Fossil Free Funds outperform! Analysis of 5 year returns shows that “investors who have dumped holdings in fossil fuel companies have outperformed those that remain invested in coal, oil and gas”. This article in the Guardian newspaper highlights analysis by MSCI, the world’s leading stock market index company, which found that “investors who divested from fossil fuel companies would have earned an average return of 13% a year since 2010, compared to the 11.8%-a-year return earned by conventional investors.” While it would be easy to dismiss these results by suggesting that the sharp decline in oil prices in 2014 was the major cause, the MSCI analysis showed that “its ‘All Companies ex Fossil Fuels Index’ outperformed throughout 2012 and 2013, before the fall in the oil price.” Past performance does not guarantee future performance. But looking ahead, there are compelling reasons to believe that fossil fuels are a risky investment.
Fossil fuel companies are certainly looking ahead. The value of energy companies’ stock is based on anticipated future earnings from selling fuels that they have yet to extract. Increasingly, the anticipated profits being recorded on balance sheets are based on ‘frontier’ assets such as deep water reserves and the Canadian tar sands, both of which are vulnerable to changes in government regulation. “These reserves are not only the most carbon intensive, risky, and expensive to extract, but the most vulnerable to devaluation,” says Natasha Lamb, Arjuna Capital’s Director of Equity Research.“ As investors, we want to ensure our companies’ capital will yield strong returns, and we are not throwing good money after bad.”
Brown coal – Net value of assets as at 06/30/2012. Image by Toby Hudson
Climate scientists state that in order to limit a global increase in temperature to 2°C, 60 to 80% of proven reserves must stay in the ground. “No more than one-third of proven reserves of fossil fuels can be consumed prior to 2050 if the world is to achieve the 2°C goal.” So what happens to stock prices that are based on future profits when global governments begin regulating to limit climate change to livable levels? Investors risk holding stranded assets of unburnable carbon reserves.
This risk is the reason that a major Norwegion pension fund, Storebrand, has already divested from 29 fossil fuel companies.
Australian coal companies have already felt the effects of China’s $1.65 billion effort to cut fossil fuel use—they became unprofitable with just a 5% decrease in coal imports. “You don’t have to cut demand by much to force prices below the cost of production,” notes Tim Flannery, scientist and author. With investments in renewable energy and vehicular efficiency regulations, a decrease in demand for fossil fuels could effect investment profits even without climate legislation.
Deepwater Horizon oil spill at Chandeleur Islands. Image by Jeffrey Warren, Grass Roots Mapping project
We’re in a carbon bubble. And, fossil fuel companies may be held liable for damages to health and property due to climate change—just like what happened to the tobacco industry. HSBC, Citigroup and many others have declared that fossil fuel stocks are overvalued and risky. They’re simply not a sound investment in the long term.
More Reading:
- Canada’s Carbon Liabilities
- Fossil fuel assets in danger of being stranded
- Globe and Mail article: “Global carbon budget is a harsh reality check for Canadian investors”
- 7 Reasons to sell coal, oil, and gas stocks
- 10 Economic risks of fossil fuels
- Carbon Tracker Initiative
- The Economic Case for Divesting from Fossil Fuels
- Debunking Divestment Myths
- Climate Change Scenarios – Implications for Strategic Asset Allocation