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Why long-term investors are killing fossil fuels

Remember the date April 26, 2017: it will go down as an important day in the history of solving climate change. That’s because Moody’s Investor’s Service released a research paper titled "Oil and Gas Industry Faces Significant Credit Risks from Carbon Transition."

That’s a headline all of us building business-led solutions to climate change have been waiting for. Increased assessed risk from rating agencies has the potential to really move the needle on institutional investors’ decisions about where they put their money. With the new administration refusing to say the words "climate change" except to deny it, this is a needed injection of reality into public markets.

For the Divest-Invest movement, it’s even more important; it’s a bright, clear LED sign pointing out how to magnify its collective impact.

But first, we need to understand what impact worked. As far as Moody’s is concerned, the financial impact of the divestment campaign is not directly registering as a contributing factor to these "significant credit risks." It’s not even mentioned. It seems plenty of asset owners and investment managers are willing to earn a short-term profit without regard for the catastrophic impacts of hydrocarbon combustion.

Instead, Moody’s reports that the primary impact driver is the Paris Agreement on climate change and subsequent global effort to reduce combustion of oil and gas. Here’s its summary:

Global policy ambition to reduce carbon emissions represents a substantial threat to the oil and gas industry. While the speed and scope of policy implementation remains uncertain, its intent and direction is not, and it is already affecting the sector. The industry’s product cannot be changed and no technology exists at scale to mitigate its carbon emissions.

As a result, demand for oil and gas is anticipated to drop globally, which will put downward pressure on prices, making exploration too expensive to fund for many integrated oil companies. This also should put additional pressure on shale oil production, which still is more expensive per barrel than conventional.

Demand for oil and gas is anticipated to drop globally, which will put downward pressure on prices, making exploration too expensive to fund for many of the integrated oil companies.

For oil, the demand reduction is already apparent, coming from efficiency gains in the vehicle fleet through a new era of innovation in the internal combustion engine, the widespread deployment of hybrid-electric vehicles and the introduction of fully electric cars.

For natural gas, demand reduction comes from the dramatic price reductions of clean alternatives, wind and solar, in particular. While the story of natural gas prices dropping below coal per BTU is well known, unsubsidized wind and solar is beating out natural gas generation, with more renewables installed than natural gas in 2016.

For the Divest-Invest movement, this is important feedback. The coalition’s impact came from the moral support that mobilized and motivated the leaders in Paris and from investments that reduced the cost of alternatives, increased their availability and drove deployment. Neither effort affected the supply of oil and gas; instead, they reduced demand.

A new investment hypothesis

This insight comes at an important time. The Divest-Invest movement has pledged for divestment more capital than markets can redeploy into renewable energy. At the end of last year, the movement’s leadership estimated total divestment pledges amounted to $3.5 trillion while total reinvested was $1.2 trillion. Obviously, $1.2 trillion should be seen as a major accomplishment and powerful market signal itself, but nearly twice that figure is waiting for a viable investment hypothesis.

And, if this Moody’s report accelerates a shift out of oil and gas sector equities by institutional investors, even more will be on the way.

If the movement is to build on what works and further reduce demand for combustion, and renewables are not expanding fast enough, where can the Divest-Invest movement look to deploy funds at scale and achieve outsized strategic impact?

The most promising investment hypothesis comes from unlocking the pent-up demand for a walkable American dream.

The most promising investment hypothesis comes from unlocking the pent-up demand for a walkable American dream. The National Association of Realtors estimates that 60 percent of Americans would prefer to buy a home in a walkable community. By reducing vehicle miles traveled and building high-efficiency homes, walkable communities further reduce demand for oil and gas, while increasing the market demand for distributed renewables, reinforcing the movement’s current strategy of the investing in the renewable retrofit.

(Full disclosure: I co-founded Long Haul Capital Group to pursue this hypothesis, one that emerged from our research into business-led strategic impact.)

Taking the long view

It’s a strong match to the needs of institutional investors. First, there’s scarcity in the marketplace, as only 1 percent of metropolitan land is currently walkable. That means a natural price premium in many metro areas during the first decade of rollout. Second, the asset duration matches well with long-term institutional investors’ obligations. The infrastructure and mortgage investments necessary to build low- or net-zero communities are all 30 years or more. And the scale is impressive: We estimate total potential annual market is $240 billion out to 2050.

But it’s the impact that’s important. Done the right way, these investments can incentivize green building standards that reduce energy for heating and cooling by over 90 percent. Combined with transportation savings and powered by renewables, urban planner Peter Calthorpe calculates this kind of green urbanism can take us to 12 percent of our 1990 per capita emissions.

Economically, the jobs created by expanding investment into the built environment would put millions more people back to work across the middle of the country, reducing income insecurity, potentially lowering the temperature of our politics. Finally, walkable communities are a necessary precursor to the regenerative economy, where our economic patterns actively restore the vitality of living systems.

Divest-Invest already has had considerable positive impact. Moody's report is well-timed insight pointing the movement towards how to multiply that impact in a way that leverages the even larger volumes of capital from more conventional institutional investors. Given what’s not coming out of Washington, this isn’t just a good idea, it’s now a fiduciary obligation.

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