Market Views: Equities
Is Bill Gates right about the “zero” climate impact of fossil fuel divestment?
Billionaire Bill Gates, known for his many philanthropic initiatives, is becoming increasingly vocal on climate change. He’s made it clear that he believes fossil fuel divestment – selling share of fossil fuel companies – is ineffective in the fight against global warming. This is an area where Schroders has recently undertaken in-depth research.
Our view? There’s some truth to it.
Gates is quoted in the Financial Times as having said: “Divestment, to date, probably has reduced about zero tonnes of emissions”.
In reality, the picture is far more complex than a simple link between divestment and carbon emissions. Yes, we agree that divestment is not necessarily the best way to promote positive change. We believe that investors looking to influence fossil fuel companies’ operations can be more effective through other means. We propose a new model to drive change that centres on tactical engagement and which restricts the supply of new capital to the industry.
Has divestment worked?
Fossil fuel divestment campaigners believe that divesting will starve companies of capital. Since its genesis on a handful of US college campuses in 2011, the fossil fuel divestment movement has continued to spread globally, and now includes pension funds, foundations, cities and municipalities. Research by Oxford University suggests that it has become the fastest growing divestment campaign in history. While campaigners have done a great job of raising public awareness and stigmatising companies, divestment itself has not had the desired impact on companies’ operations or viability.
According to Gates: “It’s not like [divestment has] capital-starved [the] people making steel and gasoline” and we agree: our research shows that attempts to remove capital sources have had a limited effect.
Take the stock market. The nature of the market means that when you divest, you sell your fossil fuel shares to a willing buyer. In this way, equity divestment doesn’t actually impact the operations of those companies, especially if there are profit-seeking investors who are willing to buy them.
Focusing on debt can have a greater impact operationally. Companies rely on bonds and bank loans to fund their exploration, development and production activities, or to refinance existing debt. The debt funding for the industry dwarfs any new capital provided by shareholders.
Some banks have ceased or have committed to cease financing for fossil fuel projects and companies but other banks have been more than willing to step in; similarly, investors are still willing to lend. The numbers say it all: the amount of debt financing provided to the oil and gas sector between 2010 and 2018 is estimated at more than $5 trillion, according to research by technology and content provider Dealogic.
Clearly, divestment campaigns have had little to no impact on companies’ operations or ability to raise financing.
If divestment doesn’t work, what can be done?
If divestment strategies have limited impact on effecting real change, what other options are available to investors?
Engage with companies
Investors should be holding companies to account by actively engaging with them to influence their behaviour rather than washing their hands of the situation. This approach requires patience - it can take years for a company to transition its business model to one that is less carbon-intensive. And of course asset owners can have even greater impact by engaging with companies collectively.
File shareholder resolutions and vote against management
If engagement on a more informal basis fails to have the desired effect, shareholders can take more formal action. And they’re already doing it. The number of shareholder resolutions related to climate change has risen significantly in recent years. The scope of the resolutions varies, but includes things like reporting annually on carbon emissions and adding a climate change expert to the board. While many of these resolutions are being supported, some of the largest asset owners in the world are voting against them. Having these asset owners on board could make a meaningful difference in getting companies to transition their business models sooner.
Focus on the new supply of capital
To impact the companies’ operations and profitability investors can focus their efforts on credit markets, as well as on the banks that supply capital to, and the insurers who underwrite, the industry. We believe this is more likely to move the needle than divestment.
Put pressure on public policymakers
Investors can only do so much; the real power lies with public policy and much more effective public policy is needed. If we are to have a chance of meeting the 2 degree target, we need to see higher carbon prices, incentives to reduce consumer demand for fossil fuels, a phasing out of the sale of petrol and diesel vehicles and an end to the significant subsidies and export finance for the industry as a whole. Taken together, the subsidies and export finance provided to the industry by G20 nations total nearly $138 billion annually between 2013 and 2015. A mere $3 billion of export finance was directed to clean energy projects each year over that same period, according to research by Oil Change International, Friends of the Earth US and WWF.
These are clearly large and important sources of finance for the industry. Redirecting the funds towards clean energy will help countries transition to a lower-carbon world.
There are better ways to protect our planet
Clearly we broadly agree with the gist of Gates’ argument: fossil fuel divestment is not the best way to curb global warming. Divestment itself hasn’t had a meaningful impact on companies’ operations or profitability so far but campaigners have successfully tainted its reputation.
Gates’ suggestion that investors rather back technology firms that are working towards a greener world is one option. We believe there are also effective ways to promote change in the fossil fuel industry. Investors should be actively pushing companies to improve their practices through engagement and voting efforts. They can also put financial pressure on operations by restricting the new supply of debt capital. But politicians can have a far greater impact on the industry than individual investors, and so asset owners should also be demanding more on the policy front to ensure economic incentives and environmental goals are more closely aligned.
While none of these are quick fixes, there can be no denying that more action is needed to really and truly protect our planet, and that investors can be more effective in bringing about change.