Carbon Bubble: Activists' Wishful Thinking?

Does the stock market know something that environmental activists don't?



ExxonMobil and Peabody Energy are in the crosshairs of New York Attorney General Eric Schneiderman, who is accusing them of knowingly failing to warn shareholders of the risks that climate change poses to their businesses. In fact, Schneiderman demanded and secured an agreement from the coal company Peabody Energy to include language in its annual reports noting that future regulatory limits on burning coal as a way to mitigate climate change could impact its bottom line.

The New York attorney general apparently believes in an impending "carbon bubble." This, as the climate change activist group 350.org explains, "is the idea that fossil fuel companies are overvalued because if and when the world ever gets serious about dealing with the climate crisis, the fossil fuel companies won't be able to burn their carbon reserves, from which they derive their value."

This idea can be traced back to an article in the April 30, 2009, issue of Nature. There a group of European researchers calculated, using climate model projections, what limits would have to be placed on future carbon dioxide emissions to keep the planet from warming no more than the internationally agreed upon goal of 2 degrees Celsius. They concluded that "less than half the proven economically recoverable oil, gas and coal reserves can still be emitted up to 2050."

The Nature paper is one of the most cited environmental science studies of recent years. The upshot of the article is that in order to prevent the world from getting too hot, at least half of the hydrocarbon assets owned by energy companies must remained buried in the earth as "unburnable carbon."

Later assessments went further, estimating that as much as 85 percent of proved fossil fuel reserves could eventually be unburnable. If these calculations are true, this information should have a big negative effect on the value of fossil fuel company stocks. In 2013, the HSBC bank issued a report that suggested that policies that aim to lower demand for oil and gas, combined with restrictions that make fossil fuel reserves unburnable, put some 40 to 60 percent of the $4 trillion market capitalization of the world's top 200 energy companies at risk.

A new study in the journal Energy Economics asks "when and whether the stock market might have recognized the potential loss of value to energy company shareholders due to unburnable carbon." They find that there has been a very limited response to the scientific finding that significant portions of fossil fuel companies' reserves are unburnable, and therefore supposedly worthless. Does the stock market know something that environmental activists don't?

To figure out what's going on, the researchers looked at how the 63 largest U.S. oil and gas companies' stocks have fared since the publication of the Nature article in 2009. The researchers also tried to determine the effect media reports of unburnable carbon have had on company valuations. Since oil and gas prices have been on something of a roller coaster in the past decade, the researchers' analysis takes into account such things as fluctuations in the price of oil, company earnings announcements, and varying analyst recommendations as they try to isolate the effect on oil and gas stocks.

What did they find? In the three days around the publication of the Nature article, the companies' average stock price dropped 1.5 to 2 percent. However, a couple of weeks later the prices bounced back and were even higher. After news stories detailing the ruinous consequences of unburnable carbon for energy companies, they found "only a small negative reaction…mostly in the two weeks following their publication."

Overall, the researchers estimate that the warnings about unburnable carbon may have reduced the value of their sample companies from $1.088 billion to 1.061 billion, a 2.48 percent drop. That's nowhere near the HSBC suggestion of a 40 to 60 percent decline in valuations. "This evidence," the researchers conclude, "does not support the predictions of many that recognition of unburnable carbon might prompt a significant and substantial reduction in the shareholder value of fossil fuel firms."

Why aren't investors more spooked? The authors speculate that they may be counting on the development of technologies that would capture and sequester carbon dioxide; that they may expect energy companies to invest in alternative no-carbon technologies; or they may think governments will make energy companies whole through rebates and tax incentives. Maybe so. But I suspect that the researchers get it right when they suggest that investors might "be skeptical about whether the demand for oil can actually be pared back within an economically meaningful horizon, regardless of the need to lessen carbon emissions." For now, most investors evidently believe that forecasts of an impending carbon bubble amount to little more than activists' wishful thinking.

Disclosure: I own 50 or 100 shares (I'm still too lazy to check my statements) of ExxonMobil stock that I bought with my own money. The stock prices is down from $103 in 2014 to $79.40 yesterday.