Why investors should focus more on fossil fuel demand

Climate disruption

To be clear, when we say “more”, we don’t mean at the expense of a focus on fossil fuel supplier – simply that there should be a better balance in what investors focus on. A key test will be the initial list of the Climate 100+ project.

Before we focus on the topic of this piece – the supply and demand sides for fossil fuels – let’s look at another issue where supply and demand are both problematic. The struggle against tobacco is being won in the developed world – note we don’t claim success in emerging markets – not by persuading tobacco companies to be good citizens and produce fewer cigarettes, but by regulation focused on demand reduction. Regulation forces smokers out in the cold (literally and figuratively), increases the costs of cigarettes and reduces their attraction through plain packaging (and in some jurisdictions such as, scare tactic packaging). Demand has gone down – from 50% adult smokers across the OECD post WWII to 20% in 2013 – because people have been persuaded that it’s bad for their health and that of their families. The contrast with the (US) “war on drugs” which is heavily focused on supply and is being lost is clear.

So let’s learn from this in the urgent campaign that we are not winning – the struggle to keep global warming to less than 2°C. Here are five reasons why we need to significantly change our strategy and put at least as much effort into cutting demand, as challenging additional production to get to a balanced approach.

A) Users have a future, suppliers (largely) don’t

Sectors like transport and energy utilities face opportunities from the energy transition, and face threats if they don’t make the transition. So, business strategy arguments work in favour of the transition. Fossil fuel companies, with the possible exception of first movers, will have to shrink almost to extinction if warming is to be kept to 2°C or less. But when did a fossil fuel company scenario show this outcome?

B) Quoted fossil fuel companies are only part of the supply system

While demand remains constant, even if publicly quoted fossil fuel companies were to voluntarily cut supply, there remain many companies, out of reach of campaigners and assertive investors, who will make up the difference.

C) The direct link to emissions

Logically, it is easier to demonstrate the impact on total emissions by extracting transition plan pledges from individual fossil fuel users, such as utility companies, than by extracting plans to reduce supply by individual producers. In reality, however, engagement with fossil fuel companies is generally not about voluntary reducing supply, but rather on reducing future risk of losses of future low returns in low-demand scenario (i.e. that the company shows that it has planned for a low-carbon transition). This is another reason why constructive engagement is fundamentally not fit for purpose when dealing with systemic risks which are created by the sector’s business model and core products.

D) The power of regulation

The supply side faces little effective climate-related regulation – as indicated by the enormous difficulty of even an obvious measure such as cutting subsidies to fossil fuel production. By contrast, demand sectors such as energy utilities and transport are increasingly subject to regulation. Investors can support ‘pro climate’ regulation by requiring the companies they own to be fully transparent about their lobbying activities and if they are lobbying against ‘pro climate’ regulation, to explain why in public and what they are spending. As sunlight is a good disinfectant, this would quickly contain the problem of corporate capture of politics. Because energy utilities have a future assuming they adapt, it is reasonable for investors to push for this transparency. In the case of fossil fuel companies, investors suspect that transparency could trigger the demise of the sector and will, therefore, tend to resist forcing disclosure of lobbying practices which are already known to be highly questionable both in terms of amounts but also political intent eg undermining the Paris agreement.

E) The public know that changing demand can work

The critical factor in this and all other climate debates is what is likely to get most public support. Whether it is tobacco or drugs, the importance of reducing demand is well understood by specialists, media and the informed public too. And there are vast numbers of the public who are trying, through lifestyle choices, to reduce their demand for fossil fuel energy. A focus on industrial demand would, therefore, resonate well with the public. In contrast. there is a widespread popular perception that fossil fuel companies are, in general, too stuck in the past and too powerful at blocking change to do anything other than convert into “cash cows” once regulators and investors start to act.

Balance means balance

In this paper where we are making the case for a bigger focus on demand, it is appropriate to highlight that all climate advocates need to focus on both supply and demand. As additional hydrocarbon (oil and gas) infrastructure is built, more hydrocarbons are extracted, refined, distributed, and combusted with the release of GHGs all along the supply chain. The bigger the beast gets, the more difficult it is to shut it down due to societal inertia. More supply keeps our civilization not just dependent on fossil fuel energy but inextricably intertwined with a narrative of extract and pollute with the greatest burden of pollution placed on those who cannot afford to get out of the way (environmental injustice). Similarly, the greatest impacts of climate change will fall disproportionately on those less privileged. The key point here is that hydrocarbon supply creates demand as Bill McKibben eloquently explains in the New Yorker. This is simply an example of Say’s Law in neoclassical economics and it is why investors – like activists – should have a balanced focused on demand and supply. As McKibben says, speaking of Governor Brown in California: “That could really be a turning point in the battle, and a way to bypass Trump—but only if Brown and others are willing to get serious about supply as well as demand.”

What does this mean in practice for investors?

This is a preliminary list and we would welcome your input.

1.   In policy documents, investors should replace “fossil fuels” with either “carbon intensive” (as the Environment Agency Pension Fund’s has done in its 2018 policy) or mention “supply and demand” as equally important.

2.   Investors who understand the urgency of the situation and who want to play their part in bending the curve of GHG by 2020 should focus on requiring companies in high demand sectors to write transition plans to a low carbon economy, consistent with science-based targets for their sector. The obvious low hanging fruit today is the energy utility sector.

3.   Major investor engagement initiatives such as Climate 100+ should include at least as many high demand companies as supply companies – 50/50 is a good target ratio. In the demand category, energy utility companies should be around 50% given their impact on GHGs (eg in the USA, energy utility companies account for 61% of GHG). Hence, there should be approximately 25 major GHG emitters from the energy utility sector in the initial list of 100 and this ratio should be maintained going forward. If this significant multi-year engagement initiative starts off on the wrong footing, and like the divestment movement focuses mainly/heavily on fossil fuel companies, it will simply perpetuate the lost opportunities and weaknesses highlighted above.

4.   Investors who assert that they are climate aware but reject divestment in favour of “constructive engagement” with fossil fuel companies should, as a matter of urgency, lead on this forceful stewardship with heavy demand sectors, starting with the energy utility sector. Constructive engagement with this sector – when it has proven so resistant to change – is at best incrementalism/gradualism and this is the latest form of denialism.

5.   The hugely impressive momentum behind divesting from fossil fuel companies – with investors accounting for $5.5 trillion – should now be used to put pressure on demand side companies. Pro-divestment investors should, given their seriousness of their concerns, add a new string to their bow, and support climate disclosure resolutions at energy utility companies in 2018. 55% of investors voted with management against a mild 2°C disclosure resolution at these US energy companies in 2017 (see Preventable Surprise’s forthcoming report). A “Divestment 2.0” campaign which could, perhaps, be called “Divest, Invest and Forcefully Engage” could correct this fundamental failure of fiduciary duty by mainstream investors, many of whom are members of UNPRI, Ceres/INCR, CDP or otherwise assert their climate credentials – some were even members of the Taskforce on Climate-related Financial Disclosure (TCFD). This new campaign could re-energise the divestment movement and show that there doesn’t need to be a sterile debate between divestment and engagement advocates. In turn, this would usefully challenge advocates of “constructive engagement” to raise their game and find an approach which was more fit for purpose.

Carolyn Hayman and Raj Thamotheram

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