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Fossil fuels are no longer blue-chip, according to new analysis

New report from philanthropy-backed Institute for Energy Economics and Financial Analysis

Future returns from the fossil fuel sector will not replicate past performance, so the financial case for divestment is clear, concludes a new report from the Institute for Energy Economics and Financial Analysis (IEEFA), a Cleveland, Ohio-based think tank backed by philanthropic organisations.
The appendices to the report – the Financial Case for Fossil Fuel Divestment – include resources for funds small or large to justify to their trustees why it is necessary to divest, from FAQs on investment impacts, rebuttals to anti-divestment arguments and a comprehensive financial history of the fossil fuel sector. This last is what provides the main argument for divestment put forward by the authors: “Over the past three and five years, respectively, global stock indexes without fossil fuel holdings have outperformed otherwise identical indexes that include fossil fuel companies.”
Ironically, the paper also recognises that most rebuttals to divestment also rely on financial arguments; that fiduciaries will be breaching their duty by not fulfilling their investment objectives because they will see their returns go down. But, of course, these arguments, the paper notes, are based on the historical performance of stocks in the sector, rather than future performance.
Other arguments against divestment recognise potential gains from dropping stocks but cite conversion fees and ongoing compliance costs that will wipe out any gains. However, as the paper notes, there is now a wide range of fossil-free funds. More interestingly, the paper is not concerned about the origins of the movement – political, social and environmental – rather it cites these as demonstrating further material risks to the industry; for example the successful Sierra Club campaign to halt the development of any new coal-fired power plants in the US. Yes, it started with an environmental movement, but since there is now a financial argument, that’s where it will end.Some of the most compelling arguments in the paper detail the failed economic models of the industry sourcing those as the reason for the decline in the industry. In the past, price spikes may have lowered demand, but they injected the sector with cash for reserve acquisitions. During its blue-chip period, investors everywhere believed that the crucial factor for an oil or gas company’s long-term financial success was “the size of its hydrocarbon reserves”. In contrast, now, the size of a company’s reserves could be more of a stranded liability than a guarantor of long-term financial success. Now, the paper says, everything is down to cash flow, so price volatility has taken on an importance it hitherto never possessed.
In addition, broader economic trends such as low energy intensity markets are not being recognised at either a macro or micro level by the industry. Fracking’s low prices are generating the thinnest of profit margins and further undermining the ‘reserves’ theory. The emergence and growth of electric and renewable vehicles is further undermining demand. Anti-fossil fuel campaigns are growing in sophistication and litigation risks – and not just from the likes of New York City funds and Californian towns and cities – are growing globally. Writedowns of reserve valuations are growing in negative effect. And capital investments – reserve acquisitions or upstream investments – look increasingly risky in a low growth, low profit environment.
The paper is realistic about the fact that fossil fuels are not going to disappear in the short-term, it doesn’t need to be anything else, since investment returns are unlikely to match those in the past, the case to get out is clear.