Oil: Why shareholder activism doesn't work and divestment does

Credit: Noah Scalin

In the news

This week the UK's biggest investment fund - the National Employment Savings Trust - has decided to divest from fossil fuels.  Their chief investment officer Mark Fawcett said

"Just like coronavirus, climate change poses serious risks to both our savers and their investments, [...] It has the potential to cause catastrophic damage and completely disrupt our way of life. No one wants to save throughout their life to retire into a world devastated by climate change."

This is in contrast to what the pensions minister Guy Opperman has said.  He thinks we should

"nudge, cajole or vote"

companies into becoming sustainable and that holding shares is the right thing to do.

They can't both be right, and they're not.  Mark Fawcett is right and Guy Opperman is wrong.  Here's why:

How are oil companies valued?

It is fairly easy to show that the market valuation of an oil company is simply the price of the oil they have in reserve minus the cost of extracting it.  Let's do the arithmetic:

• BP are sitting on 11.5 billion barrels of oil.
• Worldwide extraction of a barrel of conventional oil varies from $\$$30 to $\$$40
• As of today Brent Crude is $\$$43.61 per barrel
• So if we assume an extraction cost of $\$$35 per barrel then BP could potentially earn $\$$100 billion from the oil they have access to.
  
• As of today BPs market valuation is $\$$75 billion dollars

These figures all fluctuate wildly, and the cost $\$$35 was a crude estimate.  (Sorry for the pun.)  But I think the fact that $\$$100B is in the same ballpark as $\$$75B does make the point that BP's valuation is not based on their intellectual property!

Why they won't go green

Let's suppose that some awkward investors convince BP to start a sustainable energy project.  And let's suppose that project is a success!  The definition of success for a sustainable energy project is that there's no longer any need to dig up fossil fuels.  So, what would be the effect of that on BP's valuation?  The new project would have destroyed literally every asset they held before the project started.

They're not going to do this!

How divestment works

Divestment is not about convincing fossil fuel companies to change their ways.  That's not going to work any better than shareholder activism.  They cannot change their ways.  However, if they're unable to raise as much money they'll have less to spend on PR undermining the case for acting on climate change, and less to spend on scoping new oil fields.

Ultimately, surviving the climate crisis is incompatible with today's fossil fuel companies remaining good investments.  We're still going to need some oil and gas - and maybe a tiny bit of coal - as we wind down our emissions, but that's not going to happen at the same time as BP, Shell, and Exxon's share price rocketing.  It may be necessary to take these companies into public ownership so that they can be wound down in a graceful manner as we burn less and less carbon.

But if we take Guy Opperman's advice we're all gonna fry.