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Divestiture and Fossil Fuels:

Both sides of the argument are deploying blunt nosed instruments to address a
far more nuanced question of risk and return.
The activist movement to pressure investors to divest from fossil fuels is certainly gaining
ground. Kevin Bourne, a managing director of London-based stock market indices provider
FTSE, described divestment as one of the fastest-moving debates I think Ive seen in my
30 years in markets. So far, the movement has attracted more action with respect to
coal than oil or gas; perhaps because coal seems to be the dirtiest fuel, perhaps because
coal represents a smaller share of most portfolios, or perhaps because coal indices have
already fallen quite far. In any event, investors seem to treat each fuel type as a single
asset class to be dealt with in a uniform way. Certainly, the industry lobbying groups of
the coal, oil and gas industries have responded that way asking us to treat their
particular fuel as a uniform and uniformly important asset category we cannot possibly
abandon. Gas is playing the we are cleaner than coal card. Oil is taking the we dare
you to stop using oil even if it kills you approach. And coal appeals to motherhood and
apple pie we brought you the lifestyle you now so enjoy, job preservation and all. After
all these are giant asset classes we are dealing with oil & gas companies make up 11%
of the S&P 500 and 20% of the London FTSE 100.
Both sides of these arguments ignore that the risk profile of carbon assets has already
changed and the pace of further change is likely to accelerate. In the case of coal,
particularly in the U.S., much of the damage has already been done. Effectively, U.S.
investors in coal stocks and indices lost 75% or more of their value before any of them
reacted to the divestiture call. Those who did divest could be accused of using the
movement as a cover for losses they should have avoided by acting sooner.
But none of coal, oil or gas is an asset of uniform value or risk characteristics. The
commodities are different from each other and from the companies exploiting them. U.S.
coal faces a different prospect than coal in parts of Asia or Africa. U.S. natural gas from
fracking is in a different position than more expensive pipeline gas from Russia. Whether
your oil holdings are tied to the Saudis, BP/Shell/Exxon, smaller U.S. shale developers or
Canadian tar sands makes a bigger difference today than it did just a year ago. From an
investment perspective, the important question is just how differently will my overall
portfolio behave in the near and longer term future than it has behaved in the past?
The answer to that question is nuanced and extends further than just your oil, gas and
coal holdings. How have you factored in the announcements last week by Apple and
Google that they will source 100% of their energy needs from solar and wind sources?
What discussion is likely to take place in Fortune 500 Board rooms over the next six
months as they realize that those were financial, not social, moves by two of the biggest
corporations in the world? What about the recent Apple and Google announcements about
buildings cars and autonomous driving, added to the leadership that Tesla has shown?
How will that affect your holdings in Ford, GM, the European or the Asian carmakers and
their long-term plans for oil and fuel consumption generally? Solar first grows on sundrenched residential rooftops and subsidized regions, then as remote power in developing
countries and onward to utility scale globally. Energy storage starts maturing in consumer
electronics then jumps to cars and grows orders of magnitude in scale, setting it up to

profit in the even larger grid connected load shifting market and onward. These new
technologies each move to ever larger scales, begetting ever lower cost structures and
causing sudden, nonlinear disruptions to fine-tuned but and vulnerable business models in
the fossil fuel energy and transportation stack.
A number of consultants have compared the call for fossil divestitures to previous
divestiture efforts around alcohol, gambling or tobacco. But those analyses seem to
ignore the fact that while we might have wanted to slow or stop drinking, gambling or
smoking, no one is trying to stop energy usage. The real question in energy is once the
shift from fossils to renewables starts accelerating can anything slow it down? Why would
we ever go back if the price of the new technology keeps falling? There are certainly
those who are buying up fossils in the belief that they are being oversold; particularly in
view of recent declines in oil prices. But the smart money knows that those shifting to
solar and electric vehicles arent going back; if anything they are increasing their
commitment to the new.
What if the entire world turns to Uber and its imitators for a much more efficient transport
profile? What if the lowest cost of production national oil companies believe the world will
do something serious about Climate Change and carbon before 2020 and they would
rather sell 100% of their reserves at $50/barrel while more expensive producers are left
standing by until their holdings truly are stranded? Those are not questions best
addressed by divesting or not divesting the oil, coal or gas asset class. Those are
questions that require a vigorous reassessment of ones entire portfolio, one holding at a
time, to see just how much more risk is suddenly inherent in any number of investments
reflecting a very different risk profile only a short while ago.
The answers to those questions are likely to lead some larger investors to take a much
more active role with their portfolio holdings and portfolio managers passing the tough
questions on to them and hoping they have good answers. If you get a far better answer
from Chevron than from Exxon, or from Ford than from GM, maybe you should drop one
and buy the other, rather than dropping oil or autos.
The Internet age brings us a fairly recent precedent for how such a transition might work.
At some point around year 2000, most of us had come to a view that much if not most of
media and its associated advertising revenue was moving from paper to electronics and
that the book publishing industry, the newspaper and magazine industry, and ultimately
all of advertising would follow. Unlike some of the advertising we are now seeing from the
fossil industry; the wood and paper industry didnt try to tell us that our information world
would end because we no longer had access to their form of reading pleasure. But, as is
the case here, the ramifications were far broader than that we used less paper and more
electrons. Most of the media companies who had learned how to exploit paper, now had
to learn an entirely new industry. In doing so, they faced newcomers from the Internet
world, like Google and Facebook, Amazon and eBay, and thousands of nimble startups that
sought to eat the paper incumbents lunches while stealing more and more of their
advertising revenue.
Early on, the pace of change seemed glacial and few of the old world incumbents seemed
all that threatened. But the leading newcomers kept growing, rapidly getting to a scale
that made some of them much bigger than the old-liners they were threatening. As a
result, more and more of those old-liners found they had to change to survive. A few did

so quite effectively, others quietly faded away. But 15 years later, we have an entirely
different media and advertising business with a very different group of global leaders. In
many ways it was a bloodless coup, but investors who didnt pay attention and held on too
long or failed to capitalize on investing in the new winners either took on significant losses
or left on the table giant gains they could have had. There was no divest paper, invest
Internet solution. Instead there was a much more nuanced shift across an entire range of
industries that was affected by the shift from paper to electrons and their associated
advertising revenues.
So it is likely to be with the shift from coal, oil and gas to wind, solar, batteries and other
cleaner forms of producing electricity and fueling transport. Companies that today
produce returns from giant reserve holdings of fossil fuels, or from owning 100 year legacy
power production assets will lose ground to more nimble producers of clean electrons and
alternative fuels, many of them as a result of individual and corporate buying decisions
(not mass utility purchases). Returns on energy assets will be converted to returns on
energy services. Energy will move from a giant B-to-B business to a B-to-C business that
resembles the change from the old AT&T to todays world of global data communications
So the real question is not should I divest from coal, oil or gas. It is: how do I reallocate my
portfolio from those stuck in the old way of doing things to those who will profit from the
new way and how much time do I have to make that transition? Overweight, underweight,
and divest accordingly. Consider the global economic effects and resultant shifts in trade
flows. Which economies will suffer over the long term? What long-term assets does the
portfolio hold that are tied to those economies?
The more obvious portfolio management choices boil down to:

Monitor your exposure to fossil assets and fuels. This alternative includes a do
nothing outcome, but at least advises that you think about the full range of sectors
from mining to shipping to chemicals and steel and that you think not only of
carbon but of pollution and environmental impacts (such as flooding or drought)
more generally.
Engage with the management of exposed firms often better results can be
obtained by getting a portfolio company to change its behavior and risk profile than
by divesting from it. Also consider engaging with peers and with the press and
develop and articulate a coherent strategy. If you are divesting for impact then do
so by raising public awareness, target bad actors and influencing government
Over and Under-weight based upon responsiveness based upon the extent to
which companies are demonstrating progress in reducing their exposure to carbon
stranded assets and/or shrinking the size of their overall carbon footprints.
Selectively divest either those companies whose carbon profiles are the most
extreme or whose recovery costs suggest they are greatest risk of being stranded.
Hedge your risk through a variety of financial instruments. But remember that
when investors faced the sub-prime crisis in real estate, hedging turned out to be
far more difficult and the impacts far broader than anyone imagined.

We would suggest a different course. Although energy efficiency can certainly affect our
need and desire for fossil fuels and environmental reasons can influence our motivation to

be more efficient, our view is that global energy use will either stay relatively constant or
rise due largely to global population and GDP growth. Therefore the real business
question to be addressed is which energy assets and correlated secondary assets are at
greatest risk of being dropped in favor of newer, cheaper and cleaner energy, transport
and correlated assets? Where should your capital migrate to in anticipation of a new
equilibrium based not just on a desire to drop dirty energy but on the ability to choose a
better alternative?
Today, that transition seems as improbable as jumping from a cruise ship to a small
lifeboat in unfriendly seas. But the sooner that we realize that our burning of coal, oil and
gas must come to an end (there are, after all, quite valuable uses of these carbons that do
not involve burning them), that there is no substitute cruise ship at our ready, the sooner
we will become smarter about at least booking a reservation on that lifeboat.