Carbon budgets: Knowing when to hold and when to fold

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As global leaders sit around the negotiating table at the Paris climate talks, discussion will quickly turn to the carbon budget and how to spend it.

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fossil fuelsAs global leaders pull up a seat around the negotiating table in Paris in the next fortnight, there is no doubt discussion will quickly turn to the carbon budget and how to spend it. That’s the budget that will determine whether the world stays under two degrees of warming or sails into the unchartered waters of three, four or even a five-degree temperature increase.

No one imagines that decision will be made this December at this Conference of the Parties. However to retain any hope of a safe and stable climate, the next decade will see debate around the division of the world’s carbon budget front and centre of discussions between nations, scientists, economists and financial analysts.

It’s the gravitational pull of this discussion that will ensure the now heated debate surrounding divestment versus engagement as the most effective form of shareholder activism gets a more forensic examination. Certainly the debate is a now a fairly regular presence in the media, as individual and institutional investors become increasingly wary of the environmental, social and long-term financial risks posed by various holdings within their portfolios.

In the last few years the issue’s profile has been raised in response to the fossil fuel divestment movement. Pressure for change is growing from within the community, fuelled in part by a growing awareness of how personal finances are being invested by banks and other institutions. This awareness is largely driven by technological change – investors now have access to more information than at any point in history – if BHP Billiton has a dam wall collapse the world knows within minutes.

Investors are becoming increasingly wary of the long-term risks posed by potentially stranded fossil fuel assets, with global moves to curb carbon emissions set to render the majority of the world’s known resources unburnable. Moves to correct the overvaluation of the companies planning to exploit those reserves are likely to massively disrupt the market as the carbon bubble bursts.

Asset managers in particular are feeling the brunt of the growing wave of public pressure, and are in turn realising that the full impacts of their investments go far beyond short-term financial returns.

The concept that a company’s reputation has major impacts on its financial sustainability has taken a long time to start sinking in with investors. But now that it is, we are seeing some hints that environmental, social and governance (ESG) issues are being considered by big business – although it must be said that the vast majority of ESG frameworks currently in place are largely made up of green-washing rhetoric.

But, despite the growing prevalence of both major methods of shareholder activism, there has been little close analysis of which form of activism works best for whom and when.

So what are the arguments for and against?

Divestment campaigners decry the slow-moving, incremental and compromising nature of engagement as a means of influencing a company’s corporate governance. On the other hand, engagement supporters argue that divested assets are simply snapped up by apathetic investors, removing the leverage and bargaining power that a shareholder has. To weigh up these arguments, it is important to recognise the differing sources of power that each approach draws upon.

The symbolic power of divestment is perhaps less tangible than its economic effects, but provides its greatest strength. This is not to downplay the huge financial impact institutional divestment decisions can have – the Norwegian sovereign wealth fund’s coal divestment announcement back in June included dumping over $130 million worth of AGL shares.

Alternatively, the engagement model relies on information, awareness and compromise. It is based on the belief that corporations are capable of change and that with enough information the Board will eventually redirect the company into safer investments. It is worth noting that engagement exerts no direct economic pressure.

When employed at the right time, engagement is capable of bringing about change, but shareholders must be prepared to change tack. For example, the time for engagement with pure play fossil fuel companies has passed. If a company’s only source of revenue is derived from extracting, transporting or burning fossil fuels, their business is simply not sustainable in the long-term. Engagement is only appropriate with those companies where fossil fuels make up only part of their revenue.

It is important to understand the historic moment investors and corporations are operating within. Where engagement has failed or has proven fruitless, following through with divestment is the only effective way to exert real power. Ultimately, engagement is meaningless without being backed by a credible threat of divestment.

How does each approach work?

Divestment works to simultaneously remove money from targeted industries or companies and raise awareness about the issues that have prompted the decision to do so. It is as much a communication strategy as it is a financial one. It allows investors to align their money with their values, while also providing an opportunity to exit companies and sectors whose activities leave them dangerously exposed to reputational and financial risks.

It has been argued that divestment is ineffective because it makes little economic impact on targeted companies, with a study into the anti-apartheid South African divestment movement often cited as authority for this position.

But that particular movement has also been recognised as a resounding success. While targeted companies saw little depreciation in their market valuations, many nonetheless decided to end their South African operations to avoid negative publicity brought on by the divestment movement.

Divestment campaigns have been dismissed by some as being merely “symbolic” and therefore no real threat to a company’s bottom line. This position completely fails to understand the enormous power of symbols in our individual and collective lives. It is worth remembering that when young men and women go to war they do so around the symbols of their community. Symbols like flags and insignia, symbols of identity and community are used to motivate us when the stakes are at their highest.

It was French sociologist Pierre Bourdieu who first popularised the concept of symbolic power when he suggested cultural roles were more dominant than economic forces in determining how hierarchies of power operate across societies. Bourdieu argued symbolic capital, as distinct from financial capital, plays a key role in maintaining or gaining power. Ask Nike or BHP just after both companies experienced their own international scandals just how important reputation is to the bottom line.

Divesting from a company because it breaches community values is a powerful strategy because of its symbolic nature. It also has the added benefits of inflicting reputational and economic damage to the company if done on a large enough scale.

A 2013 Oxford University report on the fossil fuel divestment campaign recognised its stigmatising effect on targets as ‘the most far-reaching threat to fossil fuel companies,’ far outweighing any direct financial impacts.

That said, the financial impact is not to be laughed at – one of the world’s largest coal producers Peabody highlighted the divestment movement as a risk to its share price in a securities filing earlier this year.

By contrast, the vast majority of engagement takes place behind closed doors, offering little opportunity to publicise the issues raised.

Different methods of engagement are employed by investors at varying levels. A large asset manager might have the influence and standing to be able to meet with company directors to air their concerns. Individual shareholders have an opportunity to engage directly at AGMs, if they are lucky enough to be able to be in the right city at the right time, and be granted a tiny window to pose a quick question. Of course all shareholders have voting rights at these AGMs, but the influential power is minimal at best.

The most effective forms of engagement, like divestment, occur when it is accompanied by public awareness and debate. When large institutional investors publicly oppose a view of the board, the issue is then debated in the media, allowing other investors to take a position. But other than on remuneration, such debates in public are rare.

Can the two work together?

The two approaches can and must work together. Divestment is a powerful weapon for anyone trying to bring about corporate change, but its success lies in being able to turn a divestment decision into a narrative so compelling that the mainstream media adopt it – or at least cover it.

Engagement can also foster public debate and influence, but relies heavily on the power and willingness of the institution involved. Its effectiveness is severely weakened by a reluctance to follow through with the threat of divestment.

In a recent piece for the Guardian, Welcome Trust director Jeremy Farrar outlined his preference for regularly meeting with company executives, ‘supporting their best environmental initiatives and challenging their worst.’

This approach can be seen as an important first step of the shareholder activism process and should always be attempted as a first resort when there is genuine opportunity for a company to change its behaviour. If the company hadn’t previously been aware of the issues raised, then this type of engagement may well bring about the desired change. This of course assumes those wanting engagement are financially literate and know how to engage with the corporate sector, something not every NGO is able or willing to do.

However, the issue of fossil fuels causing dangerous climate change has been scientifically beyond doubt for over three decades. The time for this first step has long since passed – probably sometime back in the 80s after Exxon’s own scientists confirmed fossil fuels’ role in global warming.

At this stage, meetings with executives must encourage policy and operating changes that will help quickly steer us away from a destabilised climate and its most devastating effects. And the only bargaining power that a shareholder has in this situation is the threat of divestment.

Engagement can be seen as a necessary initial move, but when the company is unwilling to work towards the same goals, a time comes when divestment becomes the only option. Even engagement supporter Farrar notes that ‘when we are not satisfied that a company is engaging with our concerns, we are perfectly prepared to sell.’

Is there a financial argument for divestment?

For the morally apathetic investor, the only real question in the debate is: will divestment leave me better or worse off financially? A number of analyses have tried to answer this question and the results vary according to the different models applied.

For example, the independent analysis presented in Impax Asset Management’s recent white paper used seven-year historical data to determine that a fossil-fuel-free portfolio would have slightly outperformed the market over this timeframe.

Alternatively, an Independent Petroleum Association of America (IPAA) funded report compared a fossil-fuel-excluded portfolio against the market over the previous 50 years to conclude that divesting funds stand to lose money in the future. Though some may question the wisdom of applying 50-year data to this rapidly changing sector. The old adage of ‘past performance is not necessarily an indicator of future performance’ is probably best applied to the financial stability of the fossil fuel industry facing a low-carbon future.


Closer to home, it has been noted that ANU’s 2014 divestment decision – ironically labelled ‘stupid’ at the time by Tony Abbott – has in fact saved the university ‘a fortune.’

As further moves are made to decarbonise our economy – particularly with the Paris climate talks rapidly approaching – the full extent of stranded fossil fuel assets will be realised.

The Carbon Tracker Initiative’s latest report highlights the fossil fuel industry’s ongoing failure to consider the risks posed by a carbon-constrained economy. This doesn’t bode well for the industry or its investors, lending further support to the pragmatic reasons for divestment.

So the debate between divestment and engagement rages on, but meanwhile, so does climate change. The commitments made in Paris will ensure that businesses carbon exposure will be more closely monitored, prompting both wiley and ethical investors to push for change.

But for major climate change contributors, we can see that the time for engagement has long since passed, and there will be an acceleration of divestment from these holdings over the next few years.

For other, more diversified companies, engagement may still be able to bring about change, but this approach needs to be quickly followed up with divestment action if changes are not made fast enough. No investor can afford to remain complacent and accept the climate recalcitrance that is all too common at the moment.

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