To stop global warming, the accumulation of CO2 in the atmosphere needs to be halted. This means that the burning of fossil hydrocarbons needs to be discontinued. Promotion of emission reductions and the rise of renewable energy sources is well under way. But do they go far enough?

Emission reductions should go hand in hand with reductions of fossil fuel production. This will ultimately cause fossil fuel companies go out of business. Divestment is a tool to deprive fossil fuel companies of capital to develop new fields or to explore for more.

Forcing bankruptcy on a sector of industry may seem repulsive from a free-market perspective, but not doing anything will cause global heating to spin out of control with a devastating effect on the entire population of the planet. This is even more repulsive and unethical.

Is divestment from fossil fuel companies effective?

An often-heard argument against divestment, is that others will step in the vacated seat. But is this true? More than $14trn has already been divested from the fossil fuel industry and it is unlikely that such a huge amount is replaced by other investors. From the fossil fuel industry there is evidence that the drying up of funding is beginning to bite.

As early as 2018 Shell already warned in its annual report that “divestment should be considered a material risk” to its business. Governments are also leading by example on divestment such as ending fossil fuel financing abroad by the UK Overseas Investment Bank and the phasing out of fossil fuel lending by the European Investment Bank after 2021. This leading by example is putting pressure on the private investor world to follow suit.

Another argument used against divestment is that investors have more influence in the course of action when they remain shareholders. This tired argument of engaging has been used too often, but the engagement success on climate change with fossil fuel companies over the last decade has been minimal.

Voting down a CEO or a board of directors has not changed the fundamental climate change course of fossil fuel companies. This has been realised by ethical investors such as the National Trust and the Church of England, who voted with their feet by no longer investing in fossil fuel companies. Engagement does not work for companies facing an existential threat: they will fight till the bitter end.

Rather than questioning the effectiveness of divestment, the effectiveness of engagement with a company fighting for its survival, should be questioned.

Geopolitical considerations

Fossil fuel reserves are owned by both national governments as well as private companies. Whilst the total world reserves are ample, private fossil fuel companies will argue however that there are not enough reserves for them and that depriving them of funding to develop and explore for new reserves, will force them into bankruptcy.

Since national fossil fuel companies have less exposure to raising capital via the stock market, divestment will have a relatively bigger effect on private fossil fuel companies. Divestment might therefore result in an increased market share for national fossil fuel companies, who also often possess reserves, cheaper to develop.

Ceding an increasing share of fossil fuel production towards national companies, often controlled by authoritarian, corrupt or unreliable regimes, may raise alarm bells for some governments. It should be realised however that this is very much short term and that the uneasy but temporary reliance on these regimes will speed up the transition towards renewable energy with a predictable fall in oil price on which these regimes depend.

Time to change

The investor world is well-known for its conservatism, reluctance to change and entitlement to invest without constraints. As such it is susceptible for lobbying and bribing by the fossil fuel industry. It also seems that investors rather have their last supper from the familiar ‘dividend-trough’ (and yes that is about to change too), rather than opting for fundamental change.

Apart from the risk to longer-term climate change, it is astonishing that the increasing financial short-term risk of stranded assets is not taken more seriously as a reason to reduce the investment exposure to fossil fuel companies.

Investment without climate change constraints can no longer be maintained. It poses an existential threat to millions if not billions of our species. Just concentrating on emission reductions of fossil fuel users, whilst continuing to provide capital to fossil fuel producers, does not make any sense. Changes are urgently needed.

Investors and in particular pension funds are quintessential risk spreaders, sometimes irrespective of the fact that some sectors are more susceptible to risk than others. Fortunately, more and more pension funds are open to invest into low or zero-carbon funds or into funds, rich in renewable energy companies, but there is a general reluctance to invest all their assets in these funds.

Providers of investment portfolios, who have set up these special funds on demand, but who, at the same time, fail to reduce overall exposure to fossil fuel companies in existing portfolios, enable therefore only limited divestment. So, the investment world needs to work towards an annual reduction target for the exposure to fossil fuel reserves for all available fund portfolios.

These reductions are needed both for the longer-term risk of climate breakdown as for the short-term risk of stranded fossil fuel assets. Just as the Covid-19 pandemic tells us that we need to heed our limits, we need to realise that an investment world without constraints is no longer compatible with a looming climate breakdown.

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