The strengthening economic case for fossil fuel divestment

The strengthening economic case for fossil fuel divestment
Investing in fossil fuels for the long term? You might find your plans get pricked. Credit: klublu/Shutterstock

The controversy ignited by the Australian National University in October, when it decided to sell its shares in seven resources companies, has raised two important questions about divestment from assets such as fossil fuels.

The first is whether divestment is an economically prudent choice, and the second is whether there is anything special about universities that helps to inform their decision.

Any portfolio investment is a bet on the prospects of the company and industry in which the money is invested. For the bet to pay off, the company must do well relative to its competitors but, more importantly, the industry as a whole must also prosper.

So an investment in companies whose primary asset is ownership of fossil fuel reserves is a bet that those reserves will be extracted and sold at a price that exceeds the cost of production.

Situation heating up

Extracting and burning the currently known reserves of coal, oil and gas using current technologies would result in catastrophic climate change, probably in excess of 4C of warming. This change would see massive species extinction and the destruction or radical transformation of all natural ecosystems and many vulnerable societies. Coral reefs, island and coastal communities, and localised ways of life would all disappear.

Yet investors might still be willing to bet on such an outcome in the hope either that it would be delayed beyond their lifetime or that they and their descendants might be able to insulate themselves from the consequences by somehow radically divorcing themselves from the natural world. More immediately, the high discount rates typical of financial markets mean that ordinary investment decisions typically take little account of the future beyond the next 50 years anyway. At a discount rate of 6%, it's not deemed to be worth spending a dollar now to avoid the loss of $15 in 50 years' time.

Are universities different?

This brings us to our second question – do universities necessarily take a longer view? In some respects, the principles of investment appropriate to universities are similar to those for investors in general. They generally want to hold a diversified portfolio to achieve an optimal balance of risk and return.

But a university is an institution that hopes and expects to endure for centuries, and which counts the study of the natural world as a core part of its mission. It makes no sense for such an institution to bet on a course of action that may yield short-term profits but might lead to the end of the university and its mission. An investment strategy for a university must therefore be a bet on a sustainable future.

As will be argued below, the case for divesting from fossil fuel assets is strong for everyone. The long-term perspective that is natural for universities makes it overwhelming.

The best way forward

One path to a sustainable future is a fairly rapid transition to an energy system based on non-carbon technologies, such as wind, solar panels and, perhaps, nuclear energy (although this option is receding in many countries, China being the main exception).

Standard analyses suggest that such a transition would have to be largely completed by 2050. In the transition process, a good deal of carbon would be left in the ground, thus becoming stranded assets.

A good deal of carbon would still be burned: standard estimates suggest a remaining budget of just under 500 billion tonnes of carbon dioxide emissions, if the global goal of 2C warming is to be met with 50% probability.

It might seem, therefore, that investments in low-cost, high-quality fossil fuel assets might still be profitable, as these would still be extracted and sold.

However, this analysis fails to take account of prices.

If most fossil fuels are to be left in the ground, the price paid for those fuels (net of carbon taxes or similar charges) must be lower than the cost of extracting them. This in turn means that the price for those resources that are used will be barely sufficient to cover the cost of extraction, with little or nothing left as a return to the asset owners.

To spell out the logic, consider the decline in thermal coal prices over the past four years, from US$140 per tonne to US$70. At this price, most new coal projects are uneconomic, and many existing mines are not covering their extraction, transport and shipping costs. (Australian mines are hanging on because they are committed to pay transport costs anyway, under their take or pay contracts). If low prices are sustained, investments in these projects will be lost.

Mines with lower production costs, say US$40 a tonne, will stay in business. But at this cost the return per tonne of coal, which would have been US$100 four years ago, has now fallen to US$30. So while the price of coal has fallen by half, the value of the coal reserves has fallen (in this example) by 70%.

Carbon capture collapse

The other suggested path to a sustainable future is carbon capture and sequestration (or carbon capture and storage, or CCS). This requires that carbon dioxide be captured at the point of combustion, then compressed and transported for permanent storage either underground or in some form of biomass.

In the early 2000s, CCS was widely seen as the most promising technological option for mitigating carbon dioxide emissions. The G8 (the predecessor of the G20) committed to an ambitious program in 2008, proposing at least 19 projects by 2020.

CCS was a particularly attractive bet for Australia, as it would maintain the value of our large reserves of coal. Reasonably enough, the Australian government spent more than A$2 billion on it, and planned to spend even more. The coal industry also committed large sums to research.

Very little is left of this today. Internationally, only a single large-scale CCS plant is in operation, and many projects have been cancelled or suspended. In Australia, the publicly funded research program is being wound down and the coal industry has frozen its contributions to the task.

Even optimistic assessments such as that presented by CSIRO note that current carbon capture technology involves the loss of as much as 30% of the energy generated.

The asset value, net of extraction costs, is reduced even further. A 30% reduction on current coal prices would render even the most easily extracted resources almost worthless. And this is all academic anyway, because there is no large-scale sequestration technology available for the foreseeable future.

By the numbers

Leaving aside the ethics of divestment and pursuing a purely rational economic analysis, the cold hard numbers of putting money into fossil fuels don't look good.

Unless universities are willing to bet on the destruction of the planet they have committed themselves to understanding and preserving, divestment from is the only choice they can make. Forward-thinking investors of all kinds would be wise to follow suit.


Explore further

Carbon capture and storage—reality or still a dream?

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Dec 01, 2014
The world is closing in on Dirty Fuels.

We simply MUST make this transition.

Dec 01, 2014
"Alternative energy" is a massive money grubbing swindle. Windmill farms, among other things, ruin air patterns and prevent equalization of temperature. Solar farms, among other things, prevent cloud formation and superheat the dust in the air overhead. They are approved of through a process including playing only to the dullards and making sure the "news" doesn't report on the damage they do! The linchpin is the belief that "fossil fuels" cause climate change, while, in fact, it is chemtrailing that is altering the world's atmosphere. Then, when it's revealed windmill and solar farms harm the world more than their "benefits" justify, those who built them will charge twice as much to remove them!

Dec 01, 2014
Really? Who told you? We have integrated wind turbine-generators ( mills grind stuff up), into our grid since the late 1970's. Good thing we did not know they do not work.

Now, may I suggest you look up some numbers instead of arguments one way or the other? Do not take my word for it, . . or that of anyone else, these numbers are actual ones, history, not projections.

Google Updated Capital Costs from the EIA. These are the costs of building the plants only, not how much it costs to operate them, fuel them, keep them cool, and deal with the thermal waste and the pollution. Those factors are almost free for renewables.

Sorry, but the swindle was from Texas, the Saudi, the Bush Family, the Venezuelans, the Russians, and other petroleum extractors/depleters. We subsidized them for a century now, and got pollution and economic dominance in return. Their time is up.

Dec 01, 2014
Google what happens when a leaf falls on a PV panel. What happens to efficiency when it gets a layer of dust on it? Then explain how 30% gets us to a "dirty fuel" free world gkam when the sources you'd use that actually aren't dirty (sorry no bio, or landfill gas). Do we just use the lights and heat 30% of the time?

Dec 01, 2014
Only you would put a PV facility under tree cover.

Mystie, I guess all the discussion cannot calm your terrible fears.

Dec 01, 2014
Okay,here it is:

http://www.reuter...Top+News

Utilities are trying to shed their conventional loser systems for renewables.

Dec 01, 2014
Google what happens when a leaf falls on a PV panel. What happens to efficiency when it gets a layer of dust on it?
The owner would let the rain wash it off or hire a Mexican with a leafblower

Dec 01, 2014
The world needs to transition to fart power immediately. Every human and livestock animal will have a rectal methane capture device implanted post haste. The world is saved.

Dec 01, 2014
xstos shows us conservative science.

The facts are clear: We need to divest of polluting power systems. European utilities are finding ways to do it, too.

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