To Divest or Not to Divest? Sometimes the Choice Is Made for You

(Bloomberg) --

The rush from companies and investors to drop their Russian assets is a lesson for those who have been on the fence about whether to hold any questionable items in their portfolio — including global warming contributors.

I've written a few times on investment theories about the “carbon bubble” and “stranded assets.” The idea, in a nutshell, is that investing in polluting assets risks future financial losses, and these risks can be estimated with some degree of detail thanks to the science behind the carbon budget — the amount of carbon dioxide we can still afford to pump into the atmosphere if we want to limit dangerous warming.

It's perhaps the only example where Earth systems science has been internalized and translated into investment practice. It's helped drive up the cost of capital for polluting assets so that it more closely reflects their real risks. But that only takes care of your bottom line. Effecting rapid, real-world change is much harder. When someone sells a fossil fuel asset, it doesn't necessarily stop that asset from polluting. That's why there have been arguments for holding on to carbon-intensive assets to try and steer companies to be greener. At the same time, public and private financial institutions have been finding ways to shut down coal assets while minimizing losses.

The dumping of Russian-owned investments shows that sometimes the conundrum is resolved with breathtaking speed. This is because it's actually governments who ultimately make these big decisions for companies. When sentiment really shifts, assets can be stranded very quickly.

At a stroke, governments and central banks froze SWIFT transfers and currency swaps with Russia. Energy giants such as BP, Shell and Exxon declared their intention to exit ventures in Russian oil and gas projects. It's not even clear what happens now, with few, if any, buyers and many financial institutions nervous about violating sanctions or getting caught in the middle of a frozen transaction.

The situation crystalizes the longstanding dichotomy between climate-focused investing done for “moral” reasons (harming the planet is a bad thing to do) versus “financial” reasons (harming the planet means less profits).

Investing in Russia's oil and gas sector has been problematic for years. Its state energy giant Rosneft has been under some sanctions from the U.S. and Europe since an earlier Russian attack on Ukraine in 2014. Yet, until just a few days ago, BP could focus on the profits, not the emissions or human-rights issues. Bernard Looney, the chief executive of BP, until recently insisted that the company's Rosneft stake was about business, not politics. Even after Rosneft chief Igor Sechin was blacklisted by the US in 2014, BP said it “remain[ed] committed to our investment in Russia.” In the same way, investors who may have been able to shrug about the effects of their investments, citing returns and fiduciary duties — could find themselves at a point where, suddenly, they can't.

The reality of European cities being attacked changed everything. The choices companies and investors have to make pales in comparison to the devastating loss of life, with 1 million Ukrainians now seeking refuge in other countries.

Equities analysts were sanguine about the $25 billion writedown BP's Rosneft divestment would entail. JPMorgan Chase & Co. said it could even improve the company's ESG “perceptional rating” because of the reputational gain. An RBC analyst note said it “ultimately removes one of the concerns with the long-term investment case.”

Asset managers, too, were able to turn on a dime. After the announcement, the Financial Times quoted a large BP investor who called the move a “good decision” and “inevitable.” Presumably the company would face no opposition from Norway's sovereign wealth fund, the world's biggest owner of publicly traded companies, which announced its own plans for a broad divestment from Russian assets.

But if investors had found their moral compasses earlier, they may have avoided losses arising from BP's Rosneft writedown, and sent a powerful message to others, too.

There's a lesson in this for investors and companies who have put money into other problematic oil exporting regimes, whether it's buying Saudi Arabian debt or trading fuels that are extracted in ways that harm local and indigenous communities. When public opinion turns, it's fast and leaves little room for justifications.

Russia's war in Ukraine overshadowed the release of a bleak report from the United Nations this week about the consequences of global warming. Yet, in some ways, the events unfolding in real-time are directly connected to the document's main message.

The UN report was clear: It's still possible to avoid the most catastrophic outcomes of climate change, but even with the fastest reductions imaginable in planet-warming emissions, we will have to contend with at least some worsening of our climate. That means the world has to focus equally on cutting carbon pollution and adapting to a hotter Earth.

This warming is already driving situations that threaten human rights, such as conflict and displacement. How much it does so in the future will depend a lot upon the choices of powerful decision-makers. For investors, that means time is running out on dirty assets from a moral perspective, not just a financial one. The space to explain away compromised investments as “business not politics” is rapidly shrinking.

Kate Mackenzie writes the Stranded Assets column for Bloomberg Green. She advises organizations working to limit climate change to the Paris Agreement goals. Follow her on Twitter: @kmac. This column does not necessarily reflect the opinion of Bloomberg LP and its owners.