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August 6, 2015

Mercer Report’s Missing Facts on the Future of Energy Investing

A newly released study by Mercer consulting firm attempts to help investors navigate an increasingly carbon-constrained economy in the future. But while the study includes a couple of interesting and overall positive facts on the global economic outlook, we also found a few areas where Mercer applies some curious inputs and assumptions in rendering its verdict on the future. Chiefly, the report fails to consider the role that oil and gas development has played, is playing and will continue to play in the future as a driver of world economic output —and what divesting from fossil fuels today would mean for investors in the future. 

For starters, the Mercer report continually points to energy as one of the most volatile investment sectors, owing to various predictions on the impacts climate change will cause through 2050.  As the report states: “investors need to view [climate change] as a new return variable.”  Yet as a recent report from professor Daniel Fischel of the University of Chicago Law School highlights, energy plays a critical role in maintaining, and growing, a diverse investment portfolio. As Divestment Facts highlighted before, it’s not just that energy stocks have performed well over time relative to other sectors (though that is in fact true), it’s that the energy sector is highly ‘un’-correlated with other major sectors of the economy. In other words: when the rest of the economy is bad, energy stocks, historically, have done better – providing investors the well-established benefits of diversification and protecting them from volatile swings in the marketplace. Simply put, institutions that divest from fossil fuels to avoid volatility may be leaving significant short and long-term returns on the table.

The Mercer report also contradicts itself a couple times, recommending that investors move away from fossil fuels while simultaneously admitting that these oil and gas resources will continue to be a dominant part of the energy mix for decades to come. For instance, in three of the report’s four climate scenarios, Mercer predicts fossil fuels will account for at least 75 percent of the energy mix in 2050 – an estimate roughly in line with recent predictions by the U.S. Energy Information Administration, which sees oil, gas and coal supplying 80 percent of the world’s energy by 2040. In fact, even in the report’s most extreme hypothetical scenario, Mercer predicts that fossil fuels will represent 43 percent of the energy mix— an unrealistic estimate given all the data available to us today, yet still in its own right a very significant percentage of the energy mix – and thus, a very significant sector for an investor to exclude from her portfolio.

In reality, even if the sector continues to see sizable growth in renewables, fossil fuels will continue to play the dominant role in the energy space – not to mention supporting renewable energy development by providing baseload power for intermittent 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.”

The report also flogs plenty the “stranded asset” argument, a frequently raised point amongst the pro-divestment crowd. Yet while the study notes its support of the “stranded assets” argument, which essentially says that investment in fossil fuels can lose value prematurely due to factors like carbon regulation or legislation, it only sees the argument as a real liability under the most extreme climate scenario (where fossil fuels unrealistically compose only 43 percent of the energy mix). In the remaining three hypothetical climate scenarios, Mercer finds stranded assets have only a minimal effect on investment decisions – a fact echoed by many other investors both within and outside the divestment movement.

As the Mercer report itself states, we must assume that renewable technology can continue to advance so that it can “support the low-carbon economy.”  Yet as various experts have stated in the past, divestment from fossil fuels has no tangible impact on mitigating climate change or supporting future renewable growth.  As economist Christopher Fiore categorized divesting, “it’s purely a symbolic move,” not one that will create real change.

While Mercer may try to prepare its investors for a changing climate, simply divesting from the same energy resources the globe will rely upon for decades to come is far from a winning strategy.