Some ideas are so bizarre that they have to be taken seriously. I have attended several investment conferences where intelligent and experienced investment minds have turned their attention to the challenge of reducing fossil fuel investment risk by engaging with the some of the most exposed companies. The greatest example of a fossil fuel company is, of course, Exxon. There is little logic to mentioning the name simply because of their reputation and size, but they do embody the industry. Suggestions on what a new radical level of engagement would look like include everything from voting down new cap-ex to an orderly wind down and return of capital to shareholders. The recent fossil fuel divestment campaigns have served to create the obvious debate: ‘why not’? Asset owners and managers have responded with a combination of hilarity and concerned expression: hilarity if you are a fund manager driving a new Ferrari on the back of sustained fossil fuel returns, concerned expression if you are a pension fund starting to receive letters from members (heaven forbid) on the issue, or, as UK fund USS found recently, a group of activists with ‘Carbon Bubble’ placards outside their AGM. For these funds, such an outrageous or naive question still needs an answer. Put yourself in the shoes of the pension funds for a moment. What might their response be? Perhaps, “Dear Member, we hold every company in line with the Index”? No, no, that just makes us look like lemmings again following the financial crisis. What about “Dear Member, we leave it to our fund managers”? No, no, that makes us look as if we aren’t in control, and besides they were completely asleep at the wheel during the last systemic crash. What about “Dear Member, we recognise the issue but ifthere’s a problem, our very clever brokers will sell the stock at the very start of the unburnable carbon crisis”? Damn, not even our own analysts believe that one. Mmm…can’t sell, but holding is a problem….I know….”Dear Member, We are signatories to the UN Principle for Responsible Investment and so we will engage with the company”? Yes, that’s it! We’ll go and talk to Exxon and ask them to damn well manage that climate risk! Right, that’s sorted then. But hang on; what do we actually say to them? Pretty quickly, the issue of engagement starts to ask more questions than it answers. Do we empathise with the plight of the poor fossil fuel company who only stands to win in a world of deteriorating weather and a larger and larger proportion of the population pointing the finger? Are they ready to stand side by side with tobacco once the obvious becomes a little more bleeding? What about standing firm against new exploration and voting against new cap-ex? But from a company perspective, having supplied the means to shrink the Arctic a little, surely one is obliged to maximise the resulting opportunity? And so the debate continues apace at an intellectual level amongst the ESG community and the most active of the pension funds including CalPERS, Local Government Super and other climate leaders. The divestment debate is of course an interesting one and the sustainability and ethical investment community is all too quick to point to the South African apartheid campaign as a convenient precedent for future success. However, the parallels don’t convert well either in terms of scale, the ability to implement, or societal consensus.
So what are the options? One idea is to return capital to shareholders that would otherwise be spent on growth. Effectively this would imply an orderly
wind down of one of the largest industries on earth. Such a wind down would involve a scale of collaboration of shareholders on an unprecedented scale for asset owners who have completely failed to collaborate on some of the most simple issues around climate change. Examples of such missed opportunities include driving 100% CDP disclosure, creating a large scale, low carbon infrastructure fund that shifts the economies of scale, or driving fund managers to create an off-the-shelf diversified climate hedge consisting of a mixture of carbon optimised equities, efficient property, infrastructure, climate bonds and so on. How such a discussion would even start without markets getting wind of a sell-down is a question in itself. Even if the asset owners could create a large enough coalition to meet an Exxon on serious terms, they would signal an obstacle to the Exxon growth model that currently supports its share price and thus be volunteering a stock value reduction that would at the very least capture financial headlines but may also provide legal challenges from members who would want to know why their portfolios were being voluntarily devalued, at least in the short term. It would take some serious bravery from the asset owners to ride that wave of pressure until the low carbon flipside of their portfolio showed more favourable balancing returns. And what of diversification? This is certainly an option for energy utilities and such pressure is underway but still so weak that an effort to tackle a less diversifiable industry seems to lack credibility. Asset owners can hardly turn Exxon into a mobile phone company when its company competencies are in geology, mining and supply chain, and perhaps lobbying. So what could be done? In some areas the information systems might transfer and muchexecutive talent would doubtless be able to manage businesses of another type. But large swathes of the company would require redundancy and planned obsolescence. The upside of such a strategy is timing: there is time available to execute such a diversification strategy. A further upside would be the reputational damage limitation to the business-as-usual approach the companies currently adopt and the avoidance of what the Stranded Assets Programme at Oxford University correctly identified as the power of stigma. Stigma is not a technical investment force but can pervade every level of the investment chain in addition to the pressure of public sentiment, which companies like Exxon are already struggling with. This option could quickly attract plaudits both for its audacity and logic and at least a public battle with the company over a diversification strategy would fuel analysis of the options and bring all stakeholders into the debate, including politicians who could hardly argue that such moves wouldn’t benefit their citizens in the long term.
Perhaps the most pragmatic of solutions to all of the above is to form a giant asset owner coalition with the backing of the new pension member NGOs and civil society, underweight the stocks in the portfolio, start a diversification strategy, take a small hit on the share price, happily create a little but not too much stigma and drive company-level investment in low carbon alternatives. This still leaves the vexed question of human incentives. How do you incentivise a company and its staff to change its business model and move away from a comfortable existence into a period of great change and uncertainty? Could you bonus the Exxon CEO, board and staff on their management of such a change? Such a
challenge would surely have the big consultancies rubbing their hands at the prospect of such change but there might just be enough support from the marketing departments of these companies to give it momentum…it can’t be easy getting closer and closer to joining the sin-stocks label. And imagine the new enthusiasm from the internal brand police who currently switch between a green-wash mandate and a hard hat, bunkered-in mentality. The answer of course lies in the alternative. No-one is suggesting that the pro-active path is going to be easy but the alternative is to take a chance that thelow-carbon transition won’t be needed at all or that it will be smooth. Asset owners already know that neither of those two propositions is likely and so their choice is now between ignoring the issue in order to postpone the pain, or to embark on a new programme of professionalism in order to protect members’ interests. The job of civil society, ESG professionals and media alike is to ensure they cannot choose the former. Whether this generation of asset owners has the either the professionalism or the courage is another matter.
Julian Poulter is Executive Director of the Asset Owners Disclosure Project