There have been recent claims that the
market value of fossil fuel companies is grossly overstated and about to
collapse (here,
here).
One report went as far as concluding
that this would cause a major economic crisis (here).
Is there a carbon bubble about to blow? Bubbles are being blown, for sure, but
rather by the researchers making up fantastical claims (here). See also this curious we-know-he's-wrong-but-we-don't-want-to-offend-Lord-Brentford piece in the Economist.
Let us consider the causal chain step by
step.
(1)
Climate policy is about to end
the use of fossil fuels, making fossil fuel reserves worthless.
(2)
Fossil fuel reserves are a
major determinant of the value of fossil fuel companies.
(3)
The stock market value of
fossil fuel companies is a major determinant of the business cycle.
The first hypothesis is readily dismantled.
Europe, the self-proclaimed leader in climate policy, has seen a collapse of
the price of carbon dioxide emission permits. Attempts to reform the EU
Emissions Trading System have been blocked by politicians who think that cheap
energy is more important right now. Japan is likely to abandon its emissions
target after this summer’s elections. The Obama administration has ceased to
try and find bipartisan support for climate legislation. China is the only ray
of hope to those who wish for a stringent climate policy. There are persistent
signs that China will regulate emissions before the decade is over, but no sign
that regulations will be particularly stringent.
None of this particularly relevant,
however. The claim is that there is a carbon bubble. That is, the “market” puts
an unjustifiably high value on fossil fuel reserves. Put differently, traders
believe that climate policy will continue to lack ambition for the foreseeable
future, but politicians are secretly plotting to implement a stringent climate
policy soon.
As soon as the “market” expects that new
regulation will seriously devalue an asset, its price drops. Bubbles only arise
if the “market” is misinformed. The “market” is by no means infallible when it
comes to pricing risk, but an expectation of “not much climate policy any time
soon” strikes me entirely realistic.
Refuting the second hypothesis requires
more specific knowledge. The market value of fossil companies is based on a
number of factors, chief among them the expected dividends over the next few
years. The value of a company’s assets in the long term is heavily discounted,
and particularly so in a business as uncertain as energy exploration and
exploitation. Fossil fuel reserves and resources are often owned by states or
state-owned companies rather than by public companies. The supermajors in oil
and gas add value through their expertise in engineering, project management,
and finance, which could be redeployed to other activities in energy and other
areas.
In the unlikely case of unexpectedly
stringent climate policy, sovereigns would be hit. This is one reason why
climate policy will not accelerate much. It is not wise to cause unrest in
Iraq, Iran, Russia, Saudi Arabia or Venezuela.
The third hypothesis ignores basic facts.
Fossil fuel companies are among the largest companies in the world, but their
total market capitalization is small relative to the total stock market. Even
if they were wiped out completely, the world economy would shrug its shoulders and
move on. We have witnessed rapid falls in the stock market value of fossil fuel
companies – of all companies as the oil price fell, or of particular companies
as disaster struck – and we know from those episodes that the economic impact
is limited.
In sum, there is no carbon bubble. If there were a carbon bubble, it would not be about to burst. If it would burst, the economic impact would be minimal.
In sum, there is no carbon bubble. If there were a carbon bubble, it would not be about to burst. If it would burst, the economic impact would be minimal.
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