Can opinions be stronger than reality?
Investors aren't fleeing fossil fuel assets as one might expect. The reason, some scientists suspect, is belief that keeping values high may prevent governments from taking strong action on climate.
A couple of months ago, I noticed an interesting study in the journal Nature Climate Change looking at investments in fossil fuel assets. It asked a fairly simple question. Are investors valuing these assets in a reasonable way? Or, are they valuing them too highly? The answer the study gave was unexpected and puzzling. To be honest, I’m still working to fully understand it, even though I eventually wrote a short article about the paper.
I think the work highlights a bizarre area where human opinions may be able to exert considerable force over the nature of reality. If that sounds weird, and it should, here’s the background.
Stranded Assets
Because the consequences of global warming will be so severe, and we’ve reached a critical point in its emergence, it’s now widely accepted that humanity’s greenhouse gas emissions must be drastically reduced in the near future. We need to phase out fossil fuels, and turn to greener energy. Hence, investments in fossil fuels and all the associated capital equipment linked to their use ought to be on the way to becoming “stranded assets,” in the terminology first used by then Governor of the Bank of England Mark Carney.
Sooner or later, and we hope sooner, such assets will lose their value as they simply cannot be used — anyone holding them will be sorry they didn’t sell them off sooner. Obviously, this could be a good thing, as the process of assets becoming stranded should put pressure on investors to turn away from them. So, there should be less investment in the capital equipment needed for drilling for oil, processing it, transporting it, and so on, and the industry should begin to fall away.
In theory.
Now, the study I mentioned just looked to see if investors are acting as expected. Are they coming to move away from fossil fuels, and value them less? Using available data on fossil fuel holdings, this study — led by economist Gregor Semieniuk of the University of London — compared the total current value of these assets to the value they should have if investors’ expectations were moving in a consistent way to account for the emissions reductions required by several common scenarios for fossil fuel phase out. In other words, are investors leaving these assets at the rate expected by rational investors looking at government plans for addressing climate change. The answer they found is — very much NO.
Rather, the present value of oil and gas assets that ought by now to be stranded, and therefore essentially worthless, still exceeds US$1 trillion. These assets are being held by a large number of private investors in OECD countries. To get an idea of how much this is, the researchers estimate that this value is roughly twice that of the risk exposure which led to the banking collapse and financial crisis of 2007-2008.
So, investors aren’t fleeing fossil fuels as they really ought to be if the great plans to solve the climate problem were really proceeding as expected. What’s going on? There are several possibilities, some more disturbing than others.
Buoyant opinions
When I first read this study, and understood its findings, it actually didn’t seem so surprising. I just thought, well, of course, investors just really don’t believe that governments will follow through with significant actions. They don’t believe that emissions will be reduced, not as rapidly as claimed, at least, and so they don’t really think these assets are going to end up being stranded. They just don’t believe the idea of “stranded assets,” at least not yet.
And who could blame them, right? After all, for all the widespread talk of emissions reductions, after all the studies looking at various scenarios for how we might reduce emissions gradually and still keep temperatures within 2.0C above pre-industrial times, action so far hasn’t been impressive. Apart from the COVID era, when economic activity plunged due to measures to stop viral spread, emissions have been going up every year. Why should investors act as if they were falling?
Maybe, I thought, if world leaders finally get their act together, take serious action, and actually reduce emissions several years in a row, investors may take note. They’ll wake up, say, ok, now it is time to dump these assets and move into something else.
This idea, to me, seemed pretty obvious. But I then asked Gregor Semieniuk about his interpretation of the study’s findings, and he suggested a very different view. Acting to keep fossil fuel valuations high, he suggested, may actually be a strategy to keep the world on a path of high emissions, by making it too painful for governments to move away toward greener energy sources. It seems like a way to lose a lot of money, but it might be something else altogether. Here’s his logic.
If investors keep fossil fuel valuations inflated, then that is likely to have some impact on markets. If enough people think fossil fuels are still a good investment — and doubt that stranding is happening — they’re likely to go on making further investments. If enough investors get involved, if fossil-fuel interests manage to build a coalition large enough, then any aggressive move away from fossil fuels might be perceived by both governments and the public as too painful to be feasible.
And there’s more too. If investors continue to pour into fossil fuels, fewer people will have invested in green energy alternatives, which will then have the backing of a weaker lobby. In the end, we would all just go on using fossil fuels at rates incompatible with climate change mitigation regardless of the increasingly dreadful consequences emerging around us.
Not long after discussing this with Semieniuk, I attended a conference in Venice which involved a number of young scientists, especially many computer scientists. They were all working on ways to make the internet and social media more socially beneficial. People with really selfless attitudes, working hard to make the world a better place. Someone asked me what I had been writing about recently, and I mentioned this paper, and Semieniuk’s interpretation, and I will never forget the look of horror of one young computer scientist. She clearly found it almost impossible to comprehend that someone might act this way. I felt bad for even mentioning the idea.
Unfortunately, I think the idea makes a lot more sense than one might initially think. High valuations create expectations that can easily become self-fulfilling, letting governments get away with doing nothing – often the most convenient and least-painful course of action for political leaders — if politicians can be convinced that declining fossil fuel demand will lead to lost elections or social unrest.
As Semieniuk said to me, “What is expected today and happens based on today’s expectations can influence what’s feasible in the future.”