Paul Hodgson: how to pop the carbon bubble

So…how are funds going about divesting fossil fuels?

In his seminal July 2012 article for Rolling Stone founder Bill McKibben wrote: “Say something so big finally happens (a giant hurricane swamps Manhattan…) that even the political power of the industry is inadequate to restrain legislators, who manage to regulate carbon.”

Prescient, given that Hurricane Sandy’s storm surge hit New York City on October 29 that year. An activist with that kind of predictive ability is perhaps someone that we should listen to.
McKibben has been warning us that the carbon bubble is going to have a much more disastrous effect on our economies than the housing bubble. The carbon bubble is based on the assumption that the stock prices of fossil fuel companies are artificially inflated because they are based on the value of those companies’ entire reserves, and the likelihood of exploration producing greater reserves.
However, some four fifths of those reserves are unburnable if we are to keep to the “no more than 2oC” increase in average global temperatures that has been agreed upon.
You’d think this fact alone would encourage fossil fuel companies to diversify, but as Naomi Klein was quoted saying: “… with the fossil-fuel industry, wrecking the planet is their business model. It’s what they do.”
So what does McKibben want us to do in response?’s campaign Fossil Free believes that educational and religious institutions, city and state governments, and other institutions “that serve the public good” should divest from fossil fuels. In other words, it wants funds and foundations to sell their shares in fossil fuel companies through a process of immediately freezing any new investment in such companies, and divesting from direct and indirect ownership within five years.
So far in the US, nine colleges, 22 towns and cities, two counties, 22 church foundations, and 25 private foundations and other organisations have committed to owning no fossil fuel equities. But colleges (including my son’s very “right on” university UC Santa Cruz’s “Go Fossil Free!” campaign) and nine states are considering it.

There is substantial expansion of the campaign in Australia and New Zealand, and a large amount of interest in Europe, including from organisations like Operation Noah’s Bright Now (Churches for a Fossil Free Future) campaign.Just down the road from me, the citizens of Hope, Maine, are running a campaign to persuade their board of selectmen to divest the town of fossil fuel investments. This is all as a result of “Do the Math” campaign.

But hold on a minute, just how is this going to be achieved? Clearly, funds can begin by looking at their portfolios and deciding which companies to divest. But are they divesting all fossil fuel companies at once, or one by one as they go through a screening process? Is it more effective if all funds divest at the same time? Or would a piecemeal approach be better, with each fund divesting as it adopts the policy? There are fairly obvious problems here.
For example, if divestment is a fund-by-fund process, funds which have not yet divested – but maybe plan to – could have their stakes devalued.
And then there’s the question of who’s going to buy all these stocks as funds sell them? As Revd. Professor Richard Burridge, Deputy Chair of the Church’s Ethical Investments Advisory Group said: “I understand why some are calling for divestment [of fossil fuels]. But it’s not as simple as that.”
What if (hypothetically) Japan’s Government Pension Investment Fund, Norway’s Government Pension Fund, the Netherlands’ ABP and Korea’s National Pension Service, the four largest pension funds in the world, decided en masse to exit fossil fuel stocks? What would the ramifications be for any long-term investors not in on the trade?
Although espoused by, fund-by-fund divestment is not the only way to achieve the end. What if funds combined and decided to divest themselves of individual companies one by one? Take ExxonMobil, just because it is one of the largest oil companies in the world. If you burned everything ExxonMobil had in its reserves, both above ground and below, for instance, that would release more than 40 gigatons of carbon dioxide into the atmosphere. That’s only around 7% of the 565 gigatons it might be safe to burn to stay within the 2oC limit, but then it is only one company, so it is a step on the path. And if and others are to be believed, Exxon has no long-term future. Even in the short term, despite ExxonMobil’s focus on certain sustainability metrics, it was subject to more than 30 prosecutions in 2013 for health and safety and environmental accidents: spills, injuries, leaks, pollution and so on.
Thus, both because of its size and its continuing environmental damage, investors might simply want to shut it down to minimize their long-term exposure to risks inherent in owning the stock. Yes, Exxon’s stock rose in the last 10 years from $43 to $94, more than double the returns of the rest of the S&P 500, but that kind of growth is unlikely to be sustainable, unless the company transforms itself into a completely different energy company.
Still, it would be a hard sell to pension beneficiaries if funds decided to dispose of Exxon all at once, because they all would take a substantial hit on the initial face value of the investment.
And again, what would be involved in the practicalities of all those Exxon shares suddenly being on the market? Who would buy them; what would it mean for Exxon’s capital position? We’re entering the unknown. But this approach does not seem any more likely to succeed than the hypothetical consortium of giant pension funds mentioned above.
But let’s move from hypotheses to reality. In order to determine what practicalities are involved, I spoke to several organisations that had already divested or were in the process of doing so. Because it is just down the road from me, and because it was the first institute of higher learning to begin the process of fossil fuel divestment, I spoke to Deborah Cronin, the CFO at Unity College in Maine, a small liberal arts college with a focus on environmental science. Cronin was heavily involved in the process.
Unity’s divestment was initiated in 2008, well before But work began in earnest in 2012 when the college’s investment committee decided to divest over the next five years. As it happens, it took less than one and a half years for the college’s $15m endowment to achieve its target. At this point, it should be pointed out that Unity’s aim was to own less than 1% of fossil fuel stocks. It was an important part of the college’s practical approach to recognize that some level of exposure might be unavoidable. The college’s endowment is invested in exchange traded funds (ETFs) and managed by a single fund manager. The ETFs are in domestic stocks, fixed income bonds, and international equities, as well as a few alternative investments. The approach the college took was to focus on non-energy ETFs, everything from consumer discretionary to commodities.
Most importantly, Unity has not seen any damage to its fund’s performance. However, the college board understands that performance can and will be affected in the short term, but for the sake of the long term, it is prepared to accept some underperformance.I also spoke to Sarah Lewis, who is a fund manager for Spinnaker Trust, a Portland-based investment management firm that was formed out of Bob Monks’ activist hedge fund RamTrust Services; the Trust manages Unity’s endowment. Lewis noted that because of Spinnaker’s work with Unity, they had been approached by a lot of organisations interested in implementing the mode it developed; everything from the University of Maine to a single school teaching five to 18 year olds in California. In each case, Spinnaker is careful to explain that the main risks are in performance, and, given that it is an all-ETF shop, it is impossible to divest completely.
With Unity, the first steps were to identify which companies needed to be divested, but, as time went on, it seemed that the group of 200 companies identified by Carbon Tracker was the obvious and best choice. Lewis also noted that even a few years ago, there were not enough international ETFs classified by sector that would allow a properly diversified investment policy and still fossil fuel divestment. Now, however, emerging markets (EMs) presented the biggest problem, though, even here, if you concentrate on low volatility EM ETFs these just happen not to contain fossil fuel stocks. She added that clean energy firms – in which Unity continues to invest – are not in the energy sector, but in industrials, utilities or technology.
But what about when a larger fund decides to divest? Lewis warned that the biggest problem lies with the diversity of management. Even at the University of Maine at Orono, there are 40 different managers managing a larger endowment than Unity’s but a much smaller one than Harvard’s. Divesting such a fund might still be possible, but it will take at least the full five years. And even then, if funds are managed by private equity firms or hedge funds, such managers typically do not disclose which stocks they hold, so even a “less than 1%” target becomes impossible.
Movement among the larger funds, even to take the decision to divest, is glacial. For example, the Board of Supervisors of San Francisco City and County passed a resolution to direct its retirement board to divest from fossil fuels. I contacted numerous supervisors, board members, investment advisors – even the mayor’s office – but no one was interested in commenting for this story. said after the testimony that the SFERS board voted to:
• Re-evaluate how it proxy votes on resolutions filed to companies listed among the 200 top fossil fuel companies;
• Review how it evaluates ESG issues.

This was “in line with other positive developments in major institutional investment organizations such as CalPERS and is seen by many as a necessary step in establishing future fossil fuel divestment policies.” If even just the decision to divest takes this long, and the barrier is usually performance concerns, divestment is likely to take even longer than five years.But as Lewis from Spinnaker said: “Endowment money has to last forever.” Five-year terms and minor dips in performance for non-carbon funds versus carbon funds are likely to be irrelevant when measured over that time scale.

Paul Hodgson is an independent analyst.