For environmentally conscious investors committed to reducing dependence on fossil fuels and supporting the broad adoption of renewables, divesting from traditional energy companies has become a popular approach. Is it the right one?
The Pros and Cons of Divestment
Over the last decade, fossil fuel divestment has grown into a socially influential and impactful movement. It has succeeded in changing the discourse around the viability of the fossil fuel industry and has sent a clear message to companies and policy makers. From the bottom-up, divesting from heavily carbon-emitting companies makes sense. It is measurable, aligns portfolios with an investor’s values, and reduces the financial risk of “stranded assets.”1
Divestment strategies can be easily implemented via ESG-screened or low-carbon passive index funds, which are well-intentioned efforts to create more sustainable portfolios. Yet they are a short-term answer to the challenge of energy sustainability. What many people may not realize is that a lower portfolio carbon footprint will not necessarily support a transition to a lower carbon economy.
In terms of direct financial impacts and reduced emissions, divestment’s effectiveness has been unclear. Exiting has actually been found to be less effective than engaging when it comes to influencing companies to act in a socially and environmentally responsible manner.2 After all, what you don’t own still pollutes.
When you’re a part owner in a company, you have a voice – one that you lose when you divest. As RBC Global Asset Management frames it, “Fossil fuel divestment strategies have the unfortunate effect of removing climate conscious investors from a position of influence with energy companies, which are critical to the low-carbon transition.”
Engagement as a Path to Positive Change
The transition to renewable energy is crucial to securing a prosperous and sustainable future. To accomplish that transition, we need to engage with companies that are part of it. If anything, it is the energy sector that has the infrastructure, resources, and expertise to implement the changes required to transition to a lower-carbon economy. At Crestone, we seek to partner with institutional fund managers who are willing to individually engage with companies in which they invest, which may include energy companies – especially those that are committed to improving their environmental impact and shifting to renewables.
One approach is to identify portfolio companies with a substantial environmental impact and credible plans or a demonstrated record of lowering that impact. To make this more tangible, consider a business like Orsted, a now global energy company that was originally founded to manage and grow the massive oil and gas resources of Denmark. Once one of the most coal-intensive companies in Europe, Orsted still operates coal-fired power stations, which means that many environmentally conscious investors might choose to avoid it altogether. Yet over the last decade, Orsted has transformed its business model to become a global leader in the transition to green energy. Today, the company is the world’s largest developer of offshore wind power and has plans to fully transition its business to renewables—with their operations and energy production on track to be carbon neutral by 2025. Divesting from such companies is a missed opportunity to aid in the energy transition.
Another example we can point to is the mining industry, which is widely viewed as socially and environmentally destructive. Minerals such as copper, nickel, and lithium are critical to the electric car revolution and advancement of battery technology, innovations that are key to facilitating the shift to a low-carbon economy. While some prefer avoiding the mining industry altogether, the argument can be made that the more impactful course of action would be to work with the best-in-class producer, encourage it to improve its operating practices and seek to minimize its environmental impact. The costs of not engaging could include poorer mining standards, more environmental damage, and slower progress towards the low-carbon economy we all need.
Here’s a summary of why we view engagement as an effective tool to improve corporate behavior and help decarbonize the economy:
- Investors, especially those who own significant stakes in the business, are seen as influential within companies.
- Engagement with management on ESG issues is a tangible way to effect change, especially when businesses have meaningful opportunities to make a difference.
- Investors can bring shareholder resolutions on climate disclosures and climate strategy — and they can vote against management decisions that are not aligned with societal climate goals.
This level of engagement is a proactive approach, contrary to an avoidant or negative screening strategy, which dictates that the lower the emissions are in a portfolio, the “greener” it is said to be. A recent article in the Economist highlighted an inherent hypocrisy: “ESG ratings measure the risks that climate change poses to a company, rather than the threat that the company poses to the climate.”3We therefore believe that engaging with businesses that operate within the energy sector and advocating for cleaner solutions is ultimately a more effective strategy in getting from where we are today to a more sustainable future.
It is also worth pointing out that another way our clients are getting involved is by providing early-stage venture capital to cutting-edge startups, working on the development and deployment of green technologies to reduce carbon emissions and accelerate the climate transition.
Article by Justine DeCoste, Director, Investment Research, Crestone Capital.
Footnotes and Additional Resources
1 Stranded assets are now generally accepted to be those assets that at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return (i.e. meet the company’s internal rate of return), as a result of changes associated with the transition to a low-carbon economy (lower than anticipated demand / prices). Or, in simple terms, assets that turn out to be worth less than expected as a result of changes associated with the energy transition. https://carbontracker.org/terms/stranded-assets/
3 https://www.economist.com/special-report/2022/07/21/a-broken-system-needs-urgent-repairs
To learn more about engagement as a strategy, visit the links below:
https://www.ft.com/content/814cbd2c-00db-41b7-91af-28435301a8a2
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