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ASSETPRICESANDCLIMATEPOLICY

FrederickvanderPloeg(UniversityofOxford)ArmonRezai(WUWien)

Outline

• Temperaturetargetsimplyacarbonbudget.• Moststudieshavefocusedonamountofnaturalassetslocked-up.Reservesofbigoilandgascompaniesaremuchbigger(notcountingstatecompanies).• Whatarethefinancialimplicationsofclimatepolicy• Risksofstrandedfossil-fuelassets?Shorttheoilandgasmajors?• Risksforotherfinancialassets?• Risksforfossil-fuel-dependentsovereigncountries?Racetoburnthelasttonofcarbon?

StrandedAssets

• Assetsthatundergounanticipateddropsinprofitabilityandvaluation(andbecomeliabilities?)• Fossil-fuelbasedindustries• Mostimportantthreats:• Climatepolicy• TechnologicalChange

• Relevanceandmagnitudesubjecttoongoingresearch

TwoSetsofIssues(Dietz,2017)

UnburnableFossilFuel

• Howmuchunburnablecarbonistherereally?

Assumeswewill- asopposedtoshould- adheretoalowcarbonbudget

ValuationofCompanies

• Whyarefossilfuelassets(over-)valued?

SensitivetothedesignandtimingofpolicyLinkbetweenstrandedassetsandcompanyvaluationsisdifficult

Oneslideoftheory

• Theemissionofgreenhousegasesistheworld‘slargestnegativeexternality(Stern,2007).• Internalizingthisexternalitycreatesasurplus(‘efficiencygains’)whichisupforgrabs.• Mostofthebenefitsaccruetofuturegenerations.• Economicbenefits(e.g.lessdamage)mightbecapitalizedandvisibleintoday’sprices(earlierpresentationstoday).• While,inaggregate,climatepolicyisbeneficial,ownersofcertainassetclasseswillundoubtedlylose.

Carbonbudgetsandclimatetargets• Recentclimateresearcharguesthattimepathofemissionsdoesnotmatter(much).Peaktemperatureisafunctionofcumulativeemissions.

PT=TCRCExCE

TCRCEisthetransientclimateresponsetocumulativeemissions,CE.• BestestimateforTCRCEis2°C/TtC (=0.002°C/GtC)witha5-95%confidencerangeof1.4-2.5°C/TtC.(Allenetal.,2009):PT=1.2+0.002xCE2017• Ignoringuncertaintyandassumingthat600GtC havebeenburntalready,thecarbonbudgetis400GtC for2°C.• Iftargetis1.5degrees,itisonly150GtC.Onlyfifteenyearsleft.

2°Ctargetandstrandednaturalassets

Implication

Forget“peakoil”!

Keep82%ofcoal,49%ofgas,and33%ofoilunburnt.

Reserves3xandresources10xthecarbonbudget.

InMiddleEast260billionbarrelsofoilcannotbeburnt.Regional

distributiondubious.(McGlade andEkins,2015)

Thecarbonbubble

Strandedphysical capitalinthepowerindustry• Pfeifferetal.(2016)definethe“2°Ccapitalstock”astheglobalstockofinfrastructurewhich,ifoperatedtotheendofitsnormaleconomiclifetime,implieswarmingof2°Cormore(with50%probability).• UsingIPCCcarbonbudgetsandtheAR5scenario,theyshowthatthe“2°Ccapitalstock”willbereachedin2017evenwhenothersectordotheirshareofstayingbelow2oC.Hence,nonewemittinginfrastructurecanbebuiltanymoreunlessotherinfrastructureisscrappedorretrofittedwithCCS!• Pfeifferetal.(2017)showthatkeepingwarmingbelow1.5°Ccutsutilisationofcoal-firedelectricityupto2050from60to29%.

“Newwindandsolargenerationcostsfallbelowexistingcoalplants”

FT8/11/2018

Source:IPCC(2012),Renewable EnergySourcesandClimateMitigation,SRREN.Available at:https://www.ipcc.ch/report/srren/

Source:CarbonTrackerInitiative(2015),LostinTransition:Howtheenergysectorismissingpotentialdemanddestruction,S.4.Availableat: https://www.carbontracker.org/reports/lost_in_transition/

Whydoassetsgetstranded?

• (1)imperfectlyanticipatedclimatepolicyand(2)irreversibilityoforcostsforadjustinginvestmentindirtycapitalstocks.• Adjustmentcosts:intertemporalorintra-sectoral.• Strandedassetsimplyscrappingofdirtycapitalanddiscretecrashinthesharepricesofcarbon-basedindustries.Hence,theso-called“carbonbubble”.• Wefocusatexploration(andexploitation)investmentsbytheoil,gasandcoalindustry,andtheneedtolockupcarboninthecrustoftheearth(Pindyck,1978).

FocusonInternationalCarbonCompanies:optimaldiscoveries,explorationanddepletion

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ExtractionandValuation:1st and2nd bestpoliciesExtraction of oil and gas (GtC/yr) Market Valuation of the oil and gas industry ($T)

ExtractionandValuation:‘risk’oftippingintopolicyExtraction of oil and gas (GtC/yr) Market Valuation of the oil and gas industry ($T)

Financialmarkets

• CarbonTrackerInitiative(2011)suggests20-30%ofthemarketcapitalisationofthestockexchangesofLondon,SanPaolo,Moscow,AustraliaandTorontoisfossilfuelbased.• Bansaletal.(2016)userealmarketdataintheU.S.toestimatethenegativeimpactoflong-runshiftsintemperatureonshareprices.• Anderssonetal.(2016)arguethatthecostofhedgingagainsttheriskofclimatepolicysuddenlybeingtoughenedwithcarbon-freetrackersisnowverysmallindeedasthemarketisnotanticipatingit.Dothisbyinvestingincarbon-freetrackerindices(e.g.,MCCC).

Systemicrisks

Source:Battiston,S.,Mandel,A.,Monasterolo,I.,Schütze,F.,&Visentin,G.,(2017),Aclimatestress-testofthefinancialsystem, NatureClimateChange, 7(4),283.Availableat:https://www.nature.com/articles/nclimate3255

Sovereignrisks

• Oilandgasexporters(Russia,Algeria,Venezuela,Nigeria,NorwayandBrazil)havebeenhitbycrashinworldoilprice.• NorwayhasmanagedbydippinginitshugeSWFandmanagedtomitigatetheirdepreciationoftheircurrency.• Nigeriaandothershavehadhugedepreciations,highbudgetdeficits,lossofforeignreservesandinflation.Russiadidlessbad,sinceitdidabigonceandforalldepreciationoftheRuble.• Still,thesecountriessufferiftheycommittoParisCOP-21astheyhavestrandedcarbonassets.• Russiancannotburn20%ofoiland60%ofgasreservesinviewofCOP-21,soRussia’sbudgetarypolicieswillbeevenmoreunsustainableandmoretighteningoffiscalstanceisrequired- afurther1%-pointofGDPontopofwhatisneededtodealwithsustainedloweroilprices.

CountryRisks

Source:IMF(2015), LearningtoLivewithCheaperOilAmidWeakerDemand- RegionalEconomicOutlook:MiddleEastandCentralAsia,January2015Update. Availableat: https://www.imf.org/en/Publications/REO/MECA/Issues/2016/04/05/Learning-to-Live-With-Cheaper-Oil-Amid-Weaker-Demand1

UScoal:acautionary taleColumbiaCenteronGlobalEnergyPolicy(2017)CanCoalMakeaComeback?

“Iactuallythinkthenextdecadeforcoalisgoingtobeoneofthebestdecadeswe’veeverhad.”

SteveLeer,ChairmanofArchCoal,asquotedintheWallStreetJournal,February2011

UScoal:canary inthe coal mine?

4biggest coal companines:

- 52%of production in2011

- $33bnmarket cap in03/2011

- $150mn.market cap in03/2016(- 99.5%in5years)

Spares

Oversightandregulation

• Governorsofcentralbankshavewarnedforcarbonbubblesandfinancialandfiduciaryrisksofholdinglargeinvestmentsinfossilfuel;e.g.,Carney(2015).• Insurancecompaniesandespeciallypensionfundsshouldbeconcernedtoo.• Need2°Cstresstestsforinvestmentportfolios!• Notclearwhichcapitalmarketregulatorsareheldresponsibleforcarbon-relatedsystematicrisksandwhoisresponsibleforensuringthatfullcorporatedisclosureofcarbonriskstakesplace.• FollowSwedenandthedivestmentcampaign?

Intergenerationaleffectsofclimatepolicy

• KarpandRezai(2014)useOLGmodeltoshowthatatradedassetcapitalisesthereturnsfromlimitingfutureglobalwarmingsobenefitcurrent(i.e.,older)generations.• Acarbontaxhurtsthecurrentyoungergenerationsviaerosionofrealwagebutfuturegenerationsbenefit.• Intergenerationalconflictisnotbetweengenerationsaliveatdifferenttimes,butbetweengenerationslivingaliveatthetimethepolicyisimplement.• KarpandRezai(2017)showthatsmallclimatepoliciescanboostwelfareofyoungergenerationstooifEISishighenough,sosomeclimatepolicycanbepoliticallysustained.• Generally,needclimate-debt(Bovenberg andHeijdra,2002)andclimate-pensiondeals(vonBelowetal.,2016).• Newtaskforfinancialindustry.

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Forthcoming RFF-CMCC – EIEE Webinar

“Capital stranding cascades: The impact of decarbonisation on productive asset utilization”

May 9, 2019 – h. 12:00 pm CESTPresenter: Emanuele Campiglio, Vienna University of Economics and Business (WU)Moderator: Francesco Lamperti, Institute of Economics, Scuola Superiore Sant'Anna (Pisa) and RFF‐CMCC European Institute on Economics and the Environment (EIEE), Centro Euro‐ Mediterraneosui Cambiamenti Climatici, Italy