Over the past year, IPAA has commissioned a series of studies that have quantified, really for the first time ever, the actual financial impacts that divestment has on institutions that chose to adopt the policy. The reports focus on different elements of that cost question, but no matter how you break down the numbers and run the time-horizon scenarios, they all in the end arrive at the same general conclusion: divestment’s really (really) expensive; it doesn’t actually impact the targeted companies’ financial position a whit; and, not to put too fine a point on it, but it doesn’t remove even a single molecule of CO2 from the atmosphere.
So those are the facts, but, surprising to no one, the professional activist group that’s leading the charge on divestment happens not to agree with them. Earlier this week, the group took issue with these reports, putting forth a series of criticisms that are pretty familiar to us by now, but still lack the benefit of being true.
First, a quick re-cap of the three reports IPAA commissioned: Earlier this year, a groundbreaking study by Prof. Dan Fischel of the Univ. of Chicago School of Law took a look at what divestment means in a general sense for investment returns. According to the report, divestment led to reduced diversification, higher compliance and management costs, lower returns for portfolios, and no real impact on targeted energy companies.
Building off that research, Dr. Bradford Cornell of the California Institute of Technology (Caltech) conducted a separate study that digs deeper into the Fischel methodology and attempts to quantify the losses felt by real schools in real dollar terms. His research found that if Harvard, Yale, New York University, Columbia and MIT were to divest, they would collectively lose roughly $195 million annually, while returns would be about 12 percent lower over a 50-year timeframe. Lastly, a third study produced by an energy research firm in the U.K. called Economics Europe found, again, that divesting is a costly strategy for investors, leading to lower returns at higher risk. That study was conducted over a more recent timeframe, spanning from 2002 through 2014.
Given the large costs associated with divestment, it is not unexpected that 350.org has tried to downplay the reports’ findings as “industry spin” — even though their own reports have been debunked by everyone from Mother Jones to MSNBC. But what the hell? Let’s take a look at the substance of 350.org’s claims and see if we can provide some additional clarity around all the stuff they get wrong.
350.org: These reports “spin” data, are “disingenuous.”
Fact: Despite these interesting and important findings, right off the bat 350.org called the aforementioned studies conducted by distinguished professors from the likes of the University of Chicago (Dr. Fischel) and Caltech (Dr. Cornell) “disingenuous, to say the least.” That claim alone is almost comical given the recent buzz around this Arabella report which falsely claimed the divestment movement now totals $2.6 trillion in assets. In fact, as Divestment Facts has already pointed out, the $2.6 trillion amount is completely fabricated and inflated, using data that manipulates the overall number to make it seem that the divestment movement is far bigger than it really is. That seems to be, at the very least, disingenuous. And if funding alone is reason enough for 350.org to disapprove, it may need to re-think sponsoring its own reports like the recent one from Arabella.
350.org: Analyzing past performance is inappropriate, makes these studies’ findings irrelevant.
350.org takes issue with the fact that these studies rely on the evaluation of equities’ past performance, arguing that the past does not predict future results. True enough: no one in favor of or in opposition to divestment can definitively say what the future holds. But, perhaps anticipating this canard of an argument, Dr. Cornell plainly addresses this concern in his study by explaining what his findings actually mean:
“My analysis of the impact of divestment is based on the historical evidence of the last 20 years. Some divestment advocates argue that the future of the coal, oil, and gas sectors is not as bright as it has been in the past due to regulations or other market changes that will cause these firms to “strand” certain assets or otherwise experience lower profitability. I have no specific view about the likelihood of such outcomes, but as a criticism of my study, such speculation misses the point. My calculations of the declines in risk-adjusted returns depend on the historical ability of securities in the oil, gas, and coal sectors to hedge other securities. They do not depend critically on any claim that absolute returns in these sectors will be as high as they have been in the past.
“In any case, it seems far from clear that, even as a speculative investment, oil, gas, and coal securities collectively are likely to be poor investments. First of all, even if the divestment advocates are correct that regulatory or market pressure on these firms will increase, it is very often the case that new regulations make the incumbent firms in an industry more profitable, not less so. This is because, even though compliance with regulations is costly, it also can serve to restrict entry and limit competition. Moreover, firms can and do respond to regulations and changes in the market to maintain profitability, particularly when those regulations or changes are known well in advance, as divestment advocates claim they are. In any case, if reductions in profits are in fact as likely as divestment advocates claim, that fact should already be incorporated into lower current security prices, so that future investment performance would not be improved by selling these securities.” (emphasis added)
Essentially, Dr. Cornell’s study (and others) emphasizes just how vital a role the energy sector plays in constituting a balanced portfolio both in the past and in the future. A smart and responsible investor would do well to retain energy holdings because of their diversification benefits and the ability to secure higher returns at a lower unit of given risk.
350.org: The energy landscape is changing so rapidly, oil and gas will soon become obsolete.
350.org makes the point that the political, economic and social climate is changing, which will completely “restructure” the industry, and that the future demand for fossil fuels is “bleak.” This seems to be a bit of an exaggeration, considering that the Energy Information Administration (EIA) has stated multiple times that oil and gas will constitute 80 percent of the world’s energy use by 2040. Meanwhile, overall energy consumption worldwide will continue to grow by 56 percent during that period.
350.org also asserts that “energy efficiency integration” and the “trajectory of competitive alternatives” will challenge traditional energy sources, but from a numbers standpoint, what does that mean? Well, according to EIA, 21 percent of the world’s energy generation was from renewable sources in 2011, and by 2040 that number will rise a whopping 4 points—to 25 percent. According to EIA:
“Renewable energy and nuclear power are the world’s fastest-growing energy sources, each increasing 2.5% per year. However, fossil fuels continue to supply nearly 80% of world energy use through 2040. Natural gas is the fastest-growing fossil fuel, as global supplies of tight gas, shale gas, and coalbed methane increase.”
In addition, the shale revolution has ramped up domestic natural gas production, elevating the United States to the world’s number one producer of energy. And across the globe, the International Energy Agency finds that by 2040 global “demand for natural gas grows by more than half, the fastest rate among the fossil fuels.” Natural gas also continues to be vital to any shift toward renewables—providing baseload power for alternative energy sources like wind and solar. As Rhone Resch, CEO of the Solar Energy Industries Association, said in 2013, “natural gas and renewables complement each other very nicely.” Protesting natural gas is, in effect, protesting the advancement of clean energy.
So yes, renewables are growing, but the rate does not come close to meeting the world’s energy needs, and won’t get there for some time. And, again, if actual investors believed that governments around the world were going to come together and conspire to impose pan-global carbon restriction policies that prevented oil and gas firms from producing the products on which the modern economy runs, guess what? That expectation would already be priced into the stocks of those energy producers.
350.org: These studies “cherry picked” timelines in order to draw favorable results.
350.org argues that these studies rely on favorable timelines to produce favorable conclusions, before immediately using their own cherry-picked timelines to prove their point. They mention that energy stocks have underperformed in the past 1, 3 and 5 years. True, that’s typically what happens to the stock market — sometimes prices go up and sometimes they go down, but endowments and large portfolios do not invest for the short term. So it is meaningless to characterize energy stocks are underperforming dogs when you’re only using data from a handful of recent years (when oil prices basically collapsed!) to justify the claim.
To conduct a real, worthwhile analysis, observing markets over a span of decades provides a much better understanding of overall trends than simply looking at a snapshot of information. Looking at performance over a 20 or 50 year period provides a better perspective because that’s how long term investors make decisions—and that is exactly what these studies do. These aren’t “cherry picked” timeframes: more data is better than less data, last we checked.
Dr. Cornell’s report—which found divesting to have a significant and harmful effect on several universities—analyzed returns spanning from 1995-2015. With the recent decrease in oil prices, it would have been far more advantageous to shift that timeframe back just one year—in order to avoid most of the drop and consequently draw a more positive conclusion. However, the study instead utilized the most up-to-date and realistic information possible and still found that divested portfolios underperformed endowments that were invested in fossil fuels.
350.org: Due to current oil prices, energy is a bad investment
This is a very short-sighted argument, once again based on a current drop in commodity prices due to market factors and nothing else. Instead, the purpose of managing endowments is to use a balanced portfolio to achieve stable growth with a long term strategy. The energy sector is an important part of that strategy today, tomorrow, and will be for many years into the future.
Beyond individual commodity prices, energy plays a key role in ensuring portfolio diversification. Prof. Fischel emphasized this in his findings as a vital component to maximizing financial returns:
“No single piece of financial advice is more widely accepted by academics and savvy investors than portfolio diversification to increase returns and manage risk. Divestment advocates typically assume that investors can exclude fossil-fuel stocks with little or no loss. One California-based investment manager, for example, was quoted in a recent Rolling Stone article as saying that divestment would have ‘very low impact. If you take the fossil-fuel companies out, you’re still very well diversified.’ Our research shows the opposite: Of the 10 major industry sectors in the U.S. equity markets, energy has the lowest correlation with all others—which means it has the largest potential diversification benefit. The sector with the second-lowest correlation with others is utilities, which includes many fossil-fuel divestment targets such as Southern Company and Duke Energy.” (emphasis added)
To translate, since the energy sector is highly “un-”correlated with the rest of the economy, when the economy overall goes south, energy stocks, for the most part, do better. This helps investors hedge against volatility in the market, while less diversification could mean putting future returns in jeopardy. That is, unless investors have a healthy appetite for taking on risk. As the U.K. study found, in order to compensate for lower overall returns after divesting, an investor needed to take on 20 percent more risk. For endowments, pensions and large portfolios, whose focus is on steady returns over the long term, this is not a suitable or viable strategy.
In addition, one could argue that the current low price of energy stocks is deterrent enough to selling. A savvy investor may take advantage of low prices to maximize gains over a longer timeframe. Not convinced? Allow 350.org activist Naomi Klein to explain. At a web workshop earlier this year she acknowledged, “Fossil fuel stocks aren’t performing very well right now. So opponents have just lost their best argument. They won’t lose it for long. So that’s another reason to pound away at it.” Even those most ardently against investing in energy realize that the prices will eventually rebound.
Bottom line: The numbers and long term trends show that divestment overall is all cost with no benefit. Activists may try to paint studies that show the costs of divestment as “disingenuous,” and that is up to them. But what is truly disingenuous is using exaggerations, inflated statistics and convenient data points as schools and students weigh this important and costly decision.