ExxonMobil Confronts the Carbon Bubble

• Companies and investors are squaring off over the potential impact of government climate policies on asset values, particularly in the fossil fuel industry.

• ExxonMobil gave its shareholders data and assurances of asset resilience under various policies but dismissed the scenario of greatest interest to sustainability investors.

Last fall I devoted a lengthy post to the notion that future policies to address climate change expose investors in companies producing fossil fuels to a potential bubble in asset valuations. So although I am not an ExxonMobil shareholder, I was particularly interested when the company issued a report last month responding to specific shareholder concerns along these lines. Although the term “carbon asset bubble” did not appear in the report, its references to carbon budgets and the risk of stranded assets in a low-carbon scenario were aimed directly at this emerging meme.

Unsurprisingly, ExxonMobil’s management reassured investors that, “none of our hydrocarbon reserves are now or will become ‘stranded’.” Wisely avoiding past tendencies to question interpretations of climate science, their analysis appears to be grounded in mainstream views of climate change. It focuses on the costs and achievability of an extreme low-carbon scenario, and on the resilience of the company’s portfolio under various climate policies.

Exxon's analysis is based on the company’s latest Outlook for Energy, an annual global forecast broadly similar to the main “New Policies” scenario of the International Energy Agency (IEA). It has fewer similarities to the IEA’s “450″ scenario that underpins carbon bubble claims. The company expects energy demand to grow at an average of about 1% annually over the next three decades–faster than population but much slower than the global economy–with increasing efficiency and a gradual shift toward lower-emission energy sources: Gas increases faster than oil and by more BTUs in total, while coal grows for a while longer but then shrinks back to current levels. Renewables grow fastest of all, producing about as much energy in 2040 as nuclear power does today. As a result of these shifts global greenhouse gas (GHG) emissions peak around 2030 and then decline gradually.

That forecast won’t impress those advocating prompt and aggressive changes in the global energy mix to head off serious climate change, but it is not very different from the most recent global forecast of the US government’s Energy Information Administration. If anything, Exxon expects slower growth of energy and emissions than the EIA.

Ultimately, ExxonMobil's argument that it isn’t running outsized carbon asset risks depends heavily on its estimate of the implicit costs of achieving a much deeper and more rapid transition to renewables, compared to its--and others’--forecasts. It gauges this on the intensity of governments’ future climate policies, expressed in terms of their effective cost per ton of CO2 abated, and on the affordability of such measures to energy consumers, especially in the developing world, where emissions are increasing rapidly.

Without directly disputing the technical feasibility of achieving such large and rapid emissions cuts, the company's management essentially questions whether any government would or could impose the extraordinary costs necessary for that to occur. Their proxy estimate of $200/ton of CO2 for such policies is sobering. Even if the sums that would raise were all efficiently recycled by those governments–a heroic assumption–the resulting diversion of investment and increase in energy costs would adversely affect overall economic development.

The sustainable investor groups that raised this issue with ExxonMobil were apparently disappointed with the answer they got. That's not surprising, but having participated in similar exercises at Texaco, Inc., I think ExxonMobil went well beyond the kind of perfunctory reply the investors might have expected. In particular, it has provided enough data to support a more serious dialog with investors on this subject.

For example, Exxon indicated that it “stress tests” its projects and acquisitions at proxy costs of up to $80/ton of CO2, compared to current levels of $8-10/ton in the EU’s Emission Trading System. Implicit in that is the question of whether investors would reasonably expect them to test projects at $200/ton., which would equate to around $100 per average barrel of oil--roughly today's price--based on the nifty “seriatim” chart at the end of the report.

The document also includes information addressing the resiliency of the company’s assets and operations under a lower-carbon future, with their emphasis on natural gas and a global average cost of production under $12 per oil-equivalent-barrel (BOE). Climate policies would have to raise those costs and shrink the associated revenues very significantly to jeopardize current production, nor are low oil prices generally consistent with a low-carbon world. Investments in future production are another matter, though Exxon refers to the IEA’s 450 scenario to demonstrate how much additional oil and gas development would still be required in the next 20 years, even in a world that was determined to constrain global temperature increases to no more than 2°C.

ExxonMobil’s response to investors will not end the debate over the carbon bubble. While providing a lot of information, the company essentially argued that the extreme low-carbon scenario associated with the risks of a carbon bubble is irrelevant, because it can’t be achieved any time soon, irrespective of the risks associated with current emissions levels. That is close to my own view, but it is unlikely to resonate with those who are more focused on the risks of climate change than on the nuts and bolts of what it would take to avert them.

Interestingly, the company’s report on carbon risks was issued on the same day as the latest iteration of the predicted consequences of further warming from the Intergovernmental Panel on Climate Change (IPCC). In a sense each report provides context for the other, so that investors who accept the IPCC’s analysis can weigh the potential costs of global warming against the cost and scale of the changes that would be required to put the world on a crash program to avert the worst climate-change-related outcomes. They can then buy or sell accordingly.

A different version of this posting was previously published on Energy Trends Insider.