Goodbye to fossil fuel holdings: why are companies divesting?

Norway’s largest pension fund Kommunal Landspensjonskasse (KLP) recently announced it had decided to pull out of its investments in companies that derive a large proportion of their revenues from coal. The announcement came hot on the heels of a similar move by the Swedish fund Second AP, which announced in October that it will pull out of its investments in 12 coal and eight oil and gas production companies – together accounting for a divestment of holdings with a total market value of about SEK840m (£72m).

And it is not just pension funds that are pulling the plug on fossil fuel investments. A number of institutions in the higher education sector, including Stanford University and Glasgow University have followed the trend, with organisations as diverse as local authorities, medical and religious institutions, and the Rockefeller Foundation following suit.

According to Nathaniel Bullard, Director of Content at Bloomberg New Energy Finance and author of a recent Bloomberg white paper Fossil fuel divestment: a $5trn challenge, there are “numerous motivations” for divestment, including a desire to reduce exposure to the growing amount of financial risks associated with holding fossil fuel assets – resulting from the regulation of emissions, higher potential prices or falling demand – and an inclination to remove capital from investments investors see as ‘wrong’ in some way. “Objectives are again numerous, and include portfolio diversification or investment security on the part of professional investors and a moral duty on the part of others”, he adds.

Ben Caldecott, Programme Director at the University of Oxford’s Smith School of Enterprise, and the Environment and Founder and Director of its Stranded Assets Programme, agrees there are both ethical and investment arguments for fossil fuel divestment. He points out fossil fuel assets could eventually be vulnerable to “material environment related risks”, which investors are keen to manage and mitigate over the long term: “I think these investment arguments are gaining increasing traction among a wide range of investors.”

Stranded assets
In addition to environmental concerns and a commitment to adhere to ethical investment strategies, many divestment strategies are driven by a desire to avoid being left with assets that may become ‘stranded’ as a result of emissions regulations. As Caldecott explains, stranded assets are those that have “suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities”, and can be caused by a variety of risks.

“Increasingly, risk factors related to the environment are stranding assets and this trend is accelerating, potentially representing a discontinuity able to profoundly alter asset values across a wide range of sectors”, he says.

In Caldecott’s view, there are several useful strategies investors and businesses could adopt to manage the potentially negative consequences of stranded assets, including the accurate monitoring of risk exposure and a commitment to “managing it over the long term”: “This might involve investing in new products less exposed to climate change risks, engaging more proactively with fossil fuel companies, or divesting.”

More broadly speaking, Bullard believes “careful and constant assessments of supply, demand, regulation and changing behaviours” are important strategies to adopt for those investors in energy equities who are keen to manage the potential financial risks of holding fossil-fuel industry assets. “Fortunately for those holding public equities, their investments are liquid and for the most part, investors are free to buy and sell stocks at any time as their assessment of risks and rewards dictate”, he says.

As far as larger pensions funds are concerned, Bullard also argues, if institutional investors decide to divest from fossil fuel holdings, it will not occur in response to pressure from divestment campaign groups, but rather as a result of a considered “reallocation of assets”. He says: “I believe some investors may reweight their portfolios towards other assets, but in so doing they will not necessarily adopt the rhetoric of divestment, as such.”

Market impact
In the short term at least, Jeanett Bergan, Head of Responsible Investments at KLP says it is “difficult to conclude” that such divestment decisions will be of “a significant enough scale to negatively impact this market”. However, if divestment “goes mainstream” over the long term, she expects the trend will “ultimately impact fossil fuel companies’ cost of capital, all things being equal”. “Hopefully, sensible global climate regulation will enter into force and affect market conditions long before we can test that thesis out in practice”, she says.

Bullard agrees that more attention will continue be placed on the long-term viability of energy assets exposed to decarbonisation of the energy sector. For him, exactly how this will manifest is not yet clear – although he stresses that, “as potential future risks in an asset class rise, so does its cost of capital”, meaning the net effect is likely to be “a rising cost of capital for companies deemed higher risk or environmentally unsustainable”.

In the future, Caldecott predicts there will be a “growing realisation” across the investment market that fossil fuel industries are undergoing “profound structural changes” – and that many of the drivers are increasingly related to environment and climate change issues. “The other factor is changing social norms – fossil fuels are already becoming a stigmatised industry and this looks set to continue”, he says.

For Bergan, it is important pension fund managers such as KLP take the lead in adopting divestment strategies because investors are subject to “ever greater scrutiny on how their investments contribute to or detract from a low carbon future”.

“Having a climate change policy is a part of what is expected of a responsible investor”, she says. “That said, an investor’s toolbox encompasses more than divestment. At KLP, we see the divestment from coal as a way of minimising our involvement in the problem, but through our direct investments in renewable energy, we are attempting to be a part of the solution as well.”