Science and the stock market: Investors' recognition of unburnable carbon

What is it about?

Investors in U.S. oil and gas companies are not particularly worried about the effect on the value of their investment following media coverage and concern about a potential carbon asset stock price bubble that could cripple the industry. Investors in U.S. oil and gas companies, which include Anadarko – a company undertaking significant exploration in New Zealand- have furthermore not ignored the science when considering whether the potential carbon asset stock prices constitute a bubble, a concern raised in recent media reports. We found instead that investors’ rational expectations for future cash flows are based on all possible scenarios, not just particular negative ones that crop up in the media. Many are saying that the reason why these stocks continue to remain largely unaffected by these scary predictions is because investors don’t understand the carbon bubble and investors could get stranded. But our study suggests investors aren’t that naïve and they hold a different, more positive view. We found that there was limited negative impact on stock prices of fossil-fuel companies following 88 stories from 59 print media outlets, most in 2012 and 2013, and an initial story in 2009 published in the scientific journal Nature. These scientific disclosures, reported widely in the media, found that only a fraction of the world’s oil, gas, and coal reserves could be emitted if global warming by 2050 is not to exceed 2 degrees Celsius above pre-industrial levels. Subsequent media stories suggested that the value of burnable carbon reserves held by big oil and gas companies could diminish rapidly as alternative energy resources replace fossil fuels. We found that U.S. oil and gas stock prices dropped about 2 percent after the original 2009 story in Nature (a total value of $27 billion) – a comparatively small reaction, considering the value of the company. Researchers then concluded that ensuing widespread coverage in other media had little impact on these U.S. oil and gas companies’ stock prices, which dipped by a half percent collectively. Our finding suggests some commentators may be overstating the effect of unburnable carbon on the value of oil and gas investments.

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Why is it important?

Under a scenario offered by former Vice President Al Gore and others, climate change regulations could force fossil-fuel companies to leave large reserves of oil, gas, and coal in the ground untouched in order for the world to avoid global warming. The companies’ oil and gas reserves, which are a large component of their assets and market value, could be stranded as “unburnable” and potentially worthless. We found instead that investors’ rational expectations for future cash flows are based on all possible scenarios, not just particular negative ones that crop up in the media. It’s essential that the media and commentators reported by the media interpret accurately the meaning of results from science. I believe that several possibilities might help understand the limited market response to the science information. Investors might feel that carbon capture might play an important role to reduce emissions; also that tax incentives / costs could be created to mitigate the cost of change for oil and gas companies. Carbon stranding, however, may still occur in cases of the less clean alternatives, such as coal. We note that they cannot rule out the possibility of a carbon bubble. Drastic action by governments and regulators such as a prohibition on fossil fuel production on a global basis, or the imposition of a very strict cap on global carbon emissions within the framework of a workable carbon market, might be two such long-tail events that could burst a possible bubble.