Popping the Carbon Bubble

Last week in Oslo, Marius Holm of the ZERO Foundation presented a report that I co-wrote this summer along with a number of environmental and financial professionals making the case for fossil fuel divestment in Norway’s government pension fund, a portfolio so large that it dwarfs the size of all American university endowments combined. Many of the arguments were specific to Norway, which, as one of the largest producers of oil and gas in the world, is ill-advised to double down on its exposure to shifts within the fossil energy industry. As a fund that already has in place the type of Environmental, Social, and Governance (ESG) criteria for investment missing from Middlebury’s endowment, the debate in Norway is not over whether divestment is an appropriate tool for creating change, but rather how far that tool should be extended. While Middlebury would be well advised to lead the way by creating similar investment screens, even in the absence of concerns about endowment ethics the arguments for divestment in Norway can inform the ongoing debate on this campus.

Over the past six months, many market analysts have revised their predictions for future oil prices from around $110 per barrel to down into the $80 to $90 range. A number of factors are driving this downward trend — increased efficiency of automobiles, uncertainty over future regulations and a Chinese economy far more overleveraged than that of the United States prior to the financial crisis. All of these factors contribute to falling oil demand, which in a world of abundant oil supply means that prices must soon begin to fall.

At lower prices, many of the types of tar sands, ultra-deepwater and shale oil projects currently under development would fail to earn back their investment capital. Any regulatory action that limits carbon dioxide emissions will inevitably require some of these reserves — which have already been factored into the share value of oil companies — to remain in the ground. Expectations about reserves have a significant effect on the share price of fossil fuel companies. When Shell reduced its estimated reserves by 20 percent in January 2004, its share price plunged by 10 percent in a single week. These concerns recently led a large group of investors representing over $100 billion in assets managed by companies that include Boston Common Asset Management and Storebrand Asset Management to issue a call that Norwegian Oil Company Statoil withdraw from tar sands extraction.

World Financial Markets – and, by proxy, the Middlebury College Endowment – are being inflated by a looming Carbon bubble. If you accept that there is a scant one-in-four chance that the world will meet the IEA’s targets to limit global warming to two degrees Celsius, the expected value of the endowment’s position in fossil energy equities is already ten percent inflated.  The loss of value if climate change is defeated would be forty percent, which would affect the College’s ability to pay employees, undergo capital projects and award financial aid to deserving students.

The College Administration and Trustees no doubt have faith that, as professional investment managers, Investure will be able to anticipate the shift in fossil energy share prices before they actually arrive. But that poses a significant risk to the endowment – a risk that we would do well to avoid. When financial markets adjust to reflect the changing reality of fossil fuel use, the adjustment will not be smooth or gradual. It will come suddenly and leave those too slow to act with heavy losses. For some of the market, it already has. After an energy speech by President Obama that pledged increased regulation of power plants and an end to international development aid for non-Carbon Capture and Storage (CCS) coal plants, the shares of coal companies including Peabody Energy and Walter Energy took dives of 3.4 and 10.4 percent respectively, adding to a year in which Peabody Energy has lost half its value and Walter Energy has lost three quarters. The Stowe Global Coal index, which lists coal-producing companies, fell the same day to its lowest level since the 2009 financial crisis. Utilities across Europe have similarly plunged unexpectedly in response to competition from renewable energy.

To be bullish on the future of the fossil fuel industry is the rough equivalent of a bullish outlook on the nuclear industry sometime after the alarm bells went off at Three Mile Island or after the wave headed for Fukushima. It is comparable to a bet on CFC-producing companies sometime between the discovery of the massive hole in the Ozone layer and the ratification of the Montreal protocol, or a bet on fax machines after the invention of the Internet. Coal and oil powered the 19th and 20th centuries. Their glory days are past. To bet on their future is to bet either against the future of humanity or against the overwhelming judgment of science.