Home > Ecological economics > Are fossil-based assets overvalued?

Are fossil-based assets overvalued?

Among the more fascinating books I had the pleasure to read lately is 2052-A Global Forecast for the Next Forty Years by Jorgen Randers.

In this work, which is conceived as a report to the Club of Rome and a follow-up study to the famous Limits to Growth of 1972, Randers describes what he believes to be the major trends to shape the global future of the next forty years and presents a quantitative analysis based on a global forecast model.

One of the predictions that called my attention is that fossil-based assets, e.g. share prices in companies that produce and sell fossil-based energy, would suddenly lose their value. This would be a consequence from the fact that fossil-energy companies are priced based on the reserves of fossil fuels they control. This pricing does not take into account that in the coming decades demand for fossil fuels will decline due to their substitution by renewable energy and the limits to CO2 emissions imposed by climate change, hence the shares are overpriced (see p. 343 of 2052).

Randers states that he would “agree with the analysts that it will take time before this realization dawns on the investors”.

All the more interesting is an article Unburnable fuel published in this week’s edition of The Economist. The article compares the amount of proven reserves of fossil-fuel companies with the amount that still could be burnt without exceeding the limit of a 2°C increase in global temperatures and concludes that a substantial part of those reserves might never be allowed to be used.

Based on figures from a (not publicly available) report by HSBC Global Research, the value of reserves that would be unusable if policies to limit the rise in temperatures to 2°C would be implemented amounts to around 2% of the market capitalisation of Shell, around 6% for Total and BP, and over 16% for Statoil.

Finally, the article argues that markets are not adequately taking into account the risk of a devaluation of the fossil-based assets. At the same time, by failing to design an effective policy framework to limit global warming, policy makers are also not seen to take into account the risks of climate change.

Now, it will be interesting to see whether, to which extent and when investors start taking into account the low future value of fossil fuel reserves, and how strong the effect on share prices of fossil fuel companies will be.

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