Fossil fuel divestment is back in fashion

Divestment, the thinking once went, will drive up the cost of capital for badly-behaved businesses. 

Reduce the investor base enough and business decisions that undermine widely-shared social and environmental objectives will start to become expensive. Only then will company management begin making better decisions. 

But, as sustainable finance has been interrogated and reimagined by more conservative mainstream investors over the past decade, that theory of change has been discredited. 

In ‘Socially Responsible Divestment’, a paper published last year, academics from London Business School, the University of Washington and Indiana University, wrote: “Divestment does not actually deprive a company of capital. An investor can only sell if someone else buys.” 

The researchers continued: “A more nuanced argument is that divestment does not defund a company immediately but lowers the share price and makes it harder to sell shares in the future.”

But disposing of shares also means surrendering influence so investors now emphasise their role in retaining ownership of companies and convincing them to behave better.   

The launch of shareholder engagement initiative CA100+ marked the moment at which that approach officially won out when it came to climate: in 2017, more than 200 investors (now more than 700) joined forces to agree that decarbonising the global economy was best achieved by negotiating with the world’s biggest polluters, not abandoning them. 

Asset owners and managers have assigned huge amounts of hours and budget to these stewardship efforts since then. But more recently, after its spell of excommunication – and after many fruitless engagement attempts – divestment has come back into vogue. 

The Church of England, the pension fund of ING Bank, PZFW and ABP are just some of the asset owners to have stepped up their exclusions in the fossil-fuel sector recently, or exited it entirely. 

While in its previous incarnation, all this would have been motivated by a desire to influence firms’ cost of capital, and therefore behaviour, this time the reasoning is distinctly different. 

“It puzzles me when people criticise divestment for not being effective at changing companies,” says Sofia Bartholdy, head of net zero at the Church Commissioners for England, which runs a £10bn (€11.6bn) endowment. “It might be true that it doesn’t work when it comes to creating change, but it really works when it comes to removing exposure to companies that aren’t changing.”

And the evidence suggests that most fossil fuel firms fall under that category. 

A recent report by the World Benchmarking Alliance and CDP, the environmental disclosure organisation, found “the oil and gas sector has made almost no progress towards the Paris Agreement goals since 2021”. 

Reaching net zero by 2050 would require the sector to invest $600bn in low-carbon solutions by the end of the decade, the NGOs claim, but only Finland’s Neste is making credible efforts to meet that goal. Instead, the sector is still committing hundreds of bilions to new drilling and extraction and most companies still link executive pay and incentives to fossil fuel expansion. 

According to the International Energy Agency, upstream investment in oil and gas grew by an estimated 8.6% year-on-year between 2021 and 2022 (figure 1).

Pivot towards engagement with high emitters

“My answer to people who ask why we divest if it doesn’t have an impact is that there’s an opportunity cost to our assets and our time,” says Andres van der Linden, a senior responsible investment adviser at PGGM, which runs €229bn almost exclusively on behalf of Dutch healthcare pension fund PZFW. 

“We want to invest our financial and human resources in oil and gas companies that are willing to change,” he explains. “If we find one that isn’t, we could vote against the board and pester them with requests, or we could devote those resources to trying to reduce demand for fossil fuels by engaging with companies in high-emitting sectors like materials or industrials, where we might make progress.”

A growing number of PZFW’s members simply don’t want to participate in the profits (or losses) of the sector as the climate crisis worsens, van der Linden adds. But, echoing Bartholdy, he says the main driver is financial risk – that the further upstream the fossil fuel company sits in the value chain, the more chance that it will be left holding stranded assets at some point in the future. 

Tom Sanzillo, director of financial analysis at the Institute for Energy Economics and Financial Analysis (IEEFA), a US-based clean energy think tank, says that the whole fossil fuel sector “has a very weak financial rationale moving forward”. 

Sanzillo points to figures that show that, after spending decades as the golden child of the equity markets, the industry had been languishing near the bottom for nearly 10 years, until it was buoyed by last year’s energy crisis (see figure 2). 

“But even when oil and gas companies were announcing massive 2022 profits earlier this year, the industry was already back to last place on the stock market,” he notes, “because the markets understood that the invasion of Ukraine is not a viable investment proposition over the long-term.”

According to S&P Capital IQ, the global oil and gas sector reported full-year EBITDA of €2.3trn in 2022, with analysts predicting €1.9trn for 2023 (figure 3).

As well as being as being a way of managing financial exposure and resource allocation, divestment is proving to be an important tool through which investors – even relatively small ones – can create brand risk for fossil fuel companies, especially those selling directly to consumers like oil and gas firms with petrol filling stations.  

“Drawing media attention like that is naturally something that most companies want to avoid,” says Jan Erik Saugestad, CEO of Storebrand Asset Management, Norway’s biggest commercial investment house. 

Storebrand made headlines in 2020 when it divested from Exxon and Chevron over their lobbying activities, and Saugestad was vocal about naming and shaming the pair for using shareholder resources to fight climate regulation. 

“The Exxons and Chevrons of the world are holding us back,” he told IPE at the time. 

How does divestment work in practice?

Both the Church of England and PZFW have taken a staggered approach to fossil fuel divestment. 

“We had a five-year programme to divest from companies that didn’t align with the Paris Agreement,” explains Bartholdy. She adds that the process centred on firms identified by CA100+ and goals outlined by the Transition Pathway Initiative (TPI) – both projects that the Church of England helped to set up.  

Given the green light in 2018 by the synod, the Church’s governing body, the programme applies to roughly £15bn of its assets: its endowment, its pension fund and a smaller pool of local parish money (the latter is run by faith-based manager CCLA, which divested fossil fuels completely three years ago).

The Church Commissioners made the endowment’s first divestments in 2021, axeing 20 target companies under CA100+ whose commitments didn’t stack up against national climate pledges, according to TPI analysis.

Earlier this year, the rules tightened to require short-term net-zero targets and behaviour to be aligned with the Paris Agreement. That triggered the Commissioners to add the rest of the fossil fuel sector to the exclusion list it gives to all its asset managers.

“It’s a weirdly long process,” says Bartholdy. “But it’s currently being implemented and we’ll be out of the oil majors and then broader exploration, production and refining by the end of the year.”

PZFW kicked off its programme more recently, and PGGM’s van der Linden says short-term macroeconomics has been the biggest challenge. 

“We started at the beginning of 2022, when oil and gas prices were very low,” he says. “We thought we’d take advantage of that to help us pivot away [from some fossil fuel firms], and that decision was supported by a number of comprehensive transition plans we saw coming out from companies around that time.” 

In 2020 there was a short-lived period of excitement over what became known as ‘say on climate’ – corporate transition plans on which investors were given a vote at annual meetings.  

BP was one of the first out of the blocks, agreeing with shareholders in 2020 that it would slash emissions by up to 40% and diversify away from fossil fuels faster than its peers, with big commitments to renewables and low-carbon energy. 

Nearly 90% of investors endorsed Shell’s first transition plan a year later as it turbocharged its spending on renewable energy. 

But both companies have scaled back their ambitions in light of last year’s fossil fuel profits, and neither ran those revisions past shareholders. Even Exxon, often painted as the ultimate villain of climate finance, found something to row back on, recently pulling its long-standing support for research into fuel made from algae. 

Changing public mood frames debate

The developments have undermined investors on both sides of the debate: it’s harder to justify divestment when it involves sacrificing hefty returns from a sector that is booming, but also harder to justify retaining and stewarding them when they have so brazenly reneged on their promises. 

“In the short-term, the public and private discussions have changed substantially, and it’s made things much more challenging,” says van der Linden. 

PGGM sold out of 114 oil and gas companies that didn’t have carbon reduction targets last spring, to the tune of €470m. At the end of the year, it ditched a further €303m from 78 other firms, this time because their targets didn’t include an explicit commitment to the Paris Agreement. 

Now, the focus is on whether the remaining 94 companies (accounting for €2.7bn of PFZW’s portfolio) are implementing credible net-zero strategies. PGGM is focusing its engagement on just 12 of those firms, which it has identified as the most willing to transition, and in which it holds combined investments of more than €1bn. 

Estimating how many of those will survive the final round of divestments later this year, van de Linden says “there are very few that stand a chance at the moment”. But, he stresses, there have been some “really heartening” conversations with some of the 12 firms on PGGM’s engagement list, notably the smaller ones that get less media attention. 

Beyond equities

While the focus of stewardship has always been on public equities, the recent slew of fossil fuel divestments has applied across stocks and bonds.

Bartholdy says the Church Commissioners’ asset managers have accepted its new rules without pushback, but that in areas like corporate bonds or value equities, fossil fuels account for a larger part of the universe. 

“So that’s required more of a conversation. But we’ve always had exclusions, so asset managers understand that implementing those are the basis on which we invest with them.”

In private markets, liquidity constraints mean that the Church’s exclusions only apply to new investments. 

IEEFA’s Sanzillo says this is a “pretty reasonable strategy” given that pulling out of deals early in private markets can be expensive.  

Maine Public Employees Retirement System in the US allocates around half its $18bn (€108bn) of assets to private markets, and has been looking into these costs as it works out how to comply with a new state law requiring it to exit oil and gas completely by 2026. 

In a report in January, the pension fund said most of its fossil fuel exposure sat in infrastructure and private equity strategies. Advice from its consultant concluded that, while the infrastructure investments would retain their value relatively well, those in energy and natural resources faced resale discounts of up to 60% on net asset value. 

“This suggests a minimum discount of over $100m, calculated as a 10% discount applied to a projected year-end 2025 net asset value of $1,166.2m, to remove existing fossil fuel exposure from the system’s private market investments by 2026, and substantially more if divestment were to occur sooner,” MainePERS warned lawmakers in its report, adding that it “would also incur substantial legal and other costs associated with the transfer of partnership interests”.

As a result, the fund fighting for a longer run-up to divestment for private markets than for its listed assets. If it had more time, it argues, it would be able to take the same approach as asset owners like the Church of England: simply not making new deals in the space and letting the existing ones wind down by the end of the decade.