Divesting from fossil fuel assets makes a big statement. Its impact, however, is murkier. Selling off an asset requires someone else to buy it, which, in the case of fossil fuels, can mean breathing new capital into the exact assets companies are trying to choke. But there’s another approach: running those assets into the ground. By holding onto fossil fuel assets, investors can resist efforts to improve their output and extend their lives. By planning to sunset these assets, they maintain control and can ultimately have more of an impact than if they simply washed their hands and dumped these investments from their books.
Committing to divest from fossil fuels seems like a profound pro-climate statement. Selling off fossil fuel investments, the logic goes, will choke off capital from the fossil fuel companies and make it harder for them to operate. Eventually, divestment will lead to the sector’s demise and create a better environment for accelerating renewable energy efforts. By pulling money out of fossil fuel investments, companies can demonstrate how they’re taking a material step towards a more sustainable world.
Unfortunately, what looks good on paper often falls short in practice. There’s one major problem with divestment: Selling an asset requires someone to buy it. In other words, for you to divest, someone else needs to invest. As a result, divestment could end up breathing new life into fossil fuel assets – exactly the opposite of what’s intended.
So what’s a climate-minded company to do?
Divestment can work, but it needs to be part of a broader run-off strategy. Think of this comprehensive approach as taking fossil fuel investments as “running it into the ground,” the way you would an old car. Buying a new car adds one to the roads, while using the old one until it’s unusable puts off the incremental effect. To make an impact — not just a statement — companies should plan to sunset fossil fuel investments at the ends of their useful lives rather than pass the buck to someone who could try to make them productive again. Here’s how.
What is divestment?
Fossil fuel divestment is a simple concept: The owner of a fossil fuel assets commits to selling it to demonstrate adherence to sustainable finance practices and climate risk management. Divesting seeks to withdraw capital from businesses that threaten the environment, making divestment a tangible act of “voting with your dollars.” The goal is to create constraints on available capital in the fossil fuel sector, which should impede company operations in the target sector and limit shareholder returns, making the category less attractive to investors. Ultimately, divestment aims to render fossil fuel businesses so unattractive that they’ll struggle to survive.
The fossil fuel sector isn’t the first target of divestment campaigns. The classic example is the targeting of businesses in South Africa in the 1980s. Driven by opposition to apartheid, divestment achieved favorable perception and was believed to drive global awareness and sentiment against the South African government. A deeper look, however, reveals that divestment never truly influenced policy. Other divestment campaigns were even less impactful. Any benefits from the tobacco divestment campaign in the 1990s, similar to the South Africa and fossil fuel campaigns, but with much less fanfare, for example, would have been obscured by effects of litigation.
Despite divestment’s thin track record, it’s easy to claim that campaign against the fossil fuel sector is different, even if only because of scale. Fossil fuel divestment is largely believed to have become the most successful such campaign in history. More than $40 trillion in assets have been committed to divestment — that’s almost two thirds of the entirety of global pension fund assets under management ($56 trillion). And it represents 1,550 institutional investors, including AXA Investment Management, the Ford Foundation, the Norwegian Sovereign Wealth Fund, and Harvard University.
Nonetheless, many still question how well divestment works, even for fossil fuels. Specifically, there have been no clear connections to the actual realignment of capital flows away from fossil fuels, and in fact, the fundraising environment appears to have improved, growing from $234 billion in 2000 to approximately $700 million in 2015. If history is any guide, past efforts at divestment suggest limited future success at best, with capital availability emphasizing that forecast.
Why doesn’t divestment work?
How effective divestment campaigns are depends on perspective. From the perspective of the divesting party, is highly effective. Fossil fuel asset sellers vote with their dollars and proclaim their positions publicly — and $40 trillion is an eye-popping commitment. Sellers can remove undesirable assets from their portfolios, releasing capital for allocation to cleaner or otherwise more preferable investment opportunities. On the other hand, capital to the dirtier parts of the energy sector keeps on coming. Divestment by one party involves investment by another, which translates to more capital flowing to the fossil fuel sector, in contravention of the seller’s objectives.
The problem is bigger than just “money out, money in” though. The real issue is that the new buyer has a salient interest in making that asset perform and generate returns. This often means improving the overall productivity of the fossil fuel investment, including pushing for increased output through a longer useful life. So, whether divestment worked in a situation like this comes down to how the climate benefits of the divesting party’s reallocation relative to the asset improvements made by the buying party.
Consider an example. The divesting asset manager sells an oil refinery and reallocates its capital to renewable energy assets. The party buying the refinery invests in improvements. To gauge the benefits of divestiture, the climate benefits of the renewable portfolio would have to outpace those of the improved refinery. Even attempting to calculate this would be a fraught exercise, requiring both parties to commit to the effort, the engagement of a qualified independent party, and even an agreement on definitions and methodology (itself a hornets’ nest in sustainable finance).
Fossil fuel divestment certainly has some amount of value as a tool for promotion and advocacy, and in general, the decision by asset managers to divert capital from fossil fuels is laudable. However, it requires near total adoption to truly be effective, and without that penetration, divestment could have the unintended negative consequences shown above. For more effect than symbolism or public discourse, alternatives to the sale of fossil fuel assets must be considered.
What’s better than divestment?
Run-off strategies are poised to succeed where divestment campaigns fall short. As illustrated above, divestment is built on an inherently contradictory and counterproductive dynamic, in which the divested asset could become more negatively effective. On the other hand, running off an asset instead of selling it, simply means holding it until can be terminated. For example, this could entail holding a fossil fuel company’s debt to maturity and then not renewing or extending another loan, or it could mean operating a physical asset (like a refinery) until it is no longer useful, to include resisting investments in improvements that would make the asset more productive and longer-lived. Instead of extending the useful life of a fossil fuel asset or otherwise improving it, run-off involves setting a time horizon for ending its productivity.
Run-off, of course, lacks the immediacy of divestment. Selling an asset today — or committing to do so — is easy to communicate: I’m getting this off my books now. It makes for a great a great line in a letter to investors. Explaining a fossil fuel run-off strategy requires complexity, nuance, and patience. In the long run, it’s worth the effort. And, run-off can even be paired with divestment. Divesting an asset to a party that commits to running off the asset sets the asset on a course for run-off. While run-off hasn’t received as much attention as divestment, the strategy is already being used. The 2% position in fossil fuel investments that has survived the Harvard University endowment’s divestiture commitments is in fossil fuel investments to be run off.
The path of least resistance may also be the path of least result. Running off fossil fuel holdings may be more time-consuming and seemingly capital-intensive than divestment, but the strategy has teeth. Divestment, conversely, is easy to accomplish and scale. Ultimately, divestment can only work if it’s paired with long-term action, and that’s where run-off can help. Running off fossil fuel assets overcomes the fatal flaw of divestiture and stands to take fossil fuel assets out of the market. Yes, run-off lacks immediacy, and we’re running out of time for patience. Instead of looking at run-off — or divestment or anything else — as a discrete solution to climate change, consider it within a broader context of tools for mitigating climate risk. Run-off shouldn’t exist in a vacuum, and asset managers should contemplate a wide range of sustainable finance strategies for their portfolios.
Divestment makes for a better press release. Run-off makes for a better world.