I. Sick in boom times
A month ago, as the market rode a lazy 10-year incline and American investors had little concept of the coronavirus carnage to come, a dozen metro-area teenagers carpooled to the state Capitol, bent ogetting Minnesota to sell off $4 billion worth of fossil fuel stocks.
These high schoolers were the core members of the Youth Climate Strike, responsible for convening demonstrations by the thousands on the steps of the Capitol last summer.
Crisscrossing the corridors of the Capitol complex, they flocked into the cramped offices of the governor, attorney general, state auditor, and secretary of state. The four make up the State Board of Investments, which manages public employees’ pensions. At the end of the last decade, they oversaw $104 billion worth of assets.
The students knew their way well. For weeks they frequented the Capitol, dogging the officials for meetings, and threatening to protest until their demands were met.
“It’s important for us not to invest in fossil fuel industries because they’re the ones perpetuating the climate crisis,” Champlin Park High senior Grace Bassekle said, explaining the moral logic galvanizing the students. “Hopefully it would show the fossil fuel companies that we’re done with this BS.”
But for the officials, Bassekle has crafted a case for divestment from the impassive viewpoint of fiscal responsibility. For the past 10 years, fossil stocks dragged while the rest of the market soared. Regulation and lawsuits have injected coal and oil with so much risk, it no longer made sense to bet retirees’ futures on their narrowing window to grow.
Bassekle hoped the SBI would heed the dark omens other institutional investors have. “We have to divest now before we suffer the consequences,” she says.
Last year, the University of California system announced it would divest its $13.4 billion endowment and $70 billion pension—not because of political correctness, but out of concern for its retirees and research.
BlackRock, the largest asset manager in the world with $7.4 trillion, issued a piercing open letter to investors in January announcing plans to drop thermal coal because “in the near future—and sooner than most anticipate—there will be a significant reallocation of capital.”
CNBC squawker Jim Cramer disavowed fossil fuels as being “on the wrong side of history,” like “a slowly melting ice cube, a wasting asset that will have down revenues unless oil jumps higher and stays higher.”
Investment bank Goldman Sachs, followed by JP Morgan, cut off loans for thermal coal and arctic drilling. Goldman also downgraded Exxon Mobil stock from “neutral” to “sell” after analysts forecast the oil and gas giant to have lower than expected returns through 2025.
This all after it’s become woefully obvious that America’s so-called fracking boom was basically a ponzi scheme.
Determined to shake its addiction to Middle Eastern oil, the United States set off a fracking revolution that flooded the market with supply and suppressed prices. At the same time, because fracking required the nonstop pulverization of shale rock for oil and gas, companies have been directing all their cash flow into drilling new wells instead of repaying lenders and shareholders.
Last year, Minnesota’s SBI commissioned consultant Meketa Investment Group for a general report on divestment issues in response to mounting concern from pension holders and the incessant demands of the Youth Climate Strike. Meketa didn’t think dumping fossil stocks was an effective way to control carbon emissions. Yet it acknowledged predictions that peak demand for old energy sources—a potential tipping point for investors—could arrive this decade.
More recently, the International Energy Agency announced that global carbon emissions stopped growing in 2019 even as the world economy expanded 3 percent, thanks to renewable energy.
“These factors pose potential material long-term investment risks to the Minnesota State Board of Investment (SBI) investment portfolio,” Meketa warned.
That was then.
By late January, the coronavirus had arrived in America as the World Health Organization declared a global public health emergency. Minnesota had its first coronavirus case in an elderly Ramsey County resident on March 6, a Friday.
At the same time, the Saudi Arabia-led Organization of the Petroleum Exporting Countries (OPEC) looked at what was happening across the world, predicted demand for oil would tank, and proposed shutting off the taps to salvage prices. Russia pulled a power move and refused to stop pumping. That weekend OPEC doubled down, accelerating its own production and launching a price war.
The following Monday, investors staring into the eye of a pandemic dumped their riskiest assets. Financial markets crashed through the floor with oil leading the plummet. Since then, the price of crude has scraped $20 a barrel, which would have been unimaginably low less than a month ago.
As coronavirus fixates the world, the clamor in Congress is all about the $2 trillion economic rescue package passed Friday. In addition to a one-time check of $1,200 for most Americans and $500 per child, this historic stimulus includes $100 billion for hospitals, $377 billion in small business loans, and $500 billion set aside for the U.S. Treasury to dole out to any wounded corporation. The news is coaxing back some bargain-hunting investors.
How Minnesota keeps its portfolio balanced in this abrupt recession could have ramifications into the distant future.
II. Good Intentions Backfire
When Minnesota’s chief investment officer, Mansco Perry III, looks out his Capitol complex window, he sees cars running on internal combustible engines instead of batteries. And when he looks at global economies, he sees civilizations hooked on oil and gas.
Perry is an even-keeled, orthodox financial manager whose long-term approach to investing sees to it that nearly 220,000 retired teachers, law enforcement officers, and civil servants are paid each month. The average pensioner in Minnesota will need those benefits for 30 years. Compared to the manic spikes and valleys of daily markets driven by the 24/7 news cycle, his outlook is geologic in scale.
He manages this monumental duty by sticking to the dogma of diversification: Buy everything and discriminate against nothing. Follow the market, per the statistically soundest way to make money over lifespans. No vainglorious gambling. No political activism.
Ethics have nothing to do with it, with the exception of three divestment schemes mandated by politicians. State law forbids investing in Iranian businesses subject to federal sanctions as well as arms dealers complicit with genocide in Sudan. The State Board of Investments also divested some funds from Big Tobacco back in 1997, when cigarettes seemed the greatest threat to public health. Nevertheless, the state still owns a heap of Philip Morris shares.
In fact, the SBI owns stock in more than 10,000 companies, everything from Abercrombie and Fitch to Walt Disney, including sweatshop retail, private prisons, and gun manufacturers.
The state doesn’t break down how much money it has in coal and oil, but last year the Youth Climate Strike estimated Minnesota managed $2.6 billion in fossil fuel extraction, or $4 billion including companies that build the infrastructure that supports the industry. Minnesota owns shares of Chevron, Exxon Mobil, Shell, Enbridge, and more.
It didn’t take a financial expert to see energy stocks languishing last decade, but Perry doesn’t credit that to a radical shift in car culture. He blames the glut of supply and low prices set by OPEC—both potentially fleeting roadblocks.
As nations come back online after coronavirus, their economies will still hunger for fuel. Rock-bottom oil and gas prices are no good for investors, but cash-strapped consumers would take advantage and have less need to transition to green energy.
And as top fossil fuel companies pour millions into renewables, it makes it harder for SBI director Perry to distinguish between “good” and “bad” energy companies. The cautious approach is to stay invested and weather it out.
“Why would I not continue to own them if they’re going to transition themselves from being a fossil fuel-based energy company to a renewable energy company?”
If morality-driven investors sell off their shares, less ethical buyers would scoop them up, explains University of Minnesota economist V. V. Chari. Divestment won’t starve companies of capital but could hurt investors, he says.
The cola wars of South Africa offer a lesson from history. As the world grew increasingly disgusted with apartheid in the 1980s, both Coca-Cola and Pespi announced they would divest from South Africa. Only Pepsi paid more than lip service. After a regime change, Coke was left with a monopoly on the country. Even Nelson Mandela had to put aside his personal boycott of it in pursuit of a greater good—jobs for black South Africans.
In the 1990s, states raised taxes on cigarette companies, forced them to add warnings to packaging, and dumped their shares. All Big Tobacco had to do was move into emerging markets like China and India. While stigma suppressed the rise of small competitors, the giants solidified their market share. Price hikes couldn’t dissuade the addicted.
Minnesota won $6.5 billion by suing a host of cigarette companies in 1998. But it also lost money in the stock market—the SBI couldn’t say how much—by selling off high-risk, high-reward tobacco shares.
“The coronavirus is having us address climate change in a way that none of us would like, which is crunching our economy, bringing it all to a screeching halt,” says Chari. “If this continues for another six months, all types of energy, including green energy, is going to get killed.”
Oil companies are calling off plans to expand drilling in 2020. Green energy companies have been flagging from supply chain disruptions as the Chinese factories that made parts for solar panels and wind turbines went dark.
Chari doesn’t think there’s any reason altering Minnesota’s portfolio in favor of green energy would protect returns.
“It may yield a psychic return. You may feel good about it. It may help you sleep at night. But in terms of financial returns, I think that’s an illusory hope.”
III. Liquid gold with nowhere to go
Years ago Emily Moore, a pension holder and former Minnesota Pollution Control Agency chemist, became aware of a problem with oil futures.
Every quarter, publicly traded companies have to report their assets. For fossil fuel companies, those assets include their reserves of coal and oil, valued with the assumption they’ll eventually be extracted and sold.
At the same time, climatologists have reached the consensus that burning fossils would lead to mass extinction. According to the Intergovernmental Panel on Climate Change, the world has become an average 1 degree C hotter since the industrial revolution. Once warming hits 1.5 degrees C, rising sea levels will displace millions of people, and acidification will eradicate most coral reefs.
At 2 degrees nearly one-tenth of the world will face water shortages, and oceans will lose a quarter of their species.
At 3 degrees the Arctic will have no more sea ice in summer, and the planet will be in drought 10 months of the year.
In the scenario where humanity pulls together and survives, fossil reserves would have to stay buried and go to waste, Moore says. Infrastructure like drilling rigs and pipelines would become obsolete as well.
She and other pension holders presented their case to the Minnesota Association of Professional Employees—a union of state workers—in 2016 and 2017. Both years, MAPE asked the State Board of Investments to study the financial risks of Minnesota’s fossil holdings in detail. The teachers union, whose 83,000 members compose the state’s second-largest pension fund, requested immediate divestment last year as part of its legislative wishlist. The SBI hasn’t buckled to any of those demands.
This problem of “stranded assets” is big enough to shadow the oil industry even after markets bounce back from coronavirus, Moore says.
Centered Wealth financial advisor Jina Penn-Tracy believes the way Saudi Arabia and Russia reacted to coronavirus reveals the extent of their stress over global markets that have been shrinking as advanced societies pivot from carbon.
“The fighting between those players is going to get more intense,” she predicts. “I was thinking it would take some time to speed up as the [oil] market gets smaller, but we saw it in hyperspeed because of what happened in the overall economy just now.”
When the economy begins to repair itself, America’s oil and gas frackers may have a hard time reopening lines of credit, Penn-Tracy says. That’s in part because a number of large banks announced they’d stop loaning money for certain drilling projects just before the virus struck America.
While the financing issues that would naturally accompany economic upheaval are poised to hit dirty energy even harder, the industry’s international subsidies are suddenly under intense scrutiny as governments look for ways to pay for the coronavirus effort.
Meanwhile, as the virus lifts from China, green energy factories in the east are making a cautious comeback.
“Even as the economy recovers, this asset class is still going to have problems because we still have litigation ahead of us for climate-related disasters,” Penn-Tracy says. Countries are spending trillions to overcome the virus. Down the road, they’re facing the same unrelenting climate catastrophes that now plague the world perennially. “They’re going to need to have somebody foot the bill. I think litigation’s going to be on the horizon in a much more intense way than it was six months ago.”
While she usually tells her clients to stay invested and engage with morally imperfect companies, Penn-Tracy says no amount of shareholder pressure could urge an oil company to stop drilling for oil, because their mandate is to try to sell the assets on their books.
Last year, Exxon Mobil shareholders proposed getting the oil giant to pace its greenhouse gas output with the Paris Agreement—the international pledge to keep global warming below 2 degrees C. Exxon protested that reducing emissions was basically micromanaging, and wouldn’t let shareholders hold a vote.
Nevertheless, big investors keep trying. Year after year, they inundate fossil fuel companies with demands to spare the planet—and shore up shareholder value—by cutting back on pollution. As climate resolutions gain traction, the U.S. Securities and Exchange Commission proposed curbing shareholders’ rights to keep bringing them up. Large and small investors alike objected, and now await the S.E.C.’s final decision.
Shareholders have manifold reasons to worry. Governments keep threatening to enact increasingly strict regulations to throttle production, and lawsuits are bleeding companies dry.
Democratic presidential candidate Joe Biden vows to end fossil fuel subsidies worth tens of billions a year if he’s elected. Bernie Sanders, no fan of “corporate welfare,” would do the same, ban offshore drilling, and end U.S. export of fossil fuels.
Cautious investors could scrub their portfolios of a huge amount of risk by screening out the world’s top carbon reserve holders, divestment advocates argue.
Yet studies offer contradicting insight as to whether portfolios are healthier with or without oil.
A California State University study using market trends over the last 10 years found those who sold off fossil fuels in 2010, when the divestment movement first became vogue in activist circles, are richer for it now.
On the other hand, a study funded by the Independent Petroleum Association of America extrapolated 50 years’ worth of market data and found—perhaps predictably—that divestment would be an unimaginably costly mistake.
Yet another study by the University of Groningen, Norway’s second oldest college, looked back 72 years and discovered fossil fuels had little effect on well-balanced portfolios. They didn’t add that much more variety, particularly as coal and oil had all the risk but none of the reward of “sin stocks” like cigarettes and booze. No one would consume them if they didn’t have to.
The University of Minnesota’s V.V. Chari agrees there’s a good chance “a substantial amount of investments in fossil fuel production and distribution will become stranded.”
To predict the future, investors must ask whether the market is doing enough to assess the risks of climate change. Some people take the view that the market is behaving irrationally, and failing to account for stranded assets when valuing fossil companies. In that case, it makes sense from a financial standpoint to offload those assets, Chari says.
“They may be right in the future. It’s always hard to tell, but the lessons of history offer a huge caution. If history repeats itself, and it always has, [divestment] will be incurring a significant financial cost,” he warns.
IV. A fighting chance
The metastasizing hazards of the fossil fuel industry have members of Minnesota’s State Board of Investments on edge. All of their most recent meetings have begun with a discussion of Minnesota’s continued investment in dirty energy.
The governor, attorney general, auditor, and secretary of state have the right to change Minnesota’s divestment strategy with a vote. They each have their own misgivings about carbon’s profitability.
“There’s a whole field of ethical investing of good stuff that’s going to ensure our future and also have a good rate of return,” said Attorney General Keith Ellison in an interview. “In the case of fossil fuels, the projections are not that great for them anyway.”
“To give you one obvious example, coal companies are going bankrupt across the country. Is it a good idea for Minnesota or anyone for that matter to own those companies?” asked Secretary of State Steve Simon.
Still, it’s no small thing for elected officials to defy investing doctrine and blacklist a common asset class. Especially when they’re making that call on behalf of hundreds of thousands of pensioners. A coronavirus recession only magnifies the significance of their choice.
SBI staff assure the board they’re monitoring fossil fuels’ increasing regulatory, litigation, and reputational risks. But the board has to be certain.
At their final meeting in March, before coronavirus suspended most in-person government functions, the SBI approved a resolution to commission a comprehensive study of Minnesota’s fossil fuel holdings. If the risks outweigh the rewards, they say they’ll do what it takes to reduce the state’s exposure.
There’s another set of factors to consider: Minnesota’s own dog in the fight to make fossil fuel companies pay for the damages they’ve inflicted on the planet.
The National Oceanic and Atmospheric Administration ranks Minneapolis as America’s second fastest warming city. Increasingly intense flooding has drowned crops in the country and torn up roads in the cities. As pests and parasites move in, native wildlife is vanishing along with the fragile boreal forest ecosystem that defines the state’s wild north.
Fossil fuel companies are being sued by Massachusetts and Rhode Island, cities from San Francisco to New York, and an assortment of children’s groups arguing their young plaintiffs will suffer the brunt of climate change. Early subpoenas of Exxon Mobil documents found that its own scientists predicted the planet-killing potential of burning fossil fuels. Nevertheless, the company pumped millions into climate-denial think tanks like the Heartland Institute. Governments are crying fraud.
The Minnesota Attorney General’s Office is building a case, Ellison confirmed. Somehow, he’ll have to tally the state’s climate disasters and put a price on the damage.
When Minnesota boards that bandwagon, it would actively contribute to the avalanche of litigation that threatens fossil investments. But as shareholder, Minnesota pensions would be better off if the companies prevailed in court.
It’s a paradox. State Auditor Julie Blaha sees just one way out.
“If fossil fuel companies have pocketed benefits without taking on all of the costs, that’s not fair, that’s a market failure, and we have to fix that,” she says. “It may very well change how we invest.”
As coronavirus fans across America, market charts double as polygraphs taking the pulse of the nation’s anxieties. Their only hope is the United States’ $2 trillion reboot, and the coronavirus bailouts of governments around the world.
Fatih Birol, executive director of the International Energy Agency, says that amid the despair of inconsolable markets is a historic opportunity to use the downturn in oil—and near-zero interest rates—to invest in green energy.
In recent years, solar, wind, and hydropower technology have gotten to be so efficient, it’s now cheaper to produce a watt of renewable energy than oil and gas. What we need now is sufficient infrastructure—solar and wind farms—to add more of it to the grid and finally round the corner on fossils.
The pandemic’s economic effects are likely to be temporary, but the threat of climate change is inescapable, Birol wrote in a statement. The collapse of oil prices poses opportunities for countries to cancel fossil subsidies for good. A green stimulus would bring “twin benefits of stimulating economies and accelerating clean energy transitions,” he said.
“The coronavirus crisis is already doing significant damage around the world. Rather than compounding the tragedy by allowing it to hinder clean energy transitions, we need to seize the opportunity to help accelerate them.”
Nevertheless, on Thursday the Environmental Protection Agency suspended enforcement of pollution standards during the pandemic, asking companies to regulate themselves.
Then the U.S. stimulus passed without any support for green energy despite congressional Democrats’ pleas. In a compromise, the final bill also eliminated the $3 billion Donald Trump requested to buy 30 million barrels of American crude.
“With the stimulus package, they tried to put some regulations on the airlines, and it didn’t happen. Clean energy incentives weren’t a part, and they should have been,” says pension holder Jean Buckley, a former Ramsey County public health worker. She hopes Minnesota will prioritize protections for its 61,000 green energy jobs in spite of the federal government’s neglect of the industry.
“Whatever happens, we’re going to have to invest in energy, and our fund should be looking very specifically at what companies are actually investing in clean energy,” she says.
“There are a lot of newer startup companies out there and we’re all about small businesses, so I think there’s a way we can use [environmental] criteria in terms of investing, and not just divesting.”