Open thread: the Carbon Bubble


in Economics, Politics, Science, The environment

Surprisingly, despite the importance placed on it in the University of Toronto fossil fuel divestment brief and in the divestment movement generally, I don’t have a post on the idea of the carbon bubble. If we start with the temperature targets countries have chosen as the upper limit for tolerable climate change, we can calculate that the world’s total fossil fuel reserves are much bigger than necessary to bring us to that target. Hence, if governments achieve their climate change mitigation goals, most of the world’s fossil fuels will need to be left unburned and the profits firms expect to make from them will be unrealized. Under such a scenario, fossil fuel investments will be stranded.

Back in February, The Economist explained:

Yet amid the clamour is a single, jarring truth. Demand for oil is rising and the energy industry, in America and globally, is planning multi-trillion-dollar investments to satisfy it. No firm embodies this strategy better than ExxonMobil, the giant that rivals admire and green activists love to hate. As our briefing explains, it plans to pump 25% more oil and gas in 2025 than in 2017. If the rest of the industry pursues even modest growth, the consequence for the climate could be disastrous.

ExxonMobil shows that the market cannot solve climate change by itself. Muscular government action is needed. Contrary to the fears of many Republicans (and hopes of some Democrats), that need not involve a bloated role for the state.

According to ExxonMobil, global oil and gas demand will rise by 13% by 2030. All of the majors, not just ExxonMobil, are expected to expand their output. Far from mothballing all their gasfields and gushers, the industry is investing in upstream projects from Texan shale to high-tech deep-water wells. Oil companies, directly and through trade groups, lobby against measures that would limit emissions. The trouble is that, according to an assessment by the IPCC, an intergovernmental climate-science body, oil and gas production needs to fall by about 20% by 2030 and by about 55% by 2050, in order to stop the Earth’s temperature rising by more than 1.5°C above its pre-industrial level.

If accepted, this argument torpedoes the idea that sticking with fossil fuels is a path to prosperity while turning away from them to fight climate change is an economic sacrifice. If we’re really going to make the transition, the people who kept investing in fossil fuels until the end will have the most to lose.

{ 5 comments… read them below or add one }

. July 18, 2019 at 3:23 pm

ExxonMobil’s biggest risk appears to be a world where oil demand peaks as measures to combat emissions grow, and then prices fall. Projects might become uneconomic sooner than expected, stranding the company’s assets. Mr Woods says he is backing projects with low costs. He argues that his firm’s unusually high level of integration of its various businesses and technology means it can produce more efficiently than its peers. Take oil extracted in the Permian basin of Texas. ExxonMobil uses data analysis to drill for oil using extra-long wells, then transports it to company refineries and petrochemical plants nearby.

Concern is growing among investors, however. In 2017, 62% of ExxonMobil’s shareholders voted to require the company to disclose how action to limit temperature rises to 2ºC would affect its business. ExxonMobil produced a document that critics charged was too vague. This year shareholders will vote on a new resolution, filed by the pension funds for New York state and the Church of England, to require ExxonMobil to do what Shell has done and commit to reducing emissions not just from its operations but also from the products it sells.

. July 18, 2019 at 3:50 pm

Reforming energy markets

Climate change is far too complex to lend itself to an easy solution. Your case study of Exxon Mobil does indeed show that “the market cannot solve climate change by itself” and “muscular government action is needed” (“Crude awakening”, February 9th). But the hard fact is that both markets and governments fail to reflect climate-change risks, which explain the failure in slowing global warming. Without a global agreement for an effective, market-based framework for the taxing of carbon at an appropriately high level, no serious and sustainable dent can be made in greenhouse-gas emissions. This alone has doomed the Paris agreement to be a toothless deal. No wonder that coal’s share in the global energy mix keeps growing.

Only forceful policies can alter the behaviour of the energy markets, which do not reflect that fossil-fuel firms are overvalued and may become stranded assets. These firms do not even sense the long-term risk of sitting on vast volumes of unburnable carbon reserves, which is a carbon bubble. These companies continue to develop reserves that would never be used with effective climate policies in place. They are rewarded by the markets for finding and developing new reserves. There is no noticeable exit from heavy emission-producing activities in anticipation of the possible introduction of a biting carbon tax. Unless this energy-market behaviour is dealt with, the vision of a carbon-free future will remain just that, a vision.

Istvan Dobozi
Former lead energy economist at the World Bank
Gaithersburg, Maryland

Shale (or fracking) explains much of the boom in the oil market, as well as the volatile market performance of energy companies. Production increases are occurring at the same time that profitability is declining. In 1980, 29% of the Standard & Poor’s 500 index was occupied by oil and gas; today it is 5%. Fracking has flooded the market with cheap gas, pushing prices down further. Investors seduced by the promise of increased profits are being left at the altar of derivatives standing in for real economic growth.

You claim that energy companies that rely on fossil fuels are merely “responding to incentives set by society”. But oil and gas companies with their deep pockets continue to enjoy the privileges of a bygone era with the false promises of jobs and business expansion that have yet to materialise.

The fact is that last year, oil and gas stocks placed last on the s&p 500. Money managers who continue to invest looking nostalgically backwards ignore this at their own (and their beneficiaries’) peril.

Tom Sanzillo
Director of finance
Institute for Energy Economics and Financial Analysis

I take exception to the suggestion that oil companies are merely responding to incentives and are thus not “evil”. When you know how serious the consequences are; when you knew decades ago of the severity of climate change and covered it up; when, knowing all that, you just follow “incentives”—that’s pretty evil. And when you maintain a political propaganda operation to lie about the problem and protect those incentives, that’s pretty evil, too.

Sheldon Whitehouse
Senator for Rhode Island
Newport, Rhode Island

Unfortunately, a tax on carbon is regressive given that poorer families pay a higher proportion of their income on energy, especially those in rural areas who must drive long distances. The remedy you propose, to offset carbon revenues with tax cuts, is also regressive. It will reward those with high incomes who pay higher taxes. A simpler approach is to rebate all revenues as a carbon dividend with the same amount to every person. That should appeal to France’s gilets jaunes and similar protest groups in other countries whose support is needed if we are to adopt a saner climate-change policy.

Max Henrion
Los Gatos, California

. July 18, 2019 at 5:10 pm

It would help if more financial firms joined this category. But of the many financiers with “big manly voice” on the climate, plenty turn again, as does the Bard’s sixth age, to “childish treble, pipes and whistles in his sound” when it comes to allocating capital. As Mr Singhi from Dalmia Cement says, banks are loth to support projects like carbon storage because they take a short-term view and fear low returns. And even though many savers have long horizons, their fund managers only look three to five years ahead.

. May 22, 2020 at 4:57 pm

Moreover, fossil-free funds have turned out to be an even better investment than many investors expected. Since the financial crisis over a decade ago, the energy sector has fallen to its lowest share of the S&P 500 since the 1990s. Index funds without fossil fuel investments have outperformed those with fossil fuel companies in their portfolio over the past five years, according to the Institute for Energy Economics and Financial Analysis (IEEFA).

. August 13, 2020 at 2:02 pm

At the same moment, we had some of the clearest signs of the climate battle turning. On August 4th, BP became the first oil supermajor to begin abandoning its business model: it announced that it would cut oil and gas production by forty per cent over the next decade, and dramatically increase its investments in low-carbon technology. There are plenty of caveats in the pledge, but, essentially, BP capitulated to years of activist protest; to the challenge of cheap, clean renewable energy; and to the destruction of demand that came with coronavirus. The American giants—Exxon and Chevron—still have political cover from the Trump Administration, but even they are grappling with reality. On August 5th, Exxon conceded that it might have to wipe a fifth of its reserves off its books by year’s end—investments in places like Canada’s tar sands that are too expensive to be profitable at today’s prices. There’s clearly no growth coming: Exxon’s share price now depends on it paying a reliable dividend. To keep doing so, the company is taking extreme measures, like ending the match it pays its employees for their 401(k)s. The fire sale is under way.

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