, from the increasingly extreme character of fossil fuel energy development. As Shell's mishaps with arctic drilling and BP's destruction in the Gulf of Mexico demonstrate, fossil fuel corporations are seeking out ever-more-expensive and ever-more-dangerous ways of sustaining and enlarging their reserves. In 2012, the top 200 oil and gas companies spent $674 billion on exploration and development of new reserves – reserves which are at risk of becoming stranded assets in a carbon-constrained future.

The first principle in U of T's policies and procedures on divestment is prudent investment. The policy requires that legal standards applicable to prudent institutional investors be met. The university must honour its fiduciary duty to seek out strong returns and manage risks. Divestment is compatible with these obligations.


First, I will talk about returns, before turning to the subject of risk.


Compared with similar non-fossil-fuel investments, the sector has underperformed in recent years. Section 3.7.1 of the brief describes a number of credible assessments that support this conclusion, including a 2013 study by Impax Asset Management that found that fossil fuel stocks underperformed the MCSI World Index over the previous seven years and a 2013 study by MCSI ESG research which found that a divested portfolio performed 1.2 percent better between 2008 and 2013.


The coal industry has been an especially poor performer – financially as well as in terms of human health and environmental impacts. While the MCSI World Index rose 44% between 2010 and 2015, the global coal sector lost 43% of its value. 26 US coal companies went bankrupt between 2009 and 2014, and even total Chinese coal consumption has begun to fall.


We encourage the committee to request a retrospective analysis from UTAM – the U of T Asset Management Corporation – evaluating how U of T's investments would have performed if divestment from these 200 companies had happened 5, 10, or 20 years ago.


Of course, past performance does not imply future results. There are good reasons to think the future performance of the fossil fuel industry will be even worse. Firms themselves acknowledge a series of risks: governments are introducing stronger climate change regulations, the search for new reserves is driving fossil fuel corporations into the development of more expensive and riskier projects, and the economic viability of fossil fuel alternatives is improving rapidly.


Moving on to risk:


Many people have made the problematic argument that because the Canadian economy and that of the world as a whole are based to a large degree on fossil fuels, divestment is inappropriate. This contradicts the most fundamental feature of risk management: diversification. The more extensively exposed you are to a particular set of risks, the more important it becomes to hedge the risk by shifting investment elsewhere. Even if U of T sells its direct holdings in these 200 corporations, it will remain exposed to the carbon bubble and fossil fuel industry risks through general exposure to the Canadian stock market. U of T is also exposed to the risk that government revenues which rely on fossil fuel production will shrink, putting further pressure on post-secondary funding.


Because fossil fuel development happens on the timescale of decades, there is a major risk that investments will be locked in which prove unproductive in the medium and long-term. Offshore oil and gas projects, fossil fuel pipelines, refineries, and other such investments risk being unviable in a world that starts taking action with the scale and timing necessary to stay below the 2 ˚C "dangerous" limit for climate change.


These investments also risk being undermined by the improving commercial viability of climate-safe energy alternatives, from interlinked networks of renewable power sources of the sort emerging in Europe to improved energy efficiency as a route to reduced fossil fuel dependence. For example, in 1975 solar photovoltaic panels cost $101 per watt and 2 megawatts of solar capacity was installed globally; in 2015, the price per watt has fallen to $0.61 and installation has risen to nearly 65,000 megawatts. The rapid development of renewables risks undermining the financial viability of long-term fossil fuel investments, even in the absence of concerted government effort on climate change.


Price volatility is another major risk associated with fossil fuels. Oil reached $140 per barrel in June 2008, before falling to $45 per barrel in March 2015. Because investment in major fossil fuel developments happens on the timescale of decades, price volatility enhances the risk of inefficient investment. Because of very high capital costs, Canada's bituminous sands face one of the highest levels of risk from price volatility. Nonetheless, the Conference Board of Canada expects a further $364 billion to be invested in the sector by 2035. Getting off the fossil fuel price roller coaster is a major benefit associated with decarbonization.


Divestment would help control these risks, while also helping to address a major source of social injury and helping push the world as a whole toward a more enduring form of prosperity.


If U of T wants to do more to control exposure to the carbon bubble, as well to encourage a global shift to climatic stability, it could take steps that go father than what this proposal recommends. It could choose to divest from pooled funds with a large fossil fuel component, encourage the emergence of new low-carbon investment products, or adopt a portfolio-wide screening system for climate change risk.


Climate change also creates risks for U of T's portfolio as a whole, as described in detail in chapter 3. Studies like the Stern Review have attempted to quantify the total risk to the global economy from different degrees of climate change. The Stern Review estimated that climate change could cost 5-20% of global GDP, depending on the future course of emissions. Nicholas Stern has since stated that he thinks the review likely underestimated the cost. 90% of the companies in the S&P global 100 index list climate change as a present or future threat to business. U of T cannot control the threat of climate change alone, but divestment would send a powerful signal to other institutional investors and encourage a widescale transition away from fossil fuels.


A range of attractive substitutes exist, if U of T decides to divest. These are described in chapter 3 and 7. In particular, U of T should consider the return from further investments in on-campus energy efficiency. This month, U of T announced that a retrofit of the Medical Sciences Building will save more than $1 million per year, while reducing CO2 emissions by hundreds of tonnes. Updates to OISE are saving over half a million dollars per year, while others at Robarts are saving more than a million. In a city with both summer and winter temperature extremes, efficiency upgrades and higher standards for new buildings are attractive options. Such investments also address the charge that divestment is hypocritical because the university uses fossil fuels. We can divest and reduce our fossil fuel dependence at the same time.


On the subject of fiduciary duty, World Bank Group President Jim Yong Kim has urged investors to give thought to what fiduciary

duty means in a world impacted by climate change:

"Be the first mover. Use smart due diligence. Rethink what fiduciary responsibility means in this changing world. It’s simple self-interest. Every company, investor and bank that screens new and existing investments for climate risk is simply being pragmatic."

 This accords with analysis from Paul Fisher, Deputy Head of Supervision for Banks and Insurance Companies at the Bank of England, as well as the Environmental Audit Committee of the British House of Commons.


The compatibility of divestment with fiduciary duty was also supported by legal analysis carried out on behalf of U of T in 2007 by Timothy Youdan of Davies Ward Phillips & Vineberg, on the subject of tobacco divestment. He concluded that: "pension trustees [may] properly exclude investments for nonfinancial reasons if doing so will not have a detrimental effect on the financial performance of the fund."

The ad hoc committee is required to consider "the extent and significance of the University’s investment in a particular entity." The limited information made public by UTAM - combined with their unwillingness to date to provide this information when asked - makes it impossible for any divestment campaign to meet this requirement. Nonetheless, if the university's overall investments remain similar to those in 2013, the amount invested in these companies is large enough to be considered significant.


Not only are more than ten percent of these corporations' present-day revenues derived from the undesirable activity of fossil fuel production, but the extent of their reserves establishes that this will continue to be true for as long as they are able to keep using them.


Notably, Harvard's total investment in these 200 companies is US$36 million. Roughly similar holdings with a much smaller endowment means U of T is proportionately much more exposed to these risks.

The relevance of the apartheid and tobacco precedents is discussed in the brief, but one feature of climate change distinguishes it from both. While undoubtedly severe, the amount of harm done by South Africa's apartheid regime and by tobacco use was reasonably constant across time. As the chart from the IPCC on p. 26 of the brief clearly shows, the harm done by climate change rises at a growing rate as the amount of fossil fuel burned increases. By continuing with the status quo, the IPCC has concluded that we face a "high to very high risk of severe, widespread, and irreversible impacts globally." If we cross key climate thresholds, the level of damage may jump abruptly.


This proposal should be considered in context. An unprecedented coalition of influential organizations  – many of them not known for environmental advocacy – has drawn attention to the carbon bubble, the risk of fossil fuel reserves becoming stranded assets, and the prudence of divestment. Over 180 institutions with collective investments of over $50 billion have already committed to divest. The strength of the scientific, ethical, and moral cases – combined with the force of these precedents – suggest that the ad hoc committee should consider making a recommendation before the December deadline.


A strong and well-justified recommendation from the committee will set the stage for President Gertler's decision, and for the approval of the Governing Council. Both for the sake of U of T's future financial health, and for the sake of the future prosperity of the whole world, such a recommendation would be prudent.