THE FINANCIAL CASE
carbon constrained future
On March 21st, 2022 Princeton revealed that it has $1.7 billion invested in fossil fuels which represents 4.5% of the endowment. We all want the endowment to do well. To ensure it benefits future generations of Princetonians, the endowment should only be invested in winning long-term investments. The fossil fuel industry was a winning investment for much of the 20th century, but investors can no longer expect the same powerhouse performance going forward.
The fossil fuel industry has seriously underperformed the market for a decade.
Since 2011, the fossil fuel industry’s profits have shrunk and revenues have tumbled. Once a major driver of equity markets, oil companies comprised seven of the ten largest companies of the S&P 500 in the early 1980s. ExxonMobil was the last oil company to leave the top ten in 2019. Likewise, fossil fuels made up 28% of the value of the S&P 500 in 1980 and only 2.7% of the index at the end of 2021.
Volatile oil prices lead to stranded assets.
The industry’s fall from grace was largely caused by a price drop due to its own major innovation: hydraulic fracturing (fracking). Fracking increased the supply of cheap oil and gas, dropped prices and revenues, and challenged the production regime of OPEC+ oil producers. In response to fallen prices, the industry cancelled major new oilfield developments and wrote off massive amounts of oil reserves as no longer economic. A significant number of companies filed for bankruptcy. The lack of coordination between frackers and OPEC+ regarding how much oil to drill portends significant volatility in oil prices for years to come and increases the risk of stranding more of the industry’s assets.
High oil and gas prices harm developing economies and boost competing technologies.
Oil and gas prices would need to rise higher than the levels reached in 2021 and stay high for years to make up for the industry’s decade of underperformance. This would wreak havoc on the economic development plans of developing economies, inflicting inflation, trade deficits, currency imbalances, fiscal stress, and anemic economic growth. High oil and gas prices would also confer a competitive advantage on key competitors to fossil fuels, renewable energy and electric vehicles.
The risks facing the fossil fuel industry are daunting.
In addition to price risk, the oil industry faces transition risk from emerging and future policies limiting greenhouse gas emissions; physical risk to its facilities from sea level rise and extreme weather; and legal risk from a variety of lawsuits, including suits seeking compensation for misstating the value oil reserves to investors and for the costs borne by municipalities to adapt to climate change. Oil and gas companies have loaded up on unsustainable debt to continue paying dividends to investors, and face mounting cleanup costs for hundreds of thousands of active and inactive wells. Finally, insurance companies increasingly refuse to insure coal mining, coal fired power plants, and oil and gas production.
The fossil fuel industry is facing serious and intensifying market competition for the first time.
Renewable energy today costs less than fossil energy sources in many markets even without subsidies, and this advantage persists for many projects that incorporate battery storage. Renewable energy is even displacing natural gas-fired electricity from the grid. In the auto sector, the lion’s share of investment is going toward electric vehicles. Even sectors considered difficult to abate like aviation, steel, and shipping are seeing increased investment in developing alternative technologies.
Divestment has become the prudent choice for investors.
Sophisticated investors are now treating oil and gas companies as high-risk investments with no prospects for long-term growth, volatile revenues, shrunken profits, and a negative outlook. Thousands of investors controlling trillions of dollars have chosen divestment as the prudent financial choice. A study by a widely respected investor demonstrates that an institutional fund that divested from any particular sector would have only seen a negligible impact on investment returns over the long-term, but that the threat posed to fossil fuels by decarbonization merits divestment.
Significant financial institutions find few costs to divestment.
In considering divestment, New York City pension funds asked investment advisers for a plan to meet their investment targets with a fossil fuel-free portfolio. The advisers, including heavyweight asset manager BlackRock, identified few obstacles to doing so in a series of reports that were released publicly. The reports outline multiple divestment approaches and address conversion fees, which are expected to be low given the growing number of fossil-free investment products on the market.
Science Based Targets -The Science Based Targets initiative (SBTi) drives ambitious climate action in the private sector by enabling companies to set science-based emissions reduction targets.
Partnership for Carbon Accounting Financials - An industry-led partnership to facilitate transparency and accountability of the financial industry to the Paris Agreement
Influence Map - An independent think tank producing data-driven analysis on how business and finance are impacting the climate crisis