Is Divestment from Fossil Fuels a Sound Financial Play?

By Patrick McVeigh

In the 1980s, investors played an important role in helping to end apartheid in South Africa by divesting their investments in companies doing business in that country. Today, a similar strategy is being employed to counteract climate change. Pension funds, endowments and individuals are being asked to go "fossil fuel-free" and sell off any company stock in the oil, natural gas, and coal industries.

While few institutions have so far enacted a divestment strategy, more than 300 college campuses, a growing number of cities and one state are considering going down this path. According to Charles Derber, who was one of my favorite graduate school professors at Boston College, the argument for action is clear. “The two patron saints of universities are values and science, and both are telling us climate change is the biggest problem we face.”

I am certainly not here to discuss values and science, as I think the arguments for action on global warming are clear on both cases. That said, arguments for taking action against the abomination of apartheid were also clear, yet there was always one roadblock that kept investors from taking action on South African divestment: economics.

When I first began working in the field of socially responsible investing in 1982, one of my first tasks was to work on studies that examined whether divestment from companies doing business in South Africa could be done in a responsible way. This was no small job. At that time, nearly 40 percent of the market value of the S&P 500 index was made up of companies who had operations in South Africa. Asking colleges and pension funds to eliminate most major companies and entire industries seemed wrong on investment terms.

Yet what we found in our studies was that portfolios of companies without operations in South Africa outperformed the S&P 500. That was the message we took to Washington, D.C., Nebraska, Missouri and other states and colleges across the country. The fossil fuel-free movement should focus on a similar message today, but hasn’t so far.

In recent hearings, Massachusetts debated whether to become the first state in the country to go fossil fuel-free. State Senator Benjamin Downing argued, “At some point, those fossil fuel companies will not be a good investment.”

With all due respect Senator Downing, that day came and went about five years ago.

For the past five years, the stocks of fossil fuel companies have underperformed the S&P 500, and this underperformance has been accelerating in recent years. For the five years ending on September 23, 2013, the energy stock component of the S&P 500 has increased by 5.71 percent on an annualized basis versus a gain of 9.87 percent for the entire S&P 500. For the past one year, energy stocks rose by 11.79 percent versus a 19.17 percent increase for the S&P 500.

Why has this occurred? Interestingly, many of the same factors that are causing energy stocks to underperform—peak demand and technology—are the same elements that allowed South Africa-free portfolios to thrive.

Rising oil prices had the same impact on the economy in the 1970s that they have had over the past five years. While many people still argue that our demand for energy never goes down, it does, in fact, respond fairly predictably to changing prices. Following a surge in oil prices in 1979, the United States’ usage of oil did not surpass this level for 18 years. Europe has yet to use more oil than it did in 1979.

Quite similarly, U.S. demand for oil has fallen since 2007. Over the past five years, our consumption of oil has dropped by 10 percent. Not only are we driving fewer miles (-2.4 percent), but the fuel efficiency of new vehicles has risen by 22 percent. Does this sound familiar? It should: it is exactly what happened during the 1980s. During that decade, fuel efficiency grew by 15 percent and miles driven fell by -3.2 percent from peak to trough.

 

While technology has improved cars' fuel efficiency, it has also led to new growth in supplies. High prices in the late 1970s led to new oil discoveries in the early to mid-1980s as the following chart shows. The increase in new oil supplies (as well as gas, solar and wind) in the past five years dwarves what we saw in the 1980s, however.

In short, we have as a nation – indeed, as a planet – experienced peak demand for oil. Even if supply begins to wane, our consumption is on a steady downward trend. The politics of fossil fuel-free investments are well-founded; in the current environment, the economics have a strong foundation as well. Pensions or endowments that do divest from fossil fuel companies are pursuing a wise course of investment in terms of the planet’s health and their financial performance.

Patrick McVeigh is President and Chief Investment Officer at REYNDERS, MCVEIGH CAPITAL MANAGEMENT.

[image credit: eutrophication&hypoxia: Flickr cc]