Last week The Guardian reported:
Stock markets are inflating a “carbon bubble” by overvaluing companies that produce fossil fuels and greenhouse gases, and this poses a serious threat to the economy, an influential committee of UK MPs has warned.
The argument being that fossil fuel companies have more oil and coal reserves than can ever be exploited without triggering a climate catastrophe. This also forms the basis for a divestment campaign – in essence the divestment campaign isn’t just some grubby secondary boycott but rather a sensible movement away from overvalued assets.
This type of argument assumes that stock markets are informationally inefficient. Furthermore that investors could earn super-normal returns by following a mechanical trading rule. Not just any old rule, but a well-known well publicised rule – just don’t buy fossil fuel stocks. But that doesn’t sound right – earning a super-normal profit off information and a trading rule that everyone knows? That’s not going to happen – not unless everyone else is irrational. We should always be suspicious of any theory that relies on everyone else being irrational.
A working paper, recently published on the Social Science Research Network, investigates this notion that somehow the stock market is ignoring a carbon bubble – or discounting climate science. A layperson explanation here.
The study examined the stocks of the 63 largest U.S. oil and gas companies that trade on the major U.S. exchanges. Most of them disclosed significant oil and gas reserves in their financial statements. As a result, there was a higher likelihood that these companies’ stock prices might be affected by investors’ perceptions about the consequences of unburnable carbon.
The researchers studied 88 stories from 59 print media outlets, most in 2012 and 2013, and an initial story in 2009 published in the scientific journal Nature. Each story was considered a separate event that could potentially affect stock prices, with researchers measuring the average effect.
U.S. oil and gas stock prices dropped about 2 percent after the original 2009 Nature story (a total value of $27 billion). The ensuing widespread coverage had little impact on the U.S. oil and gas companies’ stock prices, which dipped by a half percent collectively.
So how do they interpret that result?
This small but detectable market response coincident with unburnable carbon news stands in contrast with the prediction of some analysts and commentators of a substantial decline in the shareholder value of fossil fuel firms from stranded carbon (e.g., HSBC 2013). We also find it interesting that one of the most cited environmental science studies in recent years seems to have had only limited sway with energy company investors, at least those who invest in U.S. oil and gas stocks, and regulators tasked with improving company disclosures about the risks of climate change for balance sheet valuations (e.g., SEC 2010).
So it isn’t that the stock market is ignoring the science or news of a carbon bubble – but rather that the market does not value the news as much as environmentalists would like.
The authors speculate why that may be the case:
- Markets may anticipate that carbon capture and sequestration technology may become viable.
- Markets may anticipate that government’s will compensate existing firms for their carbon reserves.
- Markets may anticipate that the oil and gas industry will avoid the carbon bubble but, say, coal won’t.
- The risks of the bubble are not being reported in financial statements and so are not fully priced.
Then finally there is this:
A final possible explanation for the limited stock price impact relates to the effects of potential media bias, which prior work suggests should be small, as energy stocks are largely held by institutional investors, trade in efficient markets, and their prices reflect a wide range of investment strategies with relatively few constraints. Our results are consistent with this view, as they show a small but detectable delayed reaction.
It could be that the media (and environmental activists) are over-hyping the actual risks that are fully priced in the market.