Fossil-Fuel Crash and Fiduciary Responsibility: Head for the Exit

There was dot-com crash.  Then there was housing crash.  Now we can see fossil-fuel crash on the horizon.  Which investors will suffer biggest losses in the fossil-fuel crash? 

Fossil-fuel crash is the coming correction in valuation of fossil fuel assets.  Fossil fuel assets, held by coal companies, petroleum companies, governments, and their investors are valued based on the assumption that those assets will be sold for consumption to produce energy.  Scientific consensus and casual observation indicates that using those fossil fuels to produce energy as in the past will have dire consequences due to global warming.  Fossil-fuel crash is the result of the realization that curtailing carbon emission to mitigate global warming means fossil fuel assets are currently over-valued.  With the strengthening of forces to curtail carbon emissions, fossil fuel assets are likely grossly overvalued.  

Building on scientific consensus and casual observation about the need to manage climate change, these forces are driving the reduction in carbon emissions:

• Political – Activism on the part of political constituencies working to stop climate change and protect the environment
• Legal – Legal proceedings to collect compensation from the fossil fuel industry for past damages caused by fossil fuels and prevent future damages
• Social – Growing social acceptance and pressure to move to lifestyles with reduced dependence on fossil fuels
• Competition – Improvements in the economic performance of non-fossil-fuel sources of energy
• Conservation – Improved efficiencies and reduced consumption will have a dampening effect on growth in demand for energy

The valuation of fossil fuel assets is based on a revenue stream that stretches from now to the end of the carbon-energy-era.   With the acceleration of measures to curtail carbon emissions, expectations for that revenue stream should be revised in two ways.  First, the revenue stream should be revised downward.  Second, the end of the revenue stream should be revised to occur sooner.  Both of these revisions will have the effect of reducing the value of fossil fuel assets.

Investment boards and investment managers have a responsibility to protect and grow portfolios.  Holdings in those portfolios that are valued based on fossil fuel related revenue are due for a correction.  Those with responsibility to protect investment portfolios have a duty to assess the risk, and manage portfolio strategy accordingly.  

Since fossil fuels are a finite resource, at some point fossil-fuel-based assets will cease to be a part of investment portfolios.  For those with investment responsibility, the question is not whether to exit, but when to exit investments in fossil fuels.  In the past, new fossil fuel discoveries have driven increased valuations, but management of carbon emissions means that more fossil fuel discoveries no longer means a bigger or longer revenue stream.   Rather than being constrained by supply of fossil fuels, revenue will increasingly be constrained by political, legal, social, competitive, and conservation forces driving reduced carbon emissions.  The forces to curtail carbon emissions are gaining momentum, and will gain more momentum as global warming progresses.

 

On the one hand, the forces dragging fossil fuel valuations are growing in strength.  On the other hand, the global reserves of fossil fuel are finite.    It’s unclear which investors will suffer greatest losses in the fossil fuel crash, but the ones to the exit first have least to worry about.