How fossil-fuel divestment campaigns could affect oil stocks

Some universities and foundations are dumping their fossil fuel stocks. How will it affect those who stay invested?

Illustration of oil traders frowning

(Serge Bloch)

With oil prices plummeting and their stock prices threatening to follow, energy companies are in need of some good news. They won’t find it on Canada’s campuses, where student-led movements to shame university endowment funds into divesting their fossil fuel holdings in the name of fighting climate change are gaining publicity and momentum.

In November, the Dalhousie University Board of Governors voted against selling the university’s energy securities. But the same month, the Concordia University Foundation announced it would establish a $5-million “sustainable investment fund” within its $100-million endowment, with negative screens for oil, gas and coal stocks.

University foundations make up a small portion of the Canadian investment pool, totalling just $12.1 billion. But the goal for divestment lobbyists is exposure, not direct financial impact. “If they target specific companies, they’re going to create a lot of negative press,” notes Sam La Bell, vice-president of energy and special situations at Veritas Investment Research.

That negative publicity could prove more harmful to energy companies if the divestment movement spreads to other institutional investors. In advance of the United Nations Climate Summit in September, 800 investment funds controlled by the likes of the City of Seattle, the World Council of Churches and the Rockefeller family pledged to divest US$50 billion from the hydrocarbon industry over the next five years. Stanford University plans to purge its US$18-billion endowment of coal stocks.

“Any time you reduce the pool of potential investors, you’re going to potentially reduce the share price if there’s not someone there that’s prepared to take up the slack,” notes Randy Ollenberger, an analyst at BMO Capital Markets. In the case of fossil fuel producers, there remain plenty of buyers for now. La Bell suggests there may even be some upside for shareholders; while divestment deprives targeted firms of capital, “it does nothing to the companies’ cash flows, and so returns tend to go up on divested stocks if the prices are going down.” Such has been the pattern for tobacco companies, subject to investor boycotts since the 1980s.

“Even if the maximum possible capital was divested from fossil fuel companies, their share prices are unlikely to suffer precipitous declines,” a 2013 paper by a trio of University of Oxford professors concluded, noting how “neutral” investors would be quick to snap up stocks at any sign of a discount. The paper warned, however, that the coal subsector, with its relatively small market capitalization and limited liquidity, might be more vulnerable than oil and gas.

A 1999 Journal of Business study examining the effect of the divestment campaign aimed at firms invested in apartheid-era South Africa likewise found no discernible effect on valuations, though that may have been because the companies concerned had relatively little exposure to the country. Most American, British and Canadian firms involved simply got out of South Africa. It wouldn’t be so easy for Exxon Mobil (NYSE: XOM) or Suncor Energy (TSX: SU) to get out of oil and gas.

Hydrocarbon divestment is a particularly contentious issue in Canada, since energy companies make up a quarter of the Toronto Stock Exchange’s market capitalization, and the resource industry is integral to the country’s economy. Few in the investment community believe there’s much public support or institutional investor interest in fossil fuel divestment—yet.

The question energy investors should be asking themselves is whether divestment is a harbinger of a broader shift in societal and political priorities that could disadvantage parts of the sector. Climate change meetings in Lima and Paris over the next year could lead to regulatory changes that would affect stock prices. “The companies that best manage those risks are better poised to do well,” says Stephen Hine, head of responsible investment development at research firm EIRIS.

The biggest fear is around the potential for “stranded assets”—reserves of coal, oil and gas currently on companies’ books that must stay underground to prevent irreversible environmental damage. The International Energy Agency has estimated that two-thirds of known hydrocarbon reserves must not be exploited if we are to limit the global average temperature increase to 2°C by 2050. Hine says this is causing some mainstream investors to question the long-term returns of resource companies.

In this light, trying to reform companies from the shareholders’ seats might be a more effective way to achieve activists’ aims than a boycott. Ollenberger asserts that oil producers have a vested interest in making their extraction processes more efficient, since it reduces their costs. But achieving such gains is expensive. Cut off the capital, and you cut off the efficiency.

“There are those who say you should never own fossil fuel companies,” adds Jamie Bonham, manager of extractives research and engagement at NEI Investments, a money manager that factors social criteria into its investment decisions. “We believe that if you want to make a difference, you have to actually engage these companies, while avoiding the ones you can’t change.” Bonham points out that divestment can only have so much impact on the world’s energy industry, since 80% of fossil fuel reserves are controlled by state-owned and privately held companies.

Still, it’s something energy companies and investors will likely have to deal with for a long time to come. Says Bram Freedman, president of the Concordia University Foundation: “I don’t think it’s going to die down or that it’s just a fad.”