This note is prompted by two wonderful days that I spent engaging on the issue of sustainability and fossil fuel divestment with students, faculty, staff and trustees of Swarthmore. As a long time investor, including as a Managing Director on the investment committee of a fund investing $500 million a year, I offer a perspective from beyond the Swarthmore community.
Two years ago, the inclusion of fossil fuel companies in an endowment portfolio was considered a reasonable and prudent position. Today, divestment from fossil fuels — especially coal — has become the more fiscally rational and morally grounded option.
The moral arguments for divestment are well articulated by Swarthmore students and faculty, and underlie the accelerating movement toward divestment by other higher education institutions. It is clear that Swarthmore is an exceptionally moral, socially conscientious, and engaged institution, and that these values and characteristics are central to the institution’s excellence. But because the moral dimension of the divestment discussion is more subjective than and sometimes viewed as subordinate to the financial one, for purposes of this note I will focus mainly on the financial prudence and stewardship aspect of the divestment decision.
Let’s start with two points we can all agree on: first, climate change is real and has started to drive large changes in weather, emigration, drought, and storm frequency/severity. As a result, it is beginning to drive substantial changes in physical design of cities, infrastructure and in asset allocations towards clean energy, backup power, utility energy mix, shifts in insurance, and more. Second, the reality of climate change on the ground and the greater scientific certainty and consensus on anthropogenic climate change trends both indicate that the severity of climate change is worse than we had previously imagined.
There are a few arguments against divestment which I would like to address before I lay out the reasoning behind divestment. These arguments against divestment, many of which appeared to be funded by the fossil fuel industry, typically rest on three assertions, none of which are correct.
First, they argue that the fifty year return history of fossil fuel stocks has been good. The implication is that fossil fuel share returns will continue to be good and therefore Swarthmore could or would experience lower future endowment returns from divestment. However, this 50 year time frame is not relevant to the climate change divestment and stock price risk. The relevant stock price return period is the last five years or so, during which time fossil fuel share price returns have actually underperformed the larger market.
Second, they argue that reweighting portfolios to exclude fossil fuels could be expensive both in switching to a new portfolio mix and in terms of ongoing management fees. However, at the scale of the Swarthmore portfolio, and assuming orderly exit over a few years, there is no reason for any increase in fees or costs. A reweighting of stocks against fossil fuel free criteria, especially done in conjunction with other institutions, might actually lower transaction/management fees.
Third, they assert that the exit of fossil fuel firm holdings resulting from divestment would involve dollar amounts too small to have any material impact and is therefore a pointless gesture. However, a divestment decision by Swarthmore and other leading academic institutions would have a very large public relations, moral and leadership impact vastly larger than the dollar amount involved, as demonstrated by the success of the South African divestment movement.
The financial rationale for divestment today compared to two years ago now takes into account that the likelihood of political and market intervention is far greater than it was then, which means that much of current and future fossil fuel reserves will not be burned. This would drive large valuation reductions of fossil fuel firms. Because fossil fuel companies currently represent a significant percent of Swarthmore’s endowment allocation, a large reduction in the value of fossil fuel shares would result in a corresponding reduction in Swarthmore’s endowment value. The current climate change trajectory is consistent with fossil fuel stocks starting to underperform the overall market as early smart or motivated money (such as the Stanford University and Rockefeller Foundation divestment decisions) begin to divest or reallocate toward cleaner energy.
In terms of divestment timing and risk, late exiters would experience large losses in capital. From a financial returns perspective, this means that the return upside from fossil fuels is less today than it was two years ago, while the downside is far larger as well as likely to happen sooner. This changes the risk return equation for Swarthmore’s portfolio.
The last year has seen the emergence of substantial rigorous analysis around the argument that in a carbon constrained world unburnable fossil fuel reserves are stranded assets. For example, this Forbes piece mentions that a “2013 report commissioned by the Associated Press and performed by the research firm S&P Capital IQ […] found that a university endowment that pulled out of the 200 fossil fuel companies targeted by the divestment campaign would have avoided substantial losses.” An important threshold in the recognition of fossil fuel asset value risk was the December 2014 decision by the Bank of England to “set a new standard for all central banks and financial regulators on climate risk by agreeing to examine, for the first time, the vulnerability that fossil fuel assets could pose to the stability of the financial system in a carbon constrained world.”
If we agree that climate change is a huge threat that society will act on, then it necessarily follows that divestment will occur to limit losses, that fossil fuel company prices will drop substantially and that institutions with these stocks in their portfolios will experience large losses. Aside from the financial risk of being a late exiter, the moral and brand damage to Swarthmore from being a late mover would likely be large.
A January 15, 2015 letter by many of Stanford’s faculty to the Stanford President and Board of trustees puts the issue this way: ”If a university seeks to educate extraordinary youth so they may achieve the brightest possible future, what does it mean for that university simultaneously to invest in the destruction of that future?” A Swarthmore student leader, Stephen O’Hanlon ‘17, argues that “as the school where this movement began, the world is watching us. It is unconscionable for Swarthmore… to invest in and legitimize the fossil fuel companies that are wrecking the climate, poisoning communities, and jeopardizing the very future for which our education is meant to prepare us.”
Given Swarthmore’s origins as a Quaker school, its deep engagement around civil rights, its perhaps late but ultimately successful apartheid divestment campaign, and above all the moral passion and intelligence of its students on this issue, the Swarthmore brand protection case for short term divestment is very strong.
Swarthmore rightly views itself as morally engaged on big social issues, and climate change divestment is a big issue where the benefits of being an early exiter are clearly large and the costs of being a late exiter are also clearly large. I keep coming back to the sustained, morally and logically founded divestment demands of Swarthmore’s engaged and articulate student body. It is precisely these qualities of its students that make Swarthmore great. On this issue — the defining issue of their generation and arguably many future generations to come — their voices need to be heard.
Gregory H. Kats is the President of Capital E, which invests in cleantech firms and works with companies and public institutions to transition to a sustainable economy.
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