The fossil fuel sector has lost its investment rationale

Fossil fuels have underperformed the broad market for a decade and have a negative long-term financial outlook. The sector faces intense competitive pressures that it is poorly positioned to successfully navigate. Divestment from fossil fuels is a defensive move to protect the long-term value of an investment portfolio while continuing to meet investment return targets.

For decades, fossil fuel companies were the epitome of blue-chip holdings, associated with reliable returns, steady long-term growth, and sound underlying fundamentals. The fossil fuel sector drove returns for institutional investment funds for many years.

The pattern no longer holds. Today, the industry is mired in chronic underperformance. Credit rating agencies are questioning the industry’s readiness for the future. Competitive forces from renewable energy and other low-carbon technologies and the efforts of community and climate organizations advocating for alternatives dim the sector’s financial viability. The industry has yet to demonstrate a credible plan for navigating these risks in the years to come.

 Fossil Fuels Have Financially Underperformed for a Decade

• In 1980, fossil fuels comprised nearly 30% of the S&P 500’s value. Today, the figure stands around 3%.

• The fossil fuel sector has exhibited the lowest returns and highest volatility among sectors of the S&P 500 index for a decade.

• The sector has underperformed the market seven times since 2014 and performed worst among sectors five times.

• Fossil fuels have seen the weakest recovery among sectors from the stock market trough of 2022.

Fossil Fuels are Poorly Positioned to Navigate Competitive Pressures 

Volatile commodity prices threaten revenues and profits 

• Oil and gas prices are prone to large and extended drawdowns due to intense competition between oil and gas producers amid growing global supply and slowing demand growth. This combination tends to pressure prices, lowering revenues and suppressing profits. Geopolitical disruption has driven price spikes in the recent past, but the impact on prices has not endured. 

Non-fossil technologies take growth and market share 

• Fierce competition from renewable energy and electrified technologies is slowing demand growth and increasingly taking market share across key end-markets for fossil fuels, including transport, electric power, and space and water heating. 

Fossil fuel companies don’t have a credible business plan for the future 

• Fossil fuel companies are not meaningfully investing in renewable energy: the sector devoted less than 4% of its capital expenditures to clean energy in 2023, and its clean energy spending accounted for about 1.5% of total clean energy investment globally. 
  
  Fossil fuels have no commercially viable low-carbon technology. Despite fifty years of research and development, history is littered with failed carbon capture and sequestration (CCS) projects. Existing facilities capture far less carbon dioxide than the 90-95% level advertised by proponents of the technology. Retrofitting carbon capture onto carbon emitting facilities requires significant capital outlays and adds operating costs. Projects are increasingly seen to require large and permanent public subsidies. 
  
  Fossil fuel investments in petrochemicals face a deteriorating competitive landscape. The fossil fuel sector has made significant investments into the production of petrochemicals as a diversification strategy away from extraction and refining. Petrochemical markets are seeing global overcapacity that has weakened prices and compressed margins. 

Divestment is a Tool for Protecting Portfolio Value 

More than 1,600 investment funds who manage a total of $40 trillion have committed to divest from fossil fuels, including pension funds in New York City, New York State, California, Oregon, Québec, Europe, and Australia. 

Institutional funds have divested their portfolios without incurring significant losses or management fees. This is because there are now many fossil-free investment strategies and products available at low costs. For example, the University of California’s investments office invests a defined benefit portfolio in a fossil-free strategy at a cost of only 1 basis point (1 cent per $100 of portfolio asset value). It provides fossil-free retirement options at a cost of only 5 basis points. 

Fiduciaries of long-term investment funds should carefully consider the negative long-term financial outlook for fossil fuels and the implications for protecting their fund’s investment portfolio. Proper consideration demands deliberation over multiple investment options that meet a fund’s investment return targets without fossil fuels in the portfolio. Trustees can only come to a fully informed judgment of the impacts and any timing considerations after considering a plan specifically designed for their fund.