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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, most investors seem to be treating each fuel type as
a single asset class to be treated 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. Interestingly, gas seems to be playing the we are cleaner than coal card. Oil
appears to take the we dare you to stop using us even if it kills you approach. And coal
appears to be appealing to motherhood and apple pie we brought you the lifestyle you
now so enjoy approach, job preservation and all.
What both sides of these arguments ignore is 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% 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 comes from the Saudis, from BP/Shell/Exxon, from smaller U.S. shale developers or
from Canadian tar sands will make a much bigger difference today than it did just a year
ago. From an investment perspective, the far more 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 highly nuanced and goes far 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 highly leveraged and vulnerable
business models in the fossil fuel energy and transportation stack.
What if the entire world turns to Uber and its imitators for a much more efficient transport
profile? What if the Saudis have actually come to the view that the world will do
something serious about 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 that are best addressed by divesting
or not divesting all of 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 that reflected 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 corporate 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. 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, many of them as a result of
individual and corporate buying decisions (not mass utility purchases). Returns on 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
worlds of global data communications players.
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? Where should the capital migrate to in
anticipation of a new equilibrium based on new energy technology? 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 reliance on coal, oil and gas must come to an end,
the sooner we will become smarter about at least booking a reservation on that lifeboat.