Part 1
The Moral Case: How virtuous is your fund manager really?
I just watched an advert for a new fund management company. They invest the savings, not of the old, but of the next generation. They invest, not in the fossil fuel industries of the past, but in our sustainable technological future. Stock-picking is driven, not just by mathematical investment returns, but a higher moral purpose. Allocating capital to compound virtue, the sum of which will enable its investors, not to just sit back in retirement, but to open the door to a brighter future. Yes, the future of asset management is “Guddy2Shoes Asset Management”, bringing moral as well as financial prosperity; harnessing the power of investment to save our planet!
If only it were that simple. Contrast the joyous commercial with the reality of families opening their electricity and gas bills this spring, finding they’ve soared by over £600 to an average of £1,900 per household1; their mortgage costs have increased because interest rates have gone up to fight inflation; and their taxes have also risen, partly because government has lavished subsidies of non-productive capacity, including new alternative energy technologies. And outside of the UK, what of the hopes of the 1 billon people in the world who currently have no electricity and the additional 3 billion with limited access to affordable energy? What of the hunger that accompanying food price inflation will bring to developing economies, with highly energy intensive fertilisers suddenly unaffordable? Without cheap food and energy brought by fossil fuels, life for much of the world’s population is nasty, brutish, and short. And if investors starve the fossil fuel industry of capital – with no viable alternative - then are the consequences for the global population of 8 billion people particularly ethical or likely to bring about positive societal change2?
Neo-Malthusians and the Industrial Revolution “Original Sin”
Warning about the dangers of over-population in his 1798 Essay on the Principle of Population, Thomas Malthus challenged the sustainability of Enlightenment ideas of human dominion over the earth which measured progress by economic development.3 By the early nineteenth century the world population reached 1 billion. The pace of growth accelerated with the use of fossil fuels in the industrial revolution and then again in the late 1960s when developing world agriculture was revolutionised partly through uses of chemical fertilisers, since when the global population has increased by 1 billion almost every decade, owing to a rapid decrease in infant and child mortality (See Fig 1. Global Population4).
“It was here in Glasgow 250 years ago that James Watt came up with a machine that was powered by steam that was produced by burning coal. And yes, my friends, we have brought you to the very place where the doomsday device began to tick”5
Malthusian ideas around exponential population growth, finite resources and sometimes sinister calls for birth control have maintained popularity. In 1972, The Limits of Growth6, a report commissioned by the Club of Rome using computer models to extrapolate trends, concluded with now familiar apocalypticism: “if the present growth trends in world population, industrialisation, pollution, food production, and resource depletion continue unchanged”, the “result will be a rather sudden and uncontrollable decline in both population and industrial capacity”. “Wrong on resources, but right on pollution”, concluded the Guardian newspaper more recently, as it also lauded the “startlingly prescient” “early warning of civilised collapse by early to mid-21st century”7. Like Marx, it seems that Malthus was right all along, but his ideas have just not been applied properly, until now with regards to climate change.
Economic development requires cheap and reliable energy
Fossil fuels have been key to economic development precisely because they are the best source to date of cheap and reliable energy. It should be obvious that with the developing world accounting for 2/3rds of current carbon emissions (See Fig 2. Global CO2 Emissions8), global decarbonisation cannot ever be achieved without addressing the crucial role of fossil fuels in economic development and the sensitivity of lower income nations to their replacement by more expensive, less reliable low carbon power generation.
Fig 2. Global CO2 Emissions
Those investors who would immediately and permanently starve fossil fuel industries of capital – and thus drive up the price of fossil fuel through limited supply – also tend to be against nuclear (a source of almost unlimited, reliable zero carbon generation), hydro (reliable, scalable, zero carbon) , natural gas (fracking has significantly reduced US carbon emissions, replacing coal), instead focusing on sub-scale and unreliable “sustainable” renewable projects (but still denying the environmental impact of wind turbines, the use of Chinese coal-powered energy in manufacturing most of the world’s solar cells, or that the burning of wood pellets emits more carbon than the coal it replaces). Despite concerns about the amount of land given over to farming (with less available land for wilderness) most climate change activists tend to object to genetically modified crops and even industrial fertiliser which would increase arable yields and consequently lower food prices9. Those who claim to be “saving future generations” from “climate change apocalypse” often seem to have profoundly anti-human, Malthusian agendas that negatively impact the world’s poorest. As Danish environmentalist Bjorn Lomborg has concluded:
“Today’s popular climate change policies of rolling out solar panels and wind turbines have insidious effects. They push up energy costs, hurt the poor, cut emissions ineffectively and put us on an unsustainable pathway where taxpayers eventually are likely to revolt…We also need to recognise that reducing global warming is only one of many things we can do to make the world a better place. Making the world richer is also important.”10
Oil bull market “necessary evil”
There are early signs that some governments are beginning to understand the decarbonisation shock they created through appeasing the apocalyptic environmentalists. EU governments have asked for Nuclear and Gas to be included as compliant with the EU’s “Taxonomy” (their tick-box guide for ESG inclusion). This has been opposed by some EU governments, leading ESG and climate change investor groups11. Since it includes only downstream power generation investments - rather than upstream exploration - this would in any case simply move the inflation from power generation to the upstream commodity. US President Biden demanded OPEC pump more oil before his attendance of the COP26 summit in Glasgow12. More recently, US Secretary of Energy Granholm and Secretary Wilcox for the Office of Fossil Energy and Carbon Management - in a JPMorgan roundtable event – “explained the need for more fossil fuel supply globally…recognising energy as the biggest driver of inflation”. The bank’s energy analyst concluded:
“Overall, we came away with the view that higher for longer oil prices could well become the ‘necessary evil’ of transition as cleaner fuels consume a larger proportion of energy investing at the expense of incremental dollars in oil production.13
Capital investment at the Major Oil and Gas companies has, given the institutional fund management hairshirt, fallen from $330bn in 2013 to just $140bn today. Unsurprisingly the amount of new oil and gas discovered has also plummeted from 30m/barrels of oil equivalent (boe) in 2012 to just 5m/boe in 2021 (See Fig 3. Oil Major Capex vs. Discovered Volumes14) with a record low reserve replacement ratio of new volumes found to current production forecast of just 12% (See Fig 4: Oil Major Reserve Replacement Ratio15). Even in a global economy where western democracies are hell-bent on zero carbon, in view of robust economic growth, particularly from less dogmatic developing nations and the recovery in the demand for transportation fuels post-COVID, demand for oil and gas will still grow whilst supply plummets. The result can only be a new bull market in fossil fuels and structural inflation in the wider economy.
Fig 3. Oil Major Capex vs. Discovered Volumes 
Fig 4. Oil Major Reserve Replacement Ratio
All aboard the ESG Gravy Train: but no contrarians allowed
The institutional fund management industry has fully embraced the race to zero carbon emissions, with firms outbidding each other to demonstrate their “sustainable” credentials. This is in part owing to robust investment performance, at least until recently – ESG is now just another long duration strategy hoist by its own inflationary petard - and their apparent popularity, as evidenced by growth in assets, although sceptics might think this is sometimes confused with a cannibalising supply push, sponsored by virtue signalling asset management CEO’s.
Contrarian thinking used to be nurtured at investment firms with strong and sustainable cultures, but now non-compliant funds - and their fund managers - risk being cancelled. Since the stock-market functions best as an exchange of different views expressed in the price of a transaction, a generation of investors inculcated with institutionalised anti-fossil fuel groupthink is an ill portent for structural misallocation of capital and risky investment bubbles.
There is now a plethora of industry climate change lobby groups working toward a broad goal of zero emissions by 2050 on the assumption that this will limit average global temperature rises to just 1.5%. These organisations, initiatives and networks claim to represent asset managers with a grand total of $262trillion - which is 2.5x most estimates of the $100 trillion size of the industry – owing to asset management companies being members of more than one group or having multiple affiliations.16
“Obviously” No Analysis Needed
If you were expecting the fund management industry to present a cost/benefit analysis for the extraordinary reallocation of capital required to decarbonise, you will be disappointed. Examining the websites of the different groups, only Climateaction100 make an attempt to estimate the cost of climate change, claiming that the cost of a 4 degree (rather than 1.5 degree) warming at “$23 trillion of global losses over the next 80 years” based on a single 2018 paper that suggests $18 trillion of annual economic damages by 2100 in Sub-Saharan Africa, India and South-East Asia owing to rising sea levels (and presuming an absence of any new mitigating flood defences). To put the intellectual rigour of this $23 trillion claim into perspective, these specific economies are today worth just $7triilon, annually.17 It is also claimed that climate change will cause “hunger and poverty” despite the well-known positive “greening” effect on plant growth from CO2 and higher energy prices from the end of fossil fuels that would itself negatively impact economic growth, none of which seems to have been contemplated. Argonaut contacted all of these organisations to double-check whether they had analysed the economic cost of climate change and compared it with the costs of replacing fossil fuels. Apart from UNPRI reiterating the same $23triilon figure from the same single 2018 research paper, we received just one additional response from Netzeroassetmanagers:
“To your question – what seems to be clear, the cost not to act is higher than the cost to act and the longer we wait the more costly it will be.
This is something the NZAOA really has looked into as it seems to be obvious this is the case”18
Professional investment decisions are supposed to involve meticulous analysis of numbers and facts. It seems incredible that organisations purporting to represent more than all the world’s assets under management could have done no serious cost/benefit analysis into the economic costs of climate change, the costs of decarbonisation or contemplated any mitigation actions. Has your fund manager done this analysis and published their conclusions? Or it is just easier to accept the “obvious” immediate cataclysmic climate doom and deny the entire fossil fuel industry capital based solely on emotion, institutionalised groupthink, coupled with commercial opportunism. Cancelling the entire fossil fuel industry without offering a viable alternative for the generation of cheap and reliable energy, is not responsible investing: it is morally reprehensible.
“The Science” and the Spanish Inquisition, again
Anyone curious enough will find a real and important debate around not whether climate change exists – it has existed over millennia – but the degree to which climate is changing, this can be extrapolated, change is uniform, unprecedented, man-made and therefore manageable by changes in human activity; or whether the effects of warming can be more effectively managed by mitigation tools such as flood defences, carbon capture or stratospheric aerosol injection19. In a paper due to be published this month, three University of Massachusetts Physics Professors conclude that their research shows “that the percentage of the total CO2 due to the use of fossil fuels from 1750 to 2018 increased from 0% in 1750 to 12% in 2018, is much too low to be the cause of global warming”20 We are told such credible scientific dissentient voices do not exist. What do we fear from a debate?
It would be an unfortunate mistake to undergo the most significant redeployment of capital ever witnessed in a painful energy transition only to find that it made no difference to changes in the earth’s climate. Why aren’t all scientific voices heard, not just the apocalyptic? Only then can society – and belatedly the asset management industry supposed to make decisions based on their own bespoke research and thorough analysis – conduct a rational cost/benefit analysis on the pace of decarbonisation and therefore the desirability of starving the fossil fuel industry of the capital needed for investment.
The centuries old notion of progress in human knowledge from incremental research and debate has recently been challenged by politicians claiming that there is something called “the science” written by a group of omniscient technocrats who agree on everything and - in a quasi-religious manner - believe they have exhausted all avenues of inquiry. In this process of de-enlightenment reminiscent of the Spanish Inquisition, further debate is branded taboo. We have also witnessed how politicians often out-bid each other to protect the electorate from the cataclysmic predictions of technocrats, often lionised by sections of the media for their doom-laden dispositions. Western democratic leaders have now invested so much political capital in the race to zero carbon that a U-turn seems unlikely. At the same time, the costs of decarbonisation are becoming clearer; the arrogance of the official “science” narrative too apparent and the goal of zero carbon elusive without the buy-in of developing economies.
Alternative ethical investing
The fund management industry has just accepted climate change activist apocalypticism as verbatim. It jumped on the zero carbon ESG Gravy Train without analysis of the probable economic consequences. The widespread view that starving the world of the fossil fuels is ethical, will - in the absence of cheap and reliable alternatives - lead to lower economic growth, de-industrialisation, cold and hunger amongst the world’s poor. This is not a desirable outcome.
Institutional groupthink and suppression of contrarianism has been the enemy of thoughtful capital allocation. If you are not anti-human like Malthus and his modern-day disciples, the moral – and now the economic case - for investing in fossil fuels is today compelling.
Barry Norris
Argonaut Capital
January 2022
