‘Tech Bubble’… ‘Housing Bubble’… and from the fringes of the media narrative, but well within the discussions of those following sustainability and renewable energy sectors is the ‘Carbon Bubble.’
The Carbon Bubble is, broadly construed, a view based upon the financial premise that the pricing of a stock or commodity is reflective of its value to humankind. However, such a general premise of pricing doesn’t provide all that much insight, but serves as a starting point. Therefore, the next step is to offer that pricing is at least reflective of the inputs necessary to deliver the output… but that only follows if the product is in a stable market of demand. The cost to produce an obsolete piece of technology likely exceeds what consumers are willing to pay, thus a view that the price is reflective of inputs + profit is only contingently true. For example, to build a new Betamax video player is unlikely to deliver you a sale that will recoup your costs… if you can find a buyer at all. Granted, you might find a single buyer for a vintage piece of technology, but unlikely enough that you could build a business off of building more Betamax players.
However, when demand is high and “the market” reflects stable or a future of increasing demand, then there is upward pressure on the net present value of the future cash flows of the product or firm share price. So far so good…
The valuation of energy firms, particularly fossil fuel industries, is based upon two components: 1) Rational net present valuation calculations 2) Irrational exuberance and factors not related to the firm at all.
Both components are generalizations of a multiplicity of considerations. However, I think a reader will be hard pressed to offer sufficient counterfactual information to counter the overall conclusion that significant downward pressure is both amassed and amassing against fossil fuel based energy firms. Rationally, discoveries of fossil fuel natural resources require estimates of the reserves yet to be extracted from the Earth. Secondly, consideration is offered regarding the rate of extraction. As a result financial valuation counterbalances the verified reserves, anticipated market prices, rate of extraction, and capital equipment costs to deliver a value on the find and the future cash flows. This rational approach, if it were all that is transpiring in the markets, would then result in some very stable and low volume trading of energy firm shares. Rational trading of shares would be driven by differing views of the assumptions of future market prices, interest rates, or estimates of the reserves yet to be extracted.
The second aspect, as I termed it ‘irrational exuberance and non firm related factors,’ reflect stock market participants that purchase shares based upon influences that are not the result of financial analysis. The factors are wide ranging and could be anything from a pension fund rebalancing their portfolio to the ‘gut feeling’ of a day trader. One need only remember the 100 billion dollar initial valuation of Facebook’s IPO to get a sense of the irrational exuberance aspect of the market.
Which now brings us back to the Carbon Bubble…
Many of the world’s energy firms are valued based upon fossil fuel reserves that will take many years, or decades, to extract. However, climate science is increasingly warning humankind that we cannot continue to fulfill our energy needs from fossil fuels if we want to have stable climate conditions sufficient for our flourishing. It then follows that much of the reserves that underpin fossil fuel firm valuations are based upon cash flows that will never materialize. Many may find this approach difficult to envision, however, one need only consider that there was likely once a very robust market for whale oil, horse carriages, and landline telephones that all fell victim to disruptive technology. In most cases, an economic argument is generally sufficient to account for the transition from one technology to another. If we simply accept the traditional economic view, then the tipping point for renewables is completely dependent upon their price relativity to the fossil fuel alternatives. The economic view is less persuasive when other factors are at play, such as dwindling supply or human values.
While the economic approach is not incorrect, it fails to account for values and particularly environmental virtues. Traditional economics addresses these shortcomings by offering a view that it is our preferences that are encompassed in market prices as a fix… and this solution fails upon examination. I tend to refer to this ad hoc attempt to salvage the economic view as trying to fit an incorrect puzzle piece into place by grabbing a pair of scissors. Pollution is a negative externality, a cost shifted to society, that the product price does not reflect, such as smokestack emissions or chemical run off. Defenders of the economic view try to salvage their position by stating that taxation is the instrument by which negative externalities are addressed… a view I think most find unconvincing.
Thus far, my waxing on the Carbon Bubble is not exactly offering anything new… Salon offered an excellent piece noting the disruptive devaluation of fossil fuel firms… while The Economist put it bluntly that, “either governments are not serious about climate change or fossil-fuel firms are overvalued.”
My offering here is a view that two significant developments serve as evidence that we have crossed the tipping point. The significance of the tipping point is twofold. First, those with significant resources and power are shifting their assets out of fossil fuels. Secondly, renewables are reaching price parity with fossil fuels… and that is the market price that reflects the direct cost and not the indirect. If the full costs were incorporated into fossil fuels, government tax subsidies, health costs, and pollution clean up, then renewables are already cheaper in both ethical and economic terms.
From Thinkprogress.org‘s Ari Phillips we find an answer to the question posed by the Economist… governments are serious about climate change:
Norway’s Prime Minister Erna Solberg announced plans to invest more of the nation’s $840 billion sovereign wealth fund in renewable energy in an effort to cut greenhouse gas emissions as the country struggles to meet its 2020 climate goals.
The fund invests in listed equities, bonds and real estate, about 10 percent of which is made up of coal, oil and gas investments. The fund is also evaluating whether to exit these investments, as over the last 10 years nuclear weapons producers, companies in-breach of human rights, and tobacco companies have all been excluded.
A sovereign wealth fund, particularly one as large as Norway’s, represents a significant source of market liquidity that could push down the price of the entire fossil fuel industry. Furthermore, this is significant due to the fact that much of Norway’s wealth comes from its fossil fuel reserves. Thus a major player in both the global financial marketplace AND a beneficiary of continued fossil fuel use is moving to exit.
The second story hits closer to home, and particularly from a family that has served as a significant political lobbying force to maintain the fossil fuel status quo… a Koch brother. William Koch, the brother of Charles and David Koch, noted in an interview reported by E&E Publishing, “The coal business in the United States has kind of died,” Koch said during a phone interview Friday, “so we’re out of the coal business now.”
Wait… let that sink in… at least one of the Koch’s has exited coal. While coal is only one of the fossil fuel triumvirate, coal, oil, and natural gas, the development is significant. If the Koch’s are out of coal, then a significant source of lobbying dollars has less incentive to defend coal’s interests.
While William Koch has not indicated any inclinations to become environmentally mindful, the realities of public pressure and market economics for natural gas have converged to hasten the exit of coal from the future energy landscape.
When the moneyed and the powerful head for the exits… we may soon see that Minsky Moment when the less sophisticated investors rapidly follow suit and hasten an asset collapse.
The result is that a wonderful piece out of Theguardian.com, and my favorite novel bit of critical analysis for the week, Deal of the century: buyout the US coal industry for 50bn, may yet be a price tag too high.