Divestment of fossil fuel company stocks

Stranded assets are those investments which lose their value as a result of unanticipated or premature write-offs, downward revaluations or which are converted to liabilities. Stranded assets are of concern to investors because they mean that the value of the investment is lost prematurely. However, environmental advocates often seek to trigger stranded assets as a way of reducing environmental risks. One example is the current effort to encourage universities and other large investors to withdraw their investments from fossil fuel companies. If these initiatives were fully successful, which not even the environmental advocates who are promoting divestment believe is likely, then the companies’ stock prices would collapse and the value of the asset would be lost – a typical ‘stranded asset’ situation.

Currently, campaigners are encouraging universities and large investors to eliminate fossil fuels from their investment portfolios. The Stranded Assets Programme at the University of Oxford’s Smith School has undertaken research on the risks that arise from this type of campaign. Its latest publication, Stranded Assets and the Fossil Fuel Divestment Campaign: What Does Divestment Mean for the Valuation of Fossil Fuel Assets?, states that the aims of the fossil fuel divestment campaign are threefold: (i) ‘force the hand’ of the fossil fuel companies and pressure government—e.g. via legislation—to leave the fossil fuels (oil, gas, coal) ‘down there’ ; (ii) pressure fossil fuel companies to undergo ‘transformative change’ that can cause a drastic reduction in carbon emissions—e.g. by switching to less carbon-intensive forms of energy supply; (iii) pressure governments to enact legislation such as a ban on further drilling or a carbon tax. Inspiration for the fossil fuel divestment idea leans heavily on the perceived success of the 1980s South Africa divestment campaign to put pressure on the South African government to end apartheid.

The researchers have found that:

  • Direct impacts on equity or debt are likely to be limited. The maximum possible capital that might be divested from the fossil fuel companies represents a relatively small pool of funds. Even if the maximum possible capital was divested from fossil fuel companies, their shares prices are unlikely to suffer precipitous declines over any length of time.
  • Any divested holdings are likely to find their way quickly to neutral investors. Larger fossil fuel funded sovereign wealth funds such as Norway or Abu Dhabi may even welcome the opportunity to increase their holding of fossil fuel companies—businesses they understand very well—particularly if the stocks entail a short-term discount.
  • Direct effects on coal valuations are likely to be more substantial. Coal companies represent a small fraction of market capitalisation of fossil fuel companies and coal stocks are also less liquid. Divestment announcements are thus more likely to impact coal stock prices since alternative investors cannot be as easily found as in the oil and gas sector.
  • Negative screens or passive funds that exclude fossil fuel companies will quickly emerge. Some banks, particularly multilateral institutions such as the World Bank, may stop lending to fossil fuel companies, particularly coal.
  • Since a divestment campaign has little hope of directly impacting the future cash flows of fossil fuel companies, neutral debt or equity investors have little cause to shun to fossil fuel companies.
  • Divestment announcements are more likely to impact coal stock prices.
  • Divestment campaigns will probably be at their most effective in triggering a process of stigmatization of fossil fuel companies. We find that even if the direct impacts of divestment outflows are limited in the short term, the campaigns will cause neutral equity and/or debt investors to lower their expectations of fossil fuel companies’ net cash flows in the long term. The process by which uncertainty surrounding the future of fossil fuel industry will increase is through stigmatization. In particular, the fossil fuel divestment campaign will increase legislative uncertainty and potentially also lead to multiples’ compression causing more permanent damage to the companies’ enterprise values.
  • Stigmatization, while likely to cost fossil fuel companies billions, is unlikely to threaten their survival. Coal companies will probably be the hardest hit segment of the market.

The report makes recommendations to investors, fossil fuel companies, and campaigners on how to manage these risks.

The full report is available at http://www.smithschool.ox.ac.uk/research/stranded-assets/SAP-divestment-report-final.pdf


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