A study, which the Independent Petroleum Association of America (IPAA) is calling “the first of its kind,” suggests fossil fuel divestment could cost the top US pension funds up to nearly $5 trillion over the next 50 years. That said, full divestment may not necessarily be the be-all and end-all for growth. Investment experts say the study doesn’t account for alpha to be made by investing in alternative energy products.
Using all the available data on the current holdings of each fund, the study—authored by the University of Chicago Law School’s Daniel Fischel, and coauthors Christopher Fiore and Todd Kendall of the economic consulting firm Compass Lexecon—analyzes 11 funds, including California Public Employees’ Retirement System (CalPERS) and municipal funds in New York City, Chicago, and San Francisco, to determine the financial impact of divesting from fossil fuel securities. The results claim that due to reduced portfolio diversification, these funds would lose up to a combined $4.9 trillion over 50 years.
It should be noted that the timing of the report coincides with President Trump’s decision last week to remove the US from the Paris Agreement climate accords.
While some pensions and universities agree with the report, others feel that complete divestment from fossil fuels would not cause much deficit. In fact, they claim that due to increasing advancements in technology, it would actually be more beneficial to increase portfolio diversification by divesting out of certain fossil fuels but reinvesting in alternate eco-friendly energies such as wind and solar energy.
“This may be looking at valuations and fossil fuels as our main energy source currently. However, the growth of technology within energy is unreal,” said Matthew Sherwood Ph.D, senior manager, public markets investments, MMBB Financial Services. “You have wind power, for example, improving in cost-efficiency at 15% yield a year, so right now when you have wind trading at 7to 9 cents per kilowatt hour versus natural gas at 4 cents per kilowatt/hour, wind will actually be very competitive in the next eight to nine years. Even further than that, new technology is constantly being created with certain coals and more reliable oil, and investing those technologies with a further upside is a lot more money. That’s where you generate true alpha, like investing in Tesla when it was a startup. I think the opportunities that these technologies create within energy makes it much more attractive.”
It should also be said that the IPAA’s press release makes some of these pensions and universities seem in agreement to completely divest, but their actual missions seem to suggest otherwise. For example, New York State Comptroller Thomas DiNapoli is quoted “in agreement” in the press release from his letter regarding the matter. However, the letter concludes with DiNapoli backing the decision to not only stay with fossil fuels, but that portfolio diversification is key to maximizing alpha.
“We believe in engagement with companies, and at this point we have no plans to divest completely,” he said in an interview with the Lockport Journal. “But we have been moving more of our money into companies that are working to reduce greenhouse gas emissions.”
Beginning July 1, the California State Teachers’ Retirement System (CalSTRS) will be divesting in all non-US thermal coal holdings as an effort to reduce greenhouse gas contributors. The decision was made at CalSTRS June 7 board meeting.
“The motives driving today’s decision to divest the fund from all non-US thermal coal, while reflecting the portfolio risks, is also a statement from the board to the global marketplace that we will not tolerate the deleterious effects of climate change, regardless of the recent actions taken by the federal government,” said Investment Committee Chair Harry Keiley in CalSTRS press release. “In just the past year, we have consistently reinforced our unwavering commitment to the Paris Climate Accord and our belief that climate risk is a drag on our portfolio’s long-term performance.”
The path to a brighter and cleaner future depends on not just investing and divesting, but also by watching where the puck is going. “I think really focusing on the issue of fund flow—also ESG framework by these institutions—for these pension plans that are going to affect mean variance, and going to affect the way they model the modern portfolio. For example, if there are 20 pension funds and 10 choose to divest, those 10 are going to effect the other 10 that don’t, based on fund flow,” said Sherwood, who published a paper on the subject last month titled, “The risk-adjusted return potential of integrating ESG strategies into emerging market equities” in the Journal of Sustainable Finance & Investment. “I also think it goes beyond where are you going to reinvest. How will you divest? Fossil fuels is really a large category. I would emphasize maybe divesting from coal but looking to make some investments in natural gas which is a much cleaner extraction.”