Stranded by Climate Change

Divestment can be a powerful tool for social change. The successful campaign for divestiture from South African companies during Apartheid is likely the most well-known of these campaigns. However, recognizing the powerful message that these campaigns can send and arguing that climate change is the defining moral challenge of this generation, a number of student groups have begun calling for divestment campaigns among university endowments, targeting at fossil fuel interests.

Reactions to these campaigns have been limited and the campaigns have, thus far, failed to find much success. Harvard University responded to the divestment calls on their campus by saying, in effect, that divestment would only reduce the returns of the endowment and there is a strong presumption against divestment for any reason unrelated to the financial strength of the endowment. While climate change is undeniably a challenge, and one that certainly has moral implications, it obviously does not generate the same visceral reactions that institutionalized racism did. Moreover, the proponents of fossil fuel divestment face an uphill battle attempting to force the divestiture of some of the most profitable companies on the planet. The fact that these companies offer substantial returns and their actions are not easily defined as immoral are the crux of the argument against divestiture.

But what if there was a business case for divestiture? What if the fiduciary obligations of fund managers required them to seriously consider divesting from fossil fuel companies?

That is the suggestion of a new paper by Ronald Reagan’s former SEC commissioner. Bevis Longstreth argues that there are compelling legal and financial reasons for long-term investors, such as pension funds and university endowments, to divest from fossil fuel companies. His argument boils down to the following: in an environment in which climate change is accepted as a reality which will require the cessation of fossil fuel extraction in the next 50 years, companies which extract fossil fuels are vastly overvalued. Furthermore, any expenditure on discovery of additional fossil fuel resources and any capital expenditure used to develop new fossil fuel assets is money wasted that could, and should, be returned to shareholders in the form of profit. In his words:

“Recognizing climate change as an existential threat to the planet, unique in human history, and both the compelling need to limit carbon emissions and the confidence we place in global leaders to achieve the necessary limits, the largest 200 fossil fuel companies are vastly overvalued in their trading markets and, therefore, continuing to hold investments in any of them exposes our endowment to material loss.”

Companies which continue to invest in the development of assets like the Canadian Tar Sands are, in his view, simply pouring money into projects which are likely to become very expensive stranded assets. In recognition of the increasing importance of considering the value of these stranded assets in assessing equity investments, Bloomberg recently announced the release of a new carbon risk valuation tool. Echoing the words of Mr. Longstreth, the company positions the tool as a method of assessing the “potential impact of [asset] stranding on a company’s earnings and share price” given the rising recognition that “climate change policy could induce the stranding of some conventional assets.” While only a first pass, the tool is notable because it suggests that the notion of divestiture for purely financial reasons related to climate change – completely apart from the any moral or social consideration – is legitimate.

Bloomberg is in the business of helping people make money, not suggesting that they be socially conscious. If it is worth the capital investment for them to develop a tool that explicitly considers assets stranded by climate change, then it suggests a failure to consider these assets may be financially costly. While divestiture based on climate change may lack the moral imperative of apartheid, the tool suggests that the claim that divestiture is financially irresponsible is beginning to ring a little hollow.

While it is too early to say that climate change based divestiture is mandated by fiduciary requirements, as Longstreth points out, it is not too early to see that this may be coming sooner rather than later. He cites a prescient 2nd Circuit ruling from 1932 about the standard to be applied when determining whether a manager has been negligent:

“Indeed in most cases reasonable prudence is in fact common prudence; but strictly it is never its measure; a whole calling may have unduly lagged in the adoption of new and available devices. It never may set its own tests, however persuasive be its usages. Courts must in the end say what is required; there are precautions so imperative that even their universal disregard will not excuse their omission.”

If there was ever an example of a “whole calling” lagging in its acceptance of a scientific fact and so universal in its disregard of imperative precautions, it is society’s response to climate change. It is happening, the science is understood well enough to be the basis of action, and the necessary action is clear. Our failure to act as a society will not protect fund managers who fail to divest and are left holding a portfolio of worthless assets. The case for divestiture then is not a moral one; it simply makes good financial sense.

Image Credit: Azrainman (own work) [CC-BY-2.0]

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