December 4, 2017 Read More →

IEEFA Op-Ed: ‘Pension Funds, Sell Your Gas and Oil Stock’

Former Blue-Chip Investments Bear a Greater Resemblance Now to Speculative Holdings

Last month, Norway’s $1 trillion pension fund announced plans to drop oil and gas stocks from its core benchmark stock portfolio. The move was of note because it served as an important acknowledgement by a major institutional investor that such holdings have lost their status as mainstream, blue-chip investments and are now considered speculative.

It carries special significance too because the Norwegians really know the oil and gas market. The country owns vast oil reserves and the government — and the huge fund itself — are highly dependent on revenues from North Sea oil.

New York City’s five pension funds, which are worth $186 billion, would do well to follow Norway’s example. The city’s fund managers have been slow to recognize the rising risk in oil and gas stock, which are no longer the investment they once were and which expose the funds to potential losses they can ill afford.

For decades, the oil sector was the leading industry in the world. It drove global stock markets and helped fuel returns in New York City and New York State pension portfolios.

But that changed in 2014, when a decoupling in investment markets occurred as broad stock indexes rose and gas-and-oil indexes fell. The industry has seen substantial value destruction driven by low oil prices, oversupplies of oil and natural gas, and fragmentation of alliances among oil producers. Revenues are down, profit margins are down, and substantial sectors of the industry, like the Canadian oil sands, have been all but written off.

Capital spending in the fossil fuel sector is also down, an indication that oil companies themselves see a limited future.

So prospects for oil stocks are weak, and the industry is openly conceding this reality. ExxonMobil, the International Energy Administration and the U.S. Energy Information Administration all project flat oil prices through 2022.

Those outlooks may not go far enough: The consensus in Norway is that low oil prices will persist through 2060 and that, as a result, the government is at risk of seeing its budget deficits will grow.

STANDARD INVESTMENT PHILOSOPHY SAYS THINK LONG-TERM, NOT SHORT, and ignore day-to-day fluctuations in stock prices. But Norway is feeling the impact of lower oil prices in its government budget now, and the Norwegians will need to draw on their pension fund to pay government expenses starting this year. They are in no position to permit the fund to underperform by allowing it to continue to hold oil stocks.

New York City is obviously not as dependent on oil and gas revenues as Norway is, but its budget is also affected by pension fund performance. This year, the city expects to devote 17% of its total spending — $9.6 billion — to its five pension funds. And that contribution is expected to grow.

More spending on pensions means less spending on essential services or higher taxes, and New York City is just like Norway in that it needs its pension funds to generate strong returns.

The city’s past management of its coal industry stocks offers a difficult but instructive lesson here. Although New York City dropped all of its coal stocks in 2015 as the industry declined, those stocks at that point had already lost 95% of their value. Investment advisors who had clung to conventional wisdom in holding these stocks responded to criticism by dismissing the losses as relatively small in the big picture.

But every dollar counts, and those coal stock losses could have been avoided. The information was available then — as it is now — to make the right decision at the right time.

The responsible course of action today is for the city to publicly disclose its pensions funds’ exposure to oil and gas stocks and to direct pension fund advisers to develop alternative investment strategies that will allow the funds to meet their goals while shedding oil and gas stocks.

The city’s controller, responsible for managing the funds, can take the lead here and respond appropriately to market trends that have made oil and gas stocks so much riskier than they used to be. A thorough analysis of oil and gas holdings is in order, as is a formulation of a clear plan for how to reinvest those holdings.

Norway has shown the way forward. New York City’s pension funds ignore its example at their peril.

Tom Sanzillo is IEEFA’s director of finance. The column first appeared in the New York Daily News.

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