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December 7, 2021
One of the classic arguments against fossil fuel divestment is that it doesn’t have a direct impact on profitability or on the amount of fossil fuels being consumed. This argument has merit up to a point, but we may have passed that point in terms of scale.
One of the classic arguments against fossil fuel divestment is that it doesn’t have a direct impact on profitability or on the amount of fossil fuels being consumed. This argument has merit up to a point, but we may have passed that point in terms of scale.
Institutional investors with a collective $39 trillion under management have now committed to some form of fossil fuel divestment.1 This does not include the millions of individuals and small institutions who have done the same. While there will always be buyers, we have almost certainly reached the point where the entire demand curve for the stocks and bonds of fossil fuel companies has shifted permanently and materially lower.
While a permanent decrease in demand for the securities does not directly translate to less demand for the end product, it should raise the cost of capital for the companies. Fossil fuel companies now need to issue more shares of stock or pay a higher rate of interest on their bonds to attract the same number of investment dollars they did a decade ago. All things equal, this makes fossil fuel projects less profitable and, in some cases, non-viable.
It stands to reason that some projects will simply never happen. In other cases, the higher input cost may result in higher market prices for the commodity being produced. Higher commodity prices should act as a drag on consumer demand and encourage greater adoption of alternative technologies.
In a recent analysis2, Goldman Sachs estimates that the cost of capital for hydrocarbon projects relative to renewable projects has widened by over 10 percentage points in five years, a period that corresponds to a large increase in divestment commitments. Goldman theorizes that this gap in funding costs will continue to result in chronic underinvestment in carbon intensive industries, leading to structurally higher prices for commodities. In fact, they estimate that the greater cost of capital is equivalent to a global carbon tax of $80 per ton, above actual trading prices for carbon credits on regional exchanges.
This resembles a classic “death spiral” situation where less investment leads to higher cost, which leads to less demand, which leads to even less investment, and so on. How violently this unfolds will probably depend on the future level of government intervention in energy markets globally.
As just one element of a broader theme, divestment is clearly not the only driver here. But the argument that it doesn’t have any real impact seems more and more difficult to support.
1. Bloomberg, 10/26/21.
2. “Carbonomics”, Goldman Sachs Equity Research, 11/10/21.
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