The debate over fossil fuel divestment is nothing new in Colorado. Across college campuses in the state, activists have pushed for schools to rid their endowments of fossil fuels holdings, calls which both the University of Colorado and the University of Denver have resisted due to the steep financial costs it would impose. Now we are seeing the same debate play out in the political sphere, with demands for the state to divest its public pension fund, the Colorado Public Employees’ Retirement Association (PERA).

In order to help better inform this debate, we at Compass Lexecon conducted an economic analysis that examined the cost of divestment to Colorado PERA. We considered two different scenarios –  a narrow divestment approach that included divestment only from coal, oil, and natural gas securities and a broader divestment approach that also included divestment from utilities. Our analysis confirms what basic financial theory implies, that divestment from fossil fuels would result in a substantial shortfall in investment performance for Colorado.

Colorado PERA is currently valued at $43.6 billion. Based on our analysis of 50 years of historical stock market return data, divestment would cost the fund between $36 million and $50 million in foregone returns every year. These costs would add up year over year to significantly reduce the value of the fund. Over 50 years, these costs add up, costing the fund between $470 billion and $646 billion in foregone returns.  In order to make up for these losses, Colorado would be forced to either reduce payouts to pensioners or seek new revenue from taxpayers.

These losses would come at a time when Colorado’s pension is already significantly underfunded.  According to Bloomberg, as of 2016, Colorado was in a position to fund only 46 percent of future payments to retirees.  This means that Colorado will have to come up with additional funds in order to meet its pension obligations, and given this shortfall, Colorado should consider whether it would be wise to deprive the fund of even more funds by divesting from fossil fuels.

The Colorado state legislature just passed a bill to help restore PERA funding and pay off the steep shortfalls over a period of 30 years, and it won’t be easy.  The legislation will cut the cost-of-living raises for retirees, and increase the amount that employees and government agencies contribute from each paycheck. Most public sector workers will be required to increase their individual contributions by two percentage points to about 10 percent of overall pay, while public agencies will also increase contributions on top of the 20 percent of an employee’s salary they already pay. While taxes won’t be raised immediately under the agreement, the state is set to contribute $225 million annually to paying down unfunded liabilities. At a time when the Colorado state legislature has recognized the need to address its pension funding problem, divestment would only serve to make the problem worse, and would place additional burden on public sector workers beyond those in this bill.

Our study only examined the divestment costs associated with lost diversification – focusing on the first principle of investing, that a broadly diversified portfolio generates higher risk-adjusted returns than does a narrower portfolio.  However, there are additional costs associated with divestment that should be recognized: First, the fund can expect to pay transaction costs from selling fossil fuel holdings and replacing them with other securities.  Second, there will also be ongoing compliance costs to maintain the fund’s adherence to the new fossil-free investment policy, as there is no consensus by any means of what constitutes a “fossil fuel” investment and what does not. Therefore, the true, cumulative, cost of divesting for Colorado PERA will be even higher than what is estimated in our report.

While many people support divestment with an intention of improving the environment, it’s important to recognize that academic studies have shown it is largely a symbolic gesture that will have no tangible impact on the environment or the targeted companies. Divestment simply changes the ownership of securities from those who divest to those without a divestment mandate. In addition, company stock prices are unaffected by divestment because a lower price would just result in a buying opportunity for other investors.  As a result, divestment does not deprive companies of capital or halt the consumption of fossil fuels – and therefore does not achieve any environmental impact.

Fossil fuel divestment is not an issue that should be taken lightly. It carries significant financial implications and will cost Colorado and PERA recipients tens of millions of dollars annually and hundreds of billions of dollars in the long-run. Given the precarious state of Colorado’s pension fund, divestment would only exacerbate the situation and cause further financial injury to the pensioners who depend on the fund for payments and to the taxpayers who help support it.