Dear Student,
I admire your passion and your resolve in the fight to save the planet. I agree 100% that the world is on an unsustainable path, that business as usual will lead to a devastating outcome, and that we need to align with the Paris Agreement and limit global warming to 1.5° Celsius. I even admire your ploughing skills, as demonstrated on the lawn of Trinity College Cambridge.
However, while I agree with your objectives, I disagree with your means. Divestment may be a tangible and attainable goal which offers short-term gratification, but in the long term, it may be counterproductive to what we are all trying to achieve. The effort you expend on getting your university to divest from fossil fuels is effort lost elsewhere in this existential battle. Here’s why.
The shares or bonds an endowment owns represents capital that has been spent on developing assets, rather than assets that will be developed in the future. New capital is raised by issuing new equity, selling bonds or new bank lending. For those assets already developed, there is a measure of maintenance capital expenditure, but this is typically funded by the asset’s cash flows. The rest of the cash flow goes to the owners of bonds or shares in the form of repayments, coupons and dividends.
When a company has already developed the asset – in the case of fossil fuels this could be a mine, an oil or gas well, or a coal-fired power plant – the funding is complete. Think of the asset value as the cost of developing the asset (or replacement cost) or alternatively the present value of the future cash flows.
However, the asset’s value will be depressed if there is a forced sale, as in the case of divestment driven by reputational concerns, and further depressed if there are few buyers. This means that when the endowment or corporate owner of a fossil fuel asset tries to sell it, they cannot recoup the capital they spent. This is true even when there are still attractive cash flows associated with the asset, because would-be buyers are put off by the negative publicity surrounding it.
That’s what we want, you might say.
Well, that’s not quite how it works. Right now there is a shortage of buyers for fossil fuel assets, because of ethical or commercial principles, with the latter camp worried their clients won’t tolerate such purchases. With scant interest from buyers, the asset is further discounted. Next, in steps those with low-to-no ethical principles to purchase the asset. For these buyers the asset represents simply a stream of cash flows, offered at a large discount – a wonderful investment opportunity.
To see how this is playing out in real life, look to the divestment of Rio Tinto’s Australian coal assets between 2015 and 2018. Who were the two biggest buyers? Private equity group EMR Capital and Yancoal Australia, a subsidiary of Chinese coal mining company Yankuang Group. Other Australian coal mines were sold for peppercorn amounts in a ‘heads’ the buyer wins if coal prices rise, ‘tails’ the taxpayer loses as they pick up the mine rehabilitation costs if prices fall. Another example is the scooping up of coal-fired power plants by private equity firms in the US. According to Reuters, after Blackstone and their partner PE firm ArcLight Capital Partners bought coal power assets in 2017 from the American Electric Power Company (AEP), they swiftly paid themselves a handsome $375m special dividend from those assets, representing 18% of the purchase price after only 18 months of ownership.
With little apparent sense of stewardship or climate risks, none of the above buyers were put off by the ethical arguments. No emissions were reduced as a result of these divestments, and no long-term decommissioning plans were introduced. And it’s not just private equity that benefits from the trend for dumping dirty assets off to opportunistic investors. Mining conglomerate Glencore has been another active buyer of Australian coal assets in the last five years; in 2019 coal accounted for 40% of their free cash flow. Yet as a consequence of a Damascene moment for Glencore (or by a strange twist of logic) Refinitiv rank Glencore the 4th most highly rated company on ESG metrics in the FTSE 100.
Where best, then, to direct student effort? Climate Action 100+ has just published its first ever benchmark evaluating the ambition and action of the world’s largest corporate emitters. Focus your attention and your endowment’s attention on getting those companies to pledge to achieve net zero by 2050 – not by offloading their fossil assets to less ethical bidders, but by truly decarbonising their company and helping their supply chain and customers to do the same. They should pledge to have their carbon reductions independently validated, pledge to sink no new capital into fossil fuels (most immediately coal assets) and to offer investors a ‘say on climate’ via dedicated climate votes and resolutions at their AGMs.
This is what we are doing as active, deeply concerned shareholders. These are actions that will make a real, sustained difference in keeping global warming to 1.5° Celsius.
Beyond committed effort by shareholders and citizens, we need government action. Firstly, on tough carbon pricing within our economies. Secondly, by introducing a mechanism that recognises how we offshore our CO2 emissions through the offshoring of manufacturing. And thirdly, by accelerating clean technology and energy development via regulation that supports it.
We need students to get political. What about ploughing up corporate or state lawns if no one listens? On that, I couldn’t possibly comment.
Sincerely,
John Teahan
Unless otherwise stated, all opinions within this document are those of the UK Value & Income team, as at 21st April 2021.
