Have Markets Misvalued Energy Companies?
Roger Pielke Jr. and Richard Tol
Writing in the Financial Times (Dec. 9) Lord Stern of Brentford suggests that the financial markets have grossly misjudged the valuation of companies that produce fossil fuels, writing, “the market has either not thought hard enough about the issue or thinks that governments will not do very much.” Stern argues that the misjudgment poses a “risk to the balance sheets of large companies – or to the planet, or both.”
Have markets misvalued energy companies? While markets are of course not perfect, for two reasons we believe that in this instance there is no evidence to suggest that the valuation of fossil fuel producers has been grossly misjudged.
First, let us assume that governments around the world decide to take swift and effective action to reduce emissions. Would this mean that fossil fuel companies would go out of business in the near term? No.
Consider the case of Apple. Apple’s revenues depend upon selling products that will be obsolete within years and historical relics in a generation. That does not stop the company from being among the most highly valued in the world. If the world transitions to carbon free energy supply, the big energy producers of today are likely to play a big role.
Under all scenarios for future energy consumption the world is going to need vastly more energy and – whether governments act to decarbonize or not – vastly different types of energy too. Energy majors are so highly valued not simply because of the fossil fuel reserves they own, but because they have the expertise to supply energy at a massive scale along with a track record of successful and rapid innovation, with the ongoing shale gas and ultradeep oil revolutions as the latest examples.
Second, what if governments fail to deeply cut emissions? Might the impacts of unmitigated climate change lead to a dramatic reduction in the valuation of fossil fuel companies?
According to the work of Nick Stern himself this seems highly unlikely. In his famous review of climate change Stern argued that unmitigated climate change might reduce global GDP by as much as 20% by 2100. Using Stern’s own numbers for the most extreme impacts would mean that instead of growing by 2.5% per year to 2100, GDP would grow by 2.24%, with the largest effects occurring at the end of the century. This hardly seems cause for a dramatic revaluation of fossil fuel companies today.
The impacts estimated by Stern on behalf of the British government are very pessimistic compared to the estimates found in the academic literature. Furthermore, changes in the growth rate of the economy have a muted impact on the growth in energy demand.
Indeed, future demand for energy is largely insensitive to whether governments decide to act on climate change. The more than 1.5 billion people without reliable access to electricity will demand access regardless. A world with unmitigated climate change could in fact be more energy intensive, for instance if more people demand air conditioning. In either case the future for energy companies would be bright.
Humans affect the climate system and it is important for policy makers to respond. But it is unlikely that efforts to second guess the market valuation of energy companies will contribute to such responses. Of course, if Nick Stern really believes that energy companies have been grossly over-valued he could put his money where his convictions lie. Who knows, he may one day be the subject of the sequel to the Big Short.
Roger Pielke Jr. is a professor at the University of Colorado. Richard Tol is a professor at the Economic and Social Research Institute in Dublin and at the Vrije Universiteit in Amsterdam.
21 December 2011
Have Markets Misvalued Energy Companies?
Nicholas Stern had an op-ed in the FT in which he claimed that markets are failing to reflect the risks of aggressive climate policy or climate impacts into the share prices of energy companies. Richard Tol and I submitted a short op-ed in response which was not published, so we publish it here.