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.
