Coal v Wind © Reuters/Bloomberg

Waltham Forest, a borough in north-east London best known for hosting part of the 2012 Olympics, made history last year when its pension fund for local council workers decided to pull out of fossil fuels.

In September 2016, the £735m retirement fund became the first local government pension scheme in the UK to commit to divesting from all fossil fuels.

In the months since, the retirement scheme for Southwark, another borough in the British capital, said it would also pull out of fossil fuels, while Hackney’s pension fund announced plans to cut its exposure by 50 per cent.

The London schemes join a small but growing number of pension funds across the world that have decided to fully or partially divest from companies that generate revenues from oil, gas and coal. Their withdrawal from these sectors comes as concerns mount that carbon-intensive businesses could incur significant financial losses as governments attempt to tackle climate change.

But pulling out of fossil fuel companies remains controversial. While many academics and investment experts argue that schemes that delay divestment could suffer large losses, there are also widespread fears that investors who pull out of carbon-intensive industries prematurely could miss out on future returns.

Tom Sanzillo, director of finance at the Institute for Energy Economics and Financial Analysis, a research organisation, believes the risk of remaining invested in fossil fuel companies outweighs the potential gains.

“Oil and gas [stocks] have been a major contributor to pension funds for decades. But that is changing,” he says. “Any fund that is not [having] internal discussions [about fossil fuel exposure] is not doing its fiduciary duty.”

Pension funds cite both ethical and financial reasons for reducing exposure to fossil fuels. As the body responsible for the protection of the environment in England, the UK’s Environment Agency pension fund decided in 2015 to reduce its exposure to fossil fuels in an effort to prevent climate change.

Other schemes are cutting their exposure purely for financial reasons. Since the Paris agreement of 2015, when more than 190 governments agreed to limit global warming, pension funds have come under pressure to take a closer look at how their investments could be affected by efforts to reduce climate change.

The concern is that these initiatives will lead to increased taxes and costs for highly polluting industries, leaving them less profitable and hurting returns for shareholders.

At the same time, the energy industry is changing. Last year, renewable energy, such as solar power, overtook coal as the world’s largest source of power capacity. In April, Britain went a full day without turning on its coal-fired power stations for the first time in more than 130 years.

Tarek Soliman, senior analyst at the Carbon Disclosure Project, an organisation that compiles research for investors overseeing a collective $100tn of assets, says: “Investors are increasingly viewing the prospect of sterner climate change policy and fast growth in clean energy deployment as material business risks for incumbent fossil fuel companies, and therefore something that needs addressing in their investment portfolios.”

Paul Fisher, senior associate at the Cambridge Institute for Sustainability Leadership and former deputy head of the Bank of England’s Prudential Regulation Authority, adds: “Long-term investors are increasingly aware that fossil fuels are going to be in decline, to be replaced by cheaper and cleaner renewable energy sources.”

According to data from 350.org, an organisation that campaigns for divestment, more than 700 large investors have committed to cutting their exposure to fossil fuels in recent years.

A spokesperson for 350.org says: “The rapid rise of renewable energy and the Paris climate agreement send strong signals to investors that the age of fossil fuels is coming to a rapid end. Their business model is simply outdated and they already struggle economically.

“It only makes sense for prudent investors to distance themselves from a rogue and dying industry.”

The financial arguments for remaining invested in the sector have also been questioned. MSCI, the data provider, last year found that two of its indices that excluded coal and all fossil fuels, respectively, outperformed parent indices that included these stocks between November 2010 and May 2016.

The Norwegian oil fund, the world’s largest sovereign wealth fund, said in March that it gained 0.78 per cent in returns in the decade to the end of 2016 due to its decision to exclude companies that cause severe environmental damage, such as coal miners.

Mr Sanzillo, who was deputy comptroller of New York State in 2007, where he oversaw a $156bn pension fund, says: “Oil and gas holdings have been producing substantially less value for pension funds [in recent years]. Pension funds are [re-examining their exposure to] oil and gas because of the environmental issues, but also because of weak financial performance over the past three years.”

However, the election of Donald Trump as US president last November has improved the outlook for carbon-intensive businesses, as his administration has taken a pro-fossil fuel stance. This has added to fears that fossil fuels will remain a vital source of energy for years, meaning investors that pull out could face higher losses than anticipated.

A study by Hendrik Bessembinder, a finance professor at the Arizona State University, in 2016 indicated that university funds that pulled out of fossil fuels would lose about two to 12 per cent of their endowment value over a 20-year period.

Many pension funds, including Calpers, the Californian state pension fund, have also argued that divestment from fossil fuel companies is not the solution to climate change. The University of Cambridge ruled out divesting its £5.9bn endowment fund from oil and gas last year, arguing it was better to engage with fossil fuel companies.

Lauren Compere, director of shareholder engagement at Boston Common Asset Management, the US fund house, says investors should use a “combined strategy of divestment and engagement”, rather than simply pulling out of all fossil fuels, to drive change and achieve the best financial returns.

Questions remain about whether engaging with companies to improve business practices has any positive impact on how such businesses operate.

Last year, a group of investors pushed for ExxonMobil and Chevron to “stress test” the potential impact of climate change on their businesses. At the oil producers’ annual meetings in May, both companies successfully urged their shareholders to vote against the proposals.

In Waltham Forest, the council has decided against engagement. It is pushing ahead with its plans to pull out of its fossil fuel stocks, which it hopes to complete over the next five years.

Announcing the move last September, Councillor Simon Miller, chairman of the pension fund committee, said: “Not only does this mean that the fund will not be invested in [risky] assets, but will be actively investing in cleaner, greener investments to the benefit of our community, borough and environment.”

Letters in response to this article:

Fossil fuel divestment has costs for pension funds / From Yolanda Hudson, Detroit, MI, US

Divesting stocks does not reduce fossil fuel use / From Norris McDonald, Washington, DC, US

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