An increasing number of individuals and institutions are divesting from fossil fuels, and the financial case is growing in addition to the ethical reasons for reducing carbon footprints.
For an adviser with clients looking to divest, it’s important to analyse the arguments for and against and consider the impact on financial goals.
How you define divestment dictates your available responses. At its most basic level, divestment is the full or partial disposal of specific stocks or sectors. But it’s important to define the limits and scope of divestment – and the rationale behind any decision.
This may be limited to the worst case examples, such as companies involved in the extraction of thermal coal or tar sands. But the scope of this decision may also extend further down the fossil fuel value chain to include companies engaged in exploration for new sources of fossil fuels, such as fracking.
Historically, divestment decisions have been based on the environmental and social harm caused by the extraction and use of fossil fuels. But strong financial arguments are now being made, inspired largely by the Carbon Tracker Initiative’s influential series of reports, based on the concept of a global carbon budget.
This analysis sets a constraint on the amount of carbon that can be safely burned to minimise the chance of exceeding 2C of global warming by 2050. It presented one of the first cogent arguments that a ‘carbon bubble’ exists in the valuations of fossil fuel companies. A reduction in the value of a company’s stated reserves, due to the risk of those assets becoming ‘stranded’, could have an adverse materially affect on its balance sheet and valuation.
How can you respond?
Investors have several options available – the choice is not binary – that can form part of a spectrum of actions. First, there is the option of full divestment from oil and gas producers and coal mining companies. This is relatively straightforward to execute, but can have implications for portfolio performance relative to mainstream market indices. Next, there is selective divestment from the most financially vulnerable companies, such as those involved primarily in exploration, or in projects with the highest carbon intensity or the most extreme environmental impacts, such as tar sands.
Alternatively, an extension of this approach uses a ‘best of sector’ strategy that considers the full spectrum of social and environmental risks facing companies and only invests in those demonstrating a consistent ability to manage those risks.
And finally, for many, engagement with fossil fuel companies, which power modern life and provide much of the energy we all use every day, can be a powerful agent for change. There is an argument that the engaged investor who remains invested is well-placed to conduct a constructive dialogue with company management to achieve a change of direction in the fight against climate change.
And a wider aim of divestment – beyond selling holdings in fossil fuel companies – is to encourage the creation of a low-carbon economy through reallocation of capital.