As the year-end Paris climate change summit draws ever nearer, preparatory meetings continue apace and we see a stream of reports and stories arguing how vital it is to come to a binding international agreement to limit carbon dioxide emissions. One of the key arguments is that a large proportion of the proven coal, gas and oil reserves will have to remain in the ground if the world is to stand a fair chance of limiting the rise in average temperatures to 2°C, the level beyond which the effects of climate change are considered to become negative.
The call to put a cap on consumption of fossil fuels has taken campaigners in two interrelated directions. The first is the campaign championed by the Guardian’s outgoing Editor Alan Rusbridger: Keep it in the ground. The second is a drive to encourage divestment from fossil fuel companies. And part of this is the promotion of the ‘carbon bubble’ concept.
The essence of this is that oil and coal companies are overvalued because their shares are priced on the basis of their future profit-making potential from their proven reserves. The logic is that exploitation of all these reserves will be impossible because global climate change policy will force a change. This in turn would leave investors with shares in worthless assets. The most recent manifestation of this comes from a very prominent campaigner indeed: Al Gore slams ‘mass delusion’ fuelling global carbon bubble.
While we should not doubt Gore’s commitment to the cause, it is also clear that he has a strong vested interest in moving investment out of fossil fuels and into renewable energy: he set up Generation Investment Management with former Goldman Sachs executive David Blood, and he was talking at the launch of a white paper by his ‘advocacy initiative’ the Generation Foundation (vision: ‘to strengthen the case for Sustainable Capitalism’). Not that that means we should ignore what he has to say, but climate change campaigners are ever ready to cast aspersions about the motives of those who question the received wisdom.
He draws a parallel with the reckless lending which fuelled the 2008 economic crisis. "During the sub-prime mortgage crisis there was a mass delusion that in the US 7.5 million mortgages given to people who didn't make down-payments and couldn't make monthly payments were going to be good risks. It was absurd. But it is even more absurd to base the value of equities in companies that have these proven reserves on the assumption the stated book value is accurate - it's not. When does it collapse? We have no idea. Will it collapse? Yes, it will. When that realisation takes hold the mass delusion will be punctured and the assets will be stranded."
But this is a deeply flawed argument. If a 25-year mortgage is granted to a person who cannot pay back the loan, there is really no way out short of foreclosure. If this is multiplied by 7.5 million and compounded many times over by complex swapping and sharing of debt which makes it virtually impossible to estimate the real exposure of individual institutions, you have a disaster waiting to happen. And, as we now know, it did happen.
Shares, on the other hand, are freely traded and held by different investors for different reasons. Major pension funds, for example, are generally in for the long haul and want to balance yield and growth prospects against risk. Speculators, on the other hand, look to make a fast buck on the basis of which direction they see the market going in the short term.
However, even the longest term investor bases their decisions on a range of factors, which include management strength, share price and dividend history and future prospects. The reality is that markets are not taking the threat of ‘stranded assets’ and divestment seriously at this stage. Divestment has usually been from organisations adopting a moral stance or under pressure from key stakeholders: the Church of England and the University of Oxford being prime examples.
Markets are not perfect, and bubbles form and burst depressingly often. But that’s usually because of the irrational instinct to follow the herd. It happened with tulips and the South Sea Bubble; more recently we have seen the technology bubble as investors have piled money into companies they barely understand and which have little likelihood of making a profit in the short term. These sectors experience a sudden slump – a painful market correction – before business fundamentals once again take over.
The 2008 crash was different in kind, because the colossal failures in the banking sector not only had an impact across the entire market, but also made people question the entire workings of global capitalism. Possible long-term falls in the intrinsic worth of fossil fuel stocks is simply not in the same league.
The closest parallel to what Al Gore is suggesting will happen is the oil price slump of last year. The price of oil, like that of all commodities, can be very volatile. Since 1970, the price of the benchmark WTI (West Texas Intermediate) has ranged from below $20 a barrel to over $140. The high was in mid-2008, followed by a sharp dip at the time of the economic crisis and then a recovery to around $100 until mid-2014.
High oil prices seemed to be here to stay. The $200 a barrel mark was forecast, and the Peak Oil hypothesis seemed to be proven. Except, as of course we now know, this was followed by a sharp fall to below $50 a barrel, with a modest recovery to today’s price of around $60. Technical developments in recovery of ‘tight’ oil from shale have put America once more towards the top of the oil-producing league, and OPEC has changed its strategy to maintain market share rather than force the price back up.
The shock to the industry has made a difference and perhaps pushed North Sea oil further down the path of terminal decline. But the price drop has not wiped out the US fracking industry, which has generally become a lot more efficient. Whereas supporters of renewable energy saw the apparently inevitable high price of oil as hastening a global version of Germany’s Energiewende, the fall has now prompted the call for divestment and warnings of stranded assets.
But these stories generally don’t make front page news these days (except in the Guardian, circulation now down to 180,000). And investors are clearly not convinced. For each one who wants to divest, there seems to be a willing buyer. Take as an example Exxon Mobil. Its share price peaked at a little over $100 before the oil price fall. In fell to below $84 in March last year, reflecting a realisation that oil was likely to remain relatively cheap for some time to come, but has now made modest gains to $87. This is not a company hit by investor panic.
Talk of a carbon bubble is highly exaggerated. Technological change and market forces will see a change in our energy mix this century, but this won’t be because climate change campaigners are trying to force a top-down change.
Martin Livermore
The Scientific Alliance
St John’s Innovation Centre
Cowley Road
Cambridge CB4 0WS