Is Avoiding Climate Change Causing a Market Bubble?

By Breanna Hayes

When a person buys stock in a company, they are buying a share of that company’s assets. Therefore, if a company owns $30 million in assets and issues 5 million stock, each stock entitles its owner to $6 worth of equity. When stock is sold, however, the price is not necessarily its worth in equity. Rather, many factors, such as investor enthusiasm may alter the price. If investor’s believe the company will grow, stock may sell higher than its worth in equity. However, a problem arises when stock price increases rapidly, but the assets of the company do not catch up. When assets’ price appreciates beyond its value, a market bubble emerges. Inevitably, the bubble bursts and the price drops.

Some are concerned that energy companies are creating a market bubble. The concern stems from the fact that energy companies value fossil fuel reserves as assets. However, in light of current political and social action regarding climate change, many believe that energy companies will not be able to utilize all fossil fuel reserves. The reserves that go unused will result in a depreciation of assets for energy companies.

Prior to the Paris agreement, nearly 200 countries signed the Cancun Agreement, which embodied an international commitment to keep the global temperature from rising more than two degrees Celsius from pre-industrial levels. The Cancun Agreement additionally acknowledges the possible need to further restrict global warming to 1.5 degrees Celsius. In November 2011, Carbon Tracker Initiative (CTI), a nonprofit think tank, used the Cancun Agreement as a reference point and pioneered the concept of “the Carbon Bubble.”   Relying on the assertion that the world would limit carbon usage within the bounds of the Cancun Agreement, CTI calculated that the world’s energy budge was about one third of what energy companies had in reserves. The other two-thirds would be “stranded assets.” CTI defined stranded assets as;

fossil fuel energy and generation resources which, at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return (i.e. meet the company’s internal rate of return), as a result of changes in the market and regulatory environment associated with the transition to a low-carbon economy.

CTI further calculated, that by 2011, the world had already used a third of its usable energy budget. CTI further asserted that the carbon bubble could pose financial risks to investors. The report states that

The current system of market oversight and regulatory supervision is not adequate to send the required signals to shift capital towards a low carbon economy at the speed or scale required. The current short-term approach of the investment industry leaves asset owners exposed to a portfolio of assets whose value is likely to be seriously impaired.

CTI further criticized the energy industry for continuing to use invested money to explore for more fossil fuel reserves, despite the fact that the reserves already located would exceed the carbon budget.

While the recent election of Donald Trump may impact how “stranded” energy company assets really are. During the Obama Administration, the United States made strides towards greener energy, which included signing the Paris Agreement. The President-Elect Donald Trump has pledged to withdraw from the Paris Agreement and has supported the use of fossil fuels. Therefore, the United States may not provide restricting legislation that would burst the carbon bubble. However, while a pro-fossil fuel administration in the United States may delay the shock, it will still come. The United States is only one of the countries who ratified the Paris Agreement. While fossil fuels may have a market in the United States under a Trump Administration, the global market will still decrease.

For more on this topic, please see the upcoming publication in the Environmental Law Review Syndicate: Our Money is Safe, But the Planet Is Not: How the Carbon Bubble will Cause Havoc for the Environment, but Not the Stock Market.