Fossil Fuel Divestment

There was a great pair of articles recently in the New York Times discussing Stanford’s recent divestment from coal companies; an op-ed stating the case that divestment would do little, and a few responses to that argument. I think these articles really capture the debate. I agree with both sides: i.e. that the partial equilibrium of divestment should lead to absolutely zero impact on the targeted companies’ share price, profitability, or behavior. But divestment is a powerful political statement, not unlike a boycott.

Let’s back up: one can make roughly three arguments in favor of divestment:

  1. That it will reduce the share price of the targeted companies, increasing their cost of capital, in turn both reducing investment in the sector and increasing their cost of doing business.
  2. That the sector targeted for divestment is very high risk, so exposure needs to be curtailed. With respect to fossil fuels, this is the “carbon bubble” argument, which goes roughly like this: the current share prices of fossil fuel companies reflects a level of profitability they would only have if they burned more carbon than we can burn without frying Earth. So, the argument goes, eventually policy will step in and their valuations will crash.
  3. Finally, there’s the moral argument: you do not want your money invested in companies that do something you disagree with or find objectionable. Divesting, as Stanford has done, can be a powerful political statement. These political statements in turn can change the political environment.

Let’s take on these arguments in turn: first, the argument that divestment on its own will reduce the level of activity by increasing the cost of doing business. The fundamental reason this doesn’t work is that for every seller, there’s a buyer. And there are many, many, many buyers that don’t give a fuck about anything moral, and will buy these fossil assets on the cheap and drive the price back up to where it was. But let’s even say you DID succeed in impacting the cost of capital and drive up the cost of doing business; this would just raise the marginal price, helping these companies finance new investments internally. And even if you made a few more heroic assumptions about the shape of the supply curve, etc. – most energy assets (especially in the oil market) are owned by governments, so capital market prices aren’t nearly as much of a factor.

On to the carbon bubble: I certainly hope there is a carbon bubble. I’ve devoted my young professional life to climate change, and it saddens me to think how little progress we’ve made. I hope that global policy comes around and puts fossil fuel companies out of business. But, – so the question goes – what about our financial system – don’t institutional investors depend on these companies to stay afloat? Well, yes and no. Exxon is the largest component of the S&P500, so it’s certainly going to be a part of many investment portfolios. Wouldn’t it a Bad Thing if it went bust? Well, not really. Here’s why: (a) if Exxon goes bankrupt, it’s because some other company is getting rich supplying the same energy services (i.e. Tesla), and (b) institutional investors are so widely diversified that they’ll own the “other side” of the energy transition. Exxon’s market value won’t disappear, it will be replaced. 

Finally, the moral argument. This argument resonates with me, and I support those that make this decision. There is a tricky side to it, though, because if you’re selling for non-financial reasons (and therefore at below-market prices), you’re just creating economic opportunity for less-savory people. Think the Koch brothers buying a refinery on the cheap because you were divesting – you make a below-market return, the refinery doesn’t go offline, and the worst people ever make more than the buck they deserve. Not a great outcome.

The point to all this is that there is no substitute for policies that address the underlying value of fossil fuel use. If it’s more expensive to burn gasoline and coal, we’ll do less of it. Attacks on the share prices of companies is the tail wagging the dog.