Financial Concerns and Fiduciary Responsibility
A recent report from the Institute for Energy Economics and Financial Analysis states, “In the past several years, oil industry financial statements have revealed significant signs of strain: Profits have dropped, cash flow is down, balance sheets are deteriorating and capital spending is falling. The stock market has recognized the sector’s overall weakness, punishing oil and gas shares over the past five years even as the market as a whole has soared.”
Currently the price of fossil fuels companies’ shares is calculated under the assumption that all fossil fuel reserves will be consumed. If they can’t bring reserves up from the ground, their value will go down, exposing institutions to material loss. Stranded asset estimates range from $304 Billion (IEA by 2035) to $100 Trillion (Citi).
Coal, once the titan of the U.S. economy, no longer has even one representative in the S&P 500. Coal’s investors have lost billions, a trend which has been most clearly illustrated by Peabody Energy’s downfall; the company’s 93% drop in share value resulted in a loss of $16 billion for investors, according to IEEFA.
PERA has holdings in the coal industry, which has already undergone a massive wave of bankruptcies. Statistics show that over the next 35 years, the coal industry can expect to see annual returns reduced by 26% to 82%. Similarly experts project that oil and utilities are projected to see expected median returns fall by 38% and 60% respectively over the same time frame (Source: Mercer, Climate Change Investment Risk Management: A Guide for U.S. Public Defined Benefit Plan Trustees, 2016).
PERA also has holdings in Exxon Mobil Corporation, which reflects declining stocks over the past five years. According to Seeking Alpha, shares have delivered a total return of around 1 percent annually over the last five years, falling far short of the S&P 500. At the same time, the company's return on capital employed has fallen from over 25 percent in 2012 to 9 percent in 2017 (Source: Exxon Stock Not So Slick, May, 2018, Seeking Alpha). Exxon also had to borrow money to pay out dividends and buy back shares (Source: Warning: Exxon Mobil may be in irreversible decline, CNN Money, Oct, 2016). According to the Wall Street Journal, despite billions of dollars in spending cuts and a modest oil-price rebound, Exxon Mobil, Royal Dutch Shell, Chevron, and BP didn’t make enough money in 2016 to cover their costs.
Could these trends continue?
Leading global index provider MSCI found that fossil free funds outperformed conventional ones by 1.2% during 2010-2017. Furthermore, S&P 500 Low Carbon Index returns are steadily increasing since 2012. Lost revenue from oil and gas assets is probable as demand declines and new competitive alternative technologies emerge, like electric vehicles and other renewables with strong potential in Colorado such as wind and solar.
Mercer Investments, a leading adviser of institutional investors including pension funds, evaluated several climate change scenarios and found that climate-related financial risk would affect investment performance. According to Moody’s Investors Service, the oil and natural gas industry faces significant credit risk due to carbon-related global policy initiatives, changing consumer preferences and disruptive technological advancement. New regulations and policies designed to reduce greenhouse gas emissions will increase the operating costs and in turn place downward pressure on the profitability of carbon intensive sectors and industries.
According to The Guardian, New Yorkers could have made an extra $4,500 each if fossil fuel divestment had occurred earlier. In fact, over $5 billion could have been generated if the transition to investing in renewables had happened sooner (Source: The Guardian, 2016). Over the last ten years, CalPERS (California's state pension fund) lost approximately $16.2 billion or $8,526/beneficiary due to poorly-performing fossil fuel stocks, while CalSTRS lost $24.3 billion or $26,016/beneficiary. And the worst is yet to come: A Cambridge University report suggests that pension funds could suffer permanent losses of more than 25% within five years, in the event of a climate-related market shock (Source: See Unhedgeable Risk, Cambridge University 2015, p. 7).