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Divestment Will Not Keep Carbon in the Ground

carbon pollution and divestment effect

Shuffling paper assets around does not change the production economics of the fossil fuels industry. Divestment must be justified on other grounds.

No matter how widespread any particular misconception, it is unnerving when it infects learned discourse in the academy.

Emblematic is a January 11, 2015 letter from some 300 Stanford faculty addressed to Stanford President Hennessy and the Stanford Board of Trustees calling for divestment of not just coal company holdings (already enacted by Stanford) but from all fossil-fuel companies. The letter states in part:

“The fossil-fuel companies are decent investments only under two assumptions: first, the oil and gas and coal they own in the ground shall be sold and burned. Second, they shall continue to find more oil and gas and coal and shall sell that to be burned, too.” [italics original]

So far, not inexcusably off the mark. But park in your mind for now the word “shall” used here, about which more below. (As the letter was organized by an English professor, her usage is undoubtedly purposeful.)

More troublesome is a further assertion appended to the second assumption:

“Any investor in them must want this to happen, and any investor is putting up money to make this happen with all deliberate speed.”

Oops. Major disconnect of the logical inference variety. The inference being, of course, that purchasing or owning fossil fuel company stock causes, or at least enables, the fossil fuels to be produced.

The Inference Examined

Others have pointed to the inferential problem here, notably Ivo Welch in a May 2014 New York Times article, but the present post is aimed at explaining the flaw in terms not clouded in mysterious financial jargon.

Let’s say you dig into your pocket and buy a share of (a publicly traded entity such as) Chevron Corporation. Where does your money go? Well, it goes to the party from whom you purchased it. You have transferred to yourself from this other party a (small) claim to ownership in the corporation. You now own a piece of Chevron that entitles you to a small portion of its future profit stream. Does the money you spent go into the coffers of the corporation itself to be used to invest in finding or exploiting oil and gas resources? No. The corporation sees no inflow of additional funds. It only sees a change in its ownership; its obligation to remit future profits simply changes hands.

Or let’s say you decide to sell a share of Chevron you already own. You then transfer ownership, in exchange for cash, to another party. Does the corporation see any change in its current or prospective revenues or cash flow? No.

All that happens in such transactions is a change in ownership. Any oil and gas corporation will still make its investment decisions based on the fundamental economics of oil and gas production. Its investment capacity will be unchanged and it will attempt to maximize its future profits (more exactly, the expected net present value of future cash flows) for the benefit of shareholders, irrespective of who these shareholders are. The resources thereby targeted for exploitation will be unchanged.

A lesser inferential flaw is found in the first excerpt from the letter, above. The word “shall” as used there is meant to indicate that an investor directs the company to sell (to then be burned) all the present and future resources it commands. No prudent investor (owner) will require any such thing. Rather, the prudent investor will expect the company to produce the resource only if and when it is profitable to do so. If the resource is or becomes uneconomic, owing say to low prices or competition from renewables, the company will and should not produce it. Purchasing a share of the company is not a dictate to management to produce resources no matter what. The word “shall” here is a misuse, bespeaking a fundamental misconception. “Will,” or perhaps “is expected to,” would be the accurate wording.

But What Happens with a Widespread Divestment?

Fine, you say. But suppose the divestment is large and broad. Won’t this have an effect not revealed in the above example of a single share transferred? What if nearly everyone follows the example called for by the Stanford professors and just dumps their holdings in fossil fuel companies?

A very large flight from fossil fuel stocks (incidentally, academic institutions own only a small share of fossil fuel stocks outstanding) would have the certain effect of crashing their market price. Existing owners (including corporate executives holding stock or stock options) would most definitely be hurt financially. At least to begin with.

To illustrate by appeal to the extreme, let us imagine that everyone on the planet divests of fossil fuels- based stock. Stock prices of these corporations would plummet to, well, zero. In this gedanken experiment, I personally will sit back and watch this dynamic unfold until the moment when I can buy all such stock for a song. I will then be the richest man on the planet (not my ambition, just to be clear). The economic fundamentals of fossil fuels production will not have been changed one whit by this exchange of financial assets among the parties. And even if the majority of the resources I now own are destined to stay in the ground owing to unforeseen market conditions or some international accord to keep them there, I will be rich beyond telling.

Of course, in reality what would happen is that institutional investors and others will step in during the price decline and seize this opportunity. Astute fossil fuel corporate managers will do the same, purchasing now undervalued shares on the open market to increase their financial wealth, offsetting the initial stock price decline they suffered.

The redistribution of ownership via the exchange of financial assets will have exactly no effect on the shareholder-value-creating decisions of fossil fuel corporations. Divestment will have been a total waste as regards the objective of reducing GHG emissions directly by such means.

How Could Investment Realignment Advance Sustainability in Reality?

The single potentially redeeming element of the Stanford professors’ letter is a phrase found in the last sentence:

“…there is a scientifically documented, morally clear technologically innovative right thing to do: divest from fossil fuels and reinvest in a sustainable future.”

“Reinvest in a sustainable future” is a sensible prescription, but there is herein hidden a further potential for misconception on the part of the signatory professors.

That is, simply shifting the investment portfolio from fossil fuels-producing companies to companies providing renewable alternatives once again does nothing by way of providing added capital to renewables producers, if they are publicly-held entities (i.e., if their stock trades on the open market). The funds freed up from divestment in fossil fuels companies and redirected to, say, renewables producers can only infuse such companies with added funds if these companies are either: one, privately-owned firms seeking private investors; or two, publicly-held companies issuing new stock (or debt instruments – “new capital” either way). Otherwise, the same mechanics applies as described above – they will not see, or be able to use, a single penny of the funds transferred among owners.

So okay, you say, then simply use the funds realized from the sale of stock in fossil fuels companies to fund privately-held renewables producers seeking investment capital, or publicly-held renewables producers issuing new capital.

Simple solution, it would seem. But not for the manager charged with the fiduciary responsibility of managing the academic institution’s endowment. The manager’s directive, and obligation, is to maximize the financial value of the endowment (subject to any formally-declared metrics related to other non-financial goals). But on the financial side alone, the choices become thorny. As in, “do I invest in new renewables technologies, which by their nature involve substantial risks and the potential to devalue the endowment fund; or do I invest in fossil fuels companies in face of the possibility that financial markets miscalculate the likelihood that fossil fuels resources will one day be deemed unproducable for some reason?” In one solution to this conundrum, we see Harvard’s President, Drew Faust, urging extreme caution regarding divestment in oil and gas securities.

Not a simple calculation, to be sure. One way to put this in perspective is to imagine asking the following question of faculty with pension assets: “To what degree are you willing to put your pension at risk by shifting your pension investments from fossil fuels companies to ‘sustainability’ companies asking for direct investment?” Undoubtedly a difficult conversation to engage, but one automatically called for if intellectual integrity and ethical behavior are put forth by academics as defining criteria for such decisions.

Why Do Misconceptions like this Happen?

Even among academics assiduously dedicated to the objective pursuit of truth, the psychological imperative to believe what we want to believe remains a powerful force. In the present connection, the origin of this confirmation bias is relatively easy to identify.

First, it is noteworthy that of the 295 faculty who are signatories to the letter, economists and business faculty are remarkably underrepresented. Of the 295, we see only 3 faculty from the Department of Economics. And exactly zero of the signatories are from Stanford’s renowned Graduate School of Business. Signatories include faculty from english, physics, anthropology, comparative literature, linguistics, life sciences, art history, classics, and even theater.

These faculty see an urgent cause and want to do the right thing. Placed before them is such evidence as a recent widely-cited study in Nature indicating the need to keep much of the planet’s remaining fossil fuels in the ground. Unfamiliar as they may be with the world of economics and finance, it is easy to accept a ready and widely-touted but false prescription: divestment is a means to keep hydrocarbons in the ground.

Second, these faculty are influenced by the students: young, energetic minds eager to make a contribution to the climate change challenge facing the planet, seeing the problem perhaps more clearly than any of us and the disproportionate burden on their generation, but naturally inclined toward identifying culprits standing in the way of solutions to which they want to dedicate their careers, encouraged in this perception by misguided prescriptions.

In the background are the loud voices of those who tell these students the clear answer is to call for fossil fuels divestment, exemplified by the tireless Bill McKibben and others. These voices offer a seductive but unfortunately misplaced and academically indefensible solution that ill serves the goal of guiding and educating the next generation.

A statement in the Stanford letter provides a hook on which to hang this pedagogical misfire:

“In working with students, we encourage the clarity necessary to confront complex realities and the drive to carry projects through to completion. For Stanford’s investment policies to be congruent with the clarity and drive in its classrooms, the university must divest from all fossil-fuel companies.”

Here we see an argument attached without legitimate foundation to the core of the university mission. Sadly, it places a single misguided and ill-conceived initiative above the goal of nurturing in students the all-important capacity of fact-based critical thinking. Academicians owe these young minds much more than this.

Links:

Stanford Faculty Letter: http://www.theguardian.com/environment/interactive/2015/jan/11/stanford-fossil-fuel-divestment-letter

Drew Faust, Harvard President, “Fossil Fuel Divestment Statement.”

http://www.harvard.edu/president/fossil-fuels

Nature article: http://www.nature.com/nature/journal/v517/n7533/full/nature14016.html

Bill McKibben: http://math.350.org/

Photo Credit: Fossil Fuel Divestment and Actual Impact/shutterstock

Harry Saunders's picture

Thank Harry for the Post!

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Discussions

Bob Meinetz's picture
Bob Meinetz on January 27, 2015

Harry, your conclusion might be valid if divestiture focused on exactly one type of investment (non-IPO sale of common stock).

There are a number of methods fossil fuel corporations, and all large corporations for that matter, raise new capital, including sales of bonds and preferred stock. These funds are typically used for business expansion, and for fossil fuel companies that typically means exploration and drilling. Sale of common stock lowers the value of a stock, something we’ve all learned the hard way, and directly influences the ability of fossil fuel companies to raise capital in the future.

Moreover, many equities yield dividends, usually proportional to a corporation’s profit. These dividends are sometimes reinvested in common stock, raising its price further. They can also be distributed, which results in an academic endowment directly profiting from the sale of fossil fuels. That’s dirty money – made by selling out the earth’s future health for cheap energy now. The fact that academic institutions taking this symbolic step permits people who don’t care one way or the other to profit even more is irrelevant. By reducing the number of people with skin in the game, it increases the number of people with skin out of the game – and if we accept the (admittedly fictional, at times) notion we live in a democracy, there will ultimately be real ramifications.

Your logic is parallel to that put forth by oil companies promoting the Keystone XL pipeline: that it’s folly to attempt to prevent oil from getting to market by denying its least costly path there. The more the tactic seems to be working, the louder the insistence it’s not. For that reason, your article might be considered evidence of divestiture’s efficacy.

Harry Saunders's picture
Harry Saunders on January 27, 2015

Oil and gas companies rarely rely on issuing new capital to fund investment programs and any they do is tiny.  For decades, the majors have considered such a strategy anathema, instead relying on cash flow. Endowment funds, in turn, rely on open market transactions in this sector.

You may consider returns remitted to shareholders via dividends as “dirty money,” Bob, but that is not the point of the post.  The point is simply that divestment will not keep carbon in the ground, contrary to what the Stanford professors say.  There may be other reasons for divesting, including symbolic ones, but this is not one.

Not understanding your final paragraph at all, or its connection to divestment.

Paul Ebert's picture
Paul Ebert on January 27, 2015

Well, then, what are some good ways for an individual or group of individuals to encourage the keeping of fossil fuels in the ground?

Harry Saunders's picture
Harry Saunders on January 27, 2015

Great question, Paul.  In my fantasies I see this enormous bundle of student (and other) energy organizing widespread political rallies calling for governments to undertake radical increases in basic research targeted at driving down the cost of clean energy technologies. 

 

Something that actually does stand a chance of keeping more fossil fuels in the ground over their lifetimes.  Sad to see this precious human energy instead directed toward an ineffective prescription.

 

But that’s just me.  You?

Bob Meinetz's picture
Bob Meinetz on January 29, 2015

Harry, the majors only consider raising new capital anathema because they haven’t had to – except for brief periods, profits have been consistently strong for decades. Smaller companies face the same competitive pressures as in all industries, and raising capital is part and parcel of staying alive.

There has been quite a bit of credible opinion on TEC lately that the latest drop in oil prices is a blip on the radar. I’m not so sure. Depending on carbon policy and consumption trends in coming years, raising capital, not only for new exploration but cleaner sources of energy, may become a requirement for being competitive – even for the majors.

The main point of my comment (which perhaps I didn’t make clear) was that academic institutions which divest are taking a long view which doesn’t apply to short-term trades or economics. Ownership in fossil fuel equities creates support for that industry for the simple reason that owners want their companies to succeed, and will base their policy accordingly. That divestiture decisions probably won’t make a difference in extraction for 2015 or 2016 ignores the real and potent value of symbolic action to shape policy down the road.

I brought up Keystone XL because a major rallying cry for advocates was that even without the pipeline “the oil would get to market anyway”, ignoring a longer term picture which suggested making tar sands oil more expensive might create a disincentive to extract it. That scenario seems to be playing out as predicted.

Harry Saunders's picture
Harry Saunders on January 28, 2015

Appreciate the comment, Gary.

A reduction in share price does not change the debt/equity ratio.  Balance sheet items are not affected by share price.  

Further, as argued in the post, a short-term share price decline due to divestment would soon be reversed as the market comes to see there will be no change in prospective cash flows.

I like your analysis of the “stranded carbon theory.”

Hops Gegangen's picture
Hops Gegangen on January 28, 2015

 

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Hops Gegangen's picture
Hops Gegangen on January 28, 2015

 

It may have helped in the campaign against Aparteid. Hard to see that happening with fossil fuel tho.

http://en.wikipedia.org/wiki/Disinvestment_from_South_Africa

Harry Saunders's picture
Harry Saunders on January 28, 2015

It may have helped.  May. Ivo Welch’s NYT Op Ed (cited in the post) makes a pretty good case that the South Africa divestment itself had little to no economic effect, but that the contemporaneous political isolation and direct economic sanctions by governments succeeded in inducing change.

As you say, hard to see how fossil fuel divestment is a parallel case.

Nathan Wilson's picture
Nathan Wilson on January 28, 2015

For the special case of respected academic institutions (as well as for environemental groups), they can speak the truth that politicians (with their fossil fuel funding) can’t: they can and should speak out in favor of nuclear power.  The fossil fuel companies have taught us to fear nuclear power while telling us the lie that we would be better off without it; it’s time for us to stop believing the lie.

Harry Saunders's picture
Harry Saunders on January 28, 2015

First and foremost, let me sincerely apologize to you, James, for incorrectly attributing your words to the Stanford crowd. It was two days after I posted this blog that I abashedly realized my error.

ANYONE FOLLOWING THIS POST, BE ADVISED: The text in the first section of my post is actually a quote by the Stanford professors lifted verbatim from this current commenter English professor James Engell of Harvard, and is plainly cited by them as such. (Qualifier: it is clear they endorse the quote, including the italicized use of the words “shall” and “make,” which fonts did not make it to the post itself.)

James, the points you make have considerable merit.  But I would respectfully point out that they have nothing to do with the thesis I’m presenting.  The “clearly established consensus of international science” is indeed that fossil fuels production is contributing to the problem.  I thought I made my concurrence with that clear.  Your other arguments have to do with symbolic considerations unrelated to the effectiveness of divestment itself in keeping carbon in the ground.  They may well be valid, but that is not the point of the post, which says divestment itself will be ineffective in keeping carbon in the ground given pure economic and financial considerations.

On one particular point you raise, to wit: “Would Chevron like to see its stock tank and stay low?” The post argues that stock price declines would be temporary as the market would soon come to see that there will be no resulting change in prospective cash flows, and would eventually price this accordingly, returning stock price to its previous level.

 

If you believe oil and gas businesses are going to “contract” (implying that financial markets currently mis-assess this likelihood), you should be forcefully lobbying your Harvard President Drew Faust to divest on these (purely) economic/financial grounds.  Evidently, she assess the situation differently from you.  Personally, I don’t think these businesses will contract any time soon, unfortunately.  That’s the problem.

Bob Meinetz's picture
Bob Meinetz on January 29, 2015

James, you’ve most capably and eloquently put into words the sense of purpose that drives not only divestment, but any collective action taken by individuals solely for the greater public good.

donough shanahan's picture
donough shanahan on January 29, 2015

Public support for basic energy technology research is great, but it has already produced more than enough cost reductions for non-FF technologies to take over large parts of the energy market.”

I see your throw away comment (in fact your whole post) with another. If what you say were true, fossil fuels would be in rapid decline. We are not seeing this at all.

Example China has seen a small decline on the back of double digit growth in use over the last 2 decades mainly bcause of a slowing economy. So what parts of China’s economy are being overtaken by non fossil fuels according to you? I certainly cannot see any now or in the next decade.

donough shanahan's picture
donough shanahan on January 29, 2015

Harry

surely the best thing to do would be to buy up shares and

1. Use your influence (if you have any) to change the course of the company

2. Use the divident to invest in renewables.

Thus you have a choice of investing in renewables with your now de-invested cash or keeping the investments as is and providing a cash flow to renewables. As renewables have seemingly few problems getting capital, that would support the latter action.

Andy Maybury's picture
Andy Maybury on January 29, 2015

The FF industries WILL contract, they MUST contract and we can both accelerate their contraction and disassociate ourselves from the destruction that they are causing by divesting from them.

It is disingenuous to suggest that selling one’s shares in a company has no effect on anything because one sells them TO someone else. If more people are selling than buying, then the recognised value of those shares diminishes and the amount of money that the company has to play with reduces. This is the whole basis of company shares. Companies raise money by selling shares. When everyone wants to sell them, either the company buys them back or the price falls and the last shareholders end up with worthless [or much reduced value] ownership.

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