Fossil fuels: divestment vs transition

 A question in the minds of many responsible investors these days involves the extent to which they should divest from companies with links to the fossil fuel industry, as opposed to supporting those that are making concrete efforts to transition to a carbon-neutral society by 2050, the goal set out in the Paris Agreement. Clearly, divestment is appropriate when considering companies directly involved in fossil fuel exploration, extraction or production. But what about those that support the fossil fuel industry indirectly with, for example, financing, and transportation? Attempts to find answers to this complex question formed the theme of a recent EIG event.

Presentation

Noah Dueck

Context: In which direction do we want to see the EIG equities portfolio go?

Divestment

Sale of assets that fund or otherwise support the fossil fuel industry

Pro:

• Reduces ability of company to be financed, resulting in share price dropping and being ultimately less valuable.
• Avoids risk of stranded assets.
• Investor’s capital can be redirected towards renewables, carbon capture, etc.
• Investor’s reputation enhanced by fossil-fuel-free portfolio.

Con:

• Divested assets can be purchased by others at a discount, mitigating the impact of divestment. (All sales require a buyer).
• Divested assets may be purchased by private equity, where “responsible” considerations are unknown.
• Precludes shareholder engagement with companies.
• Has a limited impact on the industry and global emissions.

Transition

Reducing emissions by engaging with companies operating in high emission-intensity sectors.

Pro:

• Allows proactive engagement with greater long-term impact on reducing emissions. 
• With fossil fuels still relied on by much of society, allows separation of good actors from bad.
• Less of a shock to the economy, so fewer layoffs for employees, especially in economies mostly powered by fossil fuels, e.g. Alberta.
• Most energy companies in Canada are leading in the move to green energy, carbon reduction, etc. Assigning them to a specific category (“oil and gas”) doesn’t reflect the reality.

Con:

• Results from shareholder engagement are not guaranteed and can take a long time.
• Risk of stranded assets if demand, technology shift too rapidly.
• Ethical burden of being “invested in fossil fuels”.

Conclusion

There are benefits to both divestment and transition. The optimal approach for greatest impact is probably a combination of the two, with decisions made on a case-by-case basis.

Discussion - General Points

In no particular chronological order:

• For EIG, simple divestment is not really an issue, since we are not – and presumably never will be – directly invested in companies contributing to increased carbon emissions from extraction and production of fossil fuels. A more complex question is indirect investment in companies that support the fossil fuel industry, e.g. in the banking and transportation sectors. This involves being able to evaluate commitments to transition to net zero by 2050, the goal of the Paris Agreement.

• The Caisse de dépôt et placement du Québec (Quebec pension fund) provides an example of a combined divestment-transition approach with its recent announcement that it will be divesting from all remaining oil-production assets, but will be retaining pipelines, creating a $10B green transition fund to support use of such infrastructure for alternative sources.

• Complicating evaluation with respect to transition is the fact that many companies are doing some good things but some less good. Where do you draw the line – 80% good / 20% bad? 70% / 30%?

• Standards and metrics are required to permit evaluation of how well a company is meeting its commitment to transition. Such standards are only in the early days of development, the most advanced being the Task Force on Climate-Related Financial Disclosures (TCFD) and the Carbon Disclosure Project (CDP). CDP ratings can be misleading though, indicating how good a company is on disclosure but not necessarily how well it meets its targets.

• Since we don’t currently have any examples of companies that are “doing transition perfectly”, a realistic approach is to engage until you feel you’ve gone as far as engagement can take you. If desired results have not been achieved, then divest.

• A number of universities have announced “divestment from fossil fuels” but, given the complex questions involved, what does this mean? This is not necessarily clear, especially when scope 3 (in addition to scopes 1 and 2) emissions enter into the equation. Generally, disclosure of scope 3 emissions is minimal.

• How balanced does EIG’s portfolio need to be, given that it probably doesn’t represent a significant proportion of most members’ investments? On the one hand, it would differentiate itself, and maybe attract more idealistic members, if it was more “pure”, with fewer companies that raise complex ethical questions. On the other hand, the “pure” approach in the early days of EIG led to significant financial losses, eventually offset by diversification of the portfolio with larger, if more ethically questionable companies. Part of EIG’s mission is to demonstrate that investing ethically can result in reasonable financial returns. 

• EIG is a small player. Whether we divest or invest in companies supporting transition has little impact on a global scale. This impact can be increased, however, by publicizing what we are doing.

Discussion - Brookfield Asset Management (BAM) Proposal

The argument for considering BAM a “good actor” makes a number of points: 

• It has a strong emphasis on ESG and a record of increasing the value of its assets by making them more operationally efficient.
• It has established a US$7B Global Transition Fund focused on attaining net zero and one of its five business arms is devoted exclusively to Renewable Power.
• Estimates of the % of its portfolio linked to fossil fuels range from 1% ($6B) to 20% maximum.
• Women are well represented on upper management (27%), as directors (50%) and as employees (45%).

Some specific concerns raised:

• How can we know the extent to which BAM’s mindset is focused on natural gas as a transition fuel? It may well be that relying on such an approach will not leave enough time to attain the emissions reduction needed, despite some companies’ attempts to brand natural gas as a transition fuel. It is stressed that natural gas is still a fossil fuel, which EIG should not consider for investment.

• BAM owns some pipelines and has just acquired one more. To what extent is this linked to its involvement in natural gas? It is pointed out that pipelines constitute infrastructure, valuable in themselves in that they can be modified in the future to transport other liquids, e.g. water from wet regions to dry.

• There was a minor kerfuffle recently when Mark Carney, Head of Transition Investing at BAM, stated that the company was already net zero on an "avoided emissions" basis. He subsequently corrected his statement to confirm that avoided emissions do not count toward net zero targets..

• We are focusing on climate issues but the largest chunk of BAM’s varied business operations is in real estate, which brings up the issue of the housing crisis. Will BAM’s focus on increasing the value of its real estate assets make life even more difficult for apartment renters? It is mentioned that much of BAM’s real estate is commercial and the focus is on making buildings more efficient, e.g. meeting LEED standards. However this is definitely a question to look at in more depth and potentially follow up with engagement in the future.

• In relation to its Latin American assets, there was some indication of BAM engaging in predatory behaviour in Columbia but we do not have details.

In conclusion, there was a general sense of participants understanding the complexity of the question, albeit with a will to limit the amount of EIG’s portfolio devoted to “transition investments” in favour of maintaining the bulk of its energy investments in renewables/alternatives.

The proposal to invest in BAM will be submitted to all partners shortly. The results should be interesting!