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Seeing Through the Bubble

Ethical investment groups have recently been hailing ExxonMobil for its willingness to formally report on the climate risks to its business model. We suspect they are less enthused about the actual report, which largely demolishes the arguments the advocates have put forward.

The carbon bubble hypothesis is based on the idea that fossil fuel assets will be stranded because at some point fossil fuels will become unsalable. The advocates point to a number of studies which have estimated how much fossil fuel can be burned to stay within the 2 degree target “world leaders agreed to” at Copenhagen. This “budget” is, they argue, much less than is held in the books of the fossil fuel companies.  Ergo, the companies are over-valued and everyone should steer clear and regulators should assess what to do about a systemic risk.  Ingenious but somewhat out of touch with reality.

First, “world leaders” have shown no sign of taking action commensurate with the 2 degree target. Second, the private oil and gas companies carry relatively few years’ production cover in their reserves  – Exxon’s is 16 years, one of the highest – and there is no credible forecast which shows even an absolute reduction in the total use of fossil fuels over such time periods. Third, if action is taken, it is not going to be in the form of banning the production or use of such fuels (major producers like Russia, not to mention OPEC, would have strong views, for example) since among other things such rationing and the inevitable price escalation would also threaten growth in developing countries. Much more likely is the wider imposition of regulatory or legislative cost penalties in richer countries to discourage the use of fossil fuels over time. So prudent companies ought to be testing their new investments against the possibility of carbon penalties. All the big oils do this, as was noted in some media coverage earlier this year.

We wonder if the campaigners will now turn their focus to the coal companies, where reserve coverage of production is much higher (40 years+ is not uncommon), often dependent on continued Federal government blessing (for reserves on Federal lands), and, to our knowledge, no one is testing their current assets or new projects against carbon price risks. There are many fewer investors to warn off, and the corporate targets are less iconic, but there is a much more real and immediate issue.

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