Fossil-Fuel Divestment Is Futile
The fossil-fuel divestment campaign has made its way from the campus quad to Wall Street. Watch for disruptions at Wednesday’s annual meeting of Exxon Mobil shareholders. Climate-change and environmental activist groups have become the ideological driving force behind the environmental-social-governance movement, or ESG, sweeping the investment-management industry.
ESG criteria purport to promote “sustainable investing” by imposing “social responsibilities” on corporations—including the responsibility to prevent global warming—under the guise of fiduciary responsibility, risk management and financial transparency. Because the environmental question relates to what oil and gas companies do, as opposed to how they operate, there is no obvious way for them to comply, apart from getting out of the business.
That means there’s no obvious way for fund managers to comply with ESG activists’ demands other than by divesting themselves of fossil-fuel companies. The activists have succeeded in redirecting investment flows away from the coal and oil-sands industries, with crude oil the next hydrocarbon in the crosshairs.
But fund managers need return performance and portfolio flexibility. That’s the main reason college endowment boards have generally ignored student climate protesters. Energy is a significant component of the world’s financial markets—too large, diverse and volatile a sector for major institutional investors not to own. Depending on the benchmark index, the industry comprises between 5% and 15% of the major U.S. debt and equity markets.
By framing the debate in terms of fiduciary responsibility, the ESG movement is actually sowing the seeds of its own destruction. In the long run, the effort to starve energy companies of capital will only make the oil and gas sector more attractive to investors.
Consider the following irony: Many traditional energy investors are making common cause with anti-fossil-fuel groups by also advocating for a curtailment of capital to the industry—including to some of the best U.S. shale-oil plays, such as the Permian Basin in West Texas. Energy-company shareholders are agitating for a shift away from the historical business model focused on growing reserves and production while perennially outspending cash flow.
Such calls for “capital discipline” are transparently self-serving. In the near term, any cash not put back into the ground through the drill bit would likely be returned to shareholders in the form of dividends and stock buybacks.
The overriding goal is to jack up oil prices by slowing down drilling activity and production growth. Despite strong wellhead economics, energy stock prices continue to lag and underperform nearly four years after the 2014 fall, due to their high correlation with world oil prices. All else equal, most energy companies and investors would prefer to leave oil in the ground until prices rise. Forcing energy companies to live within cash flow by deferring capital spending helps that happen.
That dedicated energy investors are now echoing the arguments of the ESG movement should motivate the latter to crack open an economics textbook. The basic law of supply and demand suggests that if the ESG movement gained critical mass so that it had a real effect on the cost and availability of capital for fossil-fuel companies, it would likely push oil prices well above the $100-a-barrel mark, generating windfall returns for energy companies—and for those investors who resist peer pressure and maintain exposure to the sector.
ESG-minded funds that divested from the sector for moral reasons would significantly underperform their peers and relevant benchmarks, thereby failing in their fiduciary role. And unlike 100-year climate-projection models, investment managers are gauged by their actual return performance every year.
Something for the ESG environmentalists to think about as they march toward Pyrrhic victory.
Mr. Tice works in investment management and is an adjunct professor of finance at New York University’s Stern School of Business.
Appeared in the May 30, 2018, print edition.