What do tulip bulbs, dot.com companies and real estate have in common?
All have been fodder for speculative bubbles that have famously burst, leaving unhappy investors in the lurch, and governments with the costly job of mopping up the mess inflicted on the economy.
Some people believe that our sizable investment in fossil fuel reserves - coal, oil, and natural gas - and the companies that develop them, is another bubble in the making.
Carbon bubble
These pundits, often longstanding fossil fuel critics, have coined the term 'carbon bubble' to dramatize their argument which rests on two assumptions about future demand for fossil fuels:
- First, the world has no choice but to leave two thirds of known fossil fuel reserves in the ground to avoid the worst effects of climate change.
- Second, carbon taxes and regulated usage restrictions will reduce consumption and this will also hit the value of the reserves.
Carbon bubble proponents claim that the world’s financial markets, by continuing to invest in fossil fuel energy production, have failed to take into account the certainty of diminishing demand for fossil fuels and therefore are overvaluing hydrocarbon assets.
Fossil fuel divestment
This line of thinking has been promoted aggressively in North America by environmental groups that are lobbying financial institutions and their shareholders.
It is also the underlying rationale for a number of campus divestment campaigns. Modeled on the South Africa apartheid disinvestment movement of the 1980s, students are being rallied to demand that college endowment funds sell off shares in fossil fuel energy firms.
So, are the 169 billion barrels of oil reserves located in the oil sands really overvalued?
The oil sands industry certainly doesn’t share this view. It is successfully using capital raised in world financial markets to invest heavily in developing the oil sands resource (PDF). It seems to us that the main reason for this continued investment is current and projected high demand for fossil fuels. Though far from perfect, fossil fuels are a superior option to many alternative sources, or combination of sources, when it comes to providing flexible and dense energy for transportation and electricity production.
The markets seemingly also understand the world’s population is expected to grow to 9 billion people. Much of this growth will happen in developing countries seeking to improve their standard of living through access to affordable energy.
It’s a cold, hard fact that developing and consuming fossil fuels generates greenhouse gas (GHG) emissions. Oil sands development, in particular, is associated with higher GHGs than conventional oil production.
The oil sands industry has made progress in reducing GHGs over the years, and efforts are underway to achieve further reductions in the future.
True value
The simplistic carbon bubble argument fails to recognize how societies deal with technological and economic challenges. As an oil sheik once famously said, the Stone Age did not end because the world ran out of stones. The costly carbon capture and storage approach for preventing GHG emissions, for example, would become much more attractive in a world of rising fuel costs and carbon taxes.
Fossil fuels aren’t the type of assets that would typically drive an investment bubble since their pricing is primarily based on real value and not market speculation. Unlike tulip bulbs, pets.com or Florida swampland, oil, coal and gas deliver real, tangible benefits in a world we can’t imagine without energy.
