Sticky tar of climate politics oozes over oil reserve valuations
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Environmentalist ideology and political ambition in combination make for a dangerous blend, and nowhere is that truth clearer than in the context of climate politics, the valuation of fossil-fuel reserves and accusations of “fraud.” 

With the deregulatory decisions of the Trump administration, in particular in the context of a severe prospective reduction in federal efforts to control emissions of greenhouse gases (GHG), various pressure groups and state officials have stepped up to the challenge, or the political opportunity, depending on your viewpoint.

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This dynamic has taken two related forms. First, there is the effort by the environmental left to induce or force divestment in fossil fuel companies, in substantial part on the grounds that international climate policies — i.e., limits on the emissions of greenhouse gases — will lead to a dramatic reduction in the use of fossil fuels over time and the decline in value of reserves in the ground. 

 

Accordingly, the current valuations published by companies are not to be believed. Note that the published valuations are largely irrelevant in terms of market behavior, as distinct from the demands of green-eyeshade accounting minutia, because no one should believe that the investment community fails to recognize that changes in prices yield up-and-down movements in the quantity of reserves that can be produced profitably.

Second, where political allies go, politicians follow, exercising their powers, both legitimate and not, to punish their enemies and reward their friends. If fossil-fuel producers “know” that climate change is a crisis, and that fossil-fuel use will be severely limited, and thus that much current reserves will not be produced, then their failure to announce these purported realities amounts to “fraud.” 

So, we have entered a world in which the ideological imperatives of the environmentalists dovetail nicely with the political ambitions of a number of politicians. One prominent example of such politicized legal maneuverings is offered by New York Attorney General Eric Schneiderman, hot on the trail of fossil fuel firms generally and oil and gas companies, like Exxon Mobil, in particular. 

Have they misled investors about the risks of anthropogenic climate change, the international policies to address it and, thus, the future value of their oil and gas assets? (Any such question asked by Mr. Schneiderman is purely rhetorical.) As day follows night, the bureaucracy has gotten into the act: The Securities and Exchange Commission “is investigating how Exxon Mobil Corp. values its assets in a world of increasing climate-change regulations…”

Again, the market is not stupid, regardless of the condescending view of political elites. Even if future climate policies are not mentioned at all in a financial disclosure statement, no one can believe that marginal investors fail to take such possibilities into account. More broadly, the price today is the best estimate of the price tomorrow, while the expected price tomorrow determines the price today. 

If a severe reduction in future production of fossil fuels were a realistic probability, we would expect to observe the attendant price crash now, not merely in some future year. Moreover, efforts to change estimates of proven reserves with every price shift obviously would be an administrative nightmare and would reduce the usefulness of such estimates from the viewpoint of the investing community.

There is the further matter that the premise that fossil-fuel producers somehow “know” what the future policy responses might be is preposterous. The much-ballyhooed Paris 21st Conference of the Parties (COP-21) agreement simply lumps together the plans submitted by the individual governments (the intended Nationally Determined Contributions). 

Any given “commitment” may or may not represent actual future emissions reductions. For example, the Chinese commitment is for an emissions peak “around 2030,” after which…well, what precisely? And how high will that “peak” be? More generally, many of the INDCs promise GHG reductions relative to a “business as usual” scenario, that is, relative to a future emissions path, unconstrained by any policies at all. 

Such a commitment can be “achieved” by overestimating future annual economic growth — and thus emissions — by a small amount over the commitment period; when growth proves slower than projected, so will emissions. Commitment fulfilled!

Continuing on the notion that international climate policies will force the future demand for fossil fuels to decline and collapse the economic value of current reserves: Current world oil consumption and production are around 98 million barrels per day. The International Energy Agency projects global consumption over 103 mmbd by 2040, despite some dubious assumptions. 

The projection from the Energy Information Administration is almost 121 mmbd by 2040. Will Schneiderman attempt to prosecute the IEA and EIA on the grounds that they are enabling “massive securities fraud” by fossil fuel producers?

I betray no secret when I report that Schneiderman has ambitions for the New York governorship. So, it is hardly a surprise that he would undertake actions currying favor with important interest groups and wealthy donors. That these groups and donors are the heavy-hitters in the mainstream environmentalist community generally, and the climate campaign in particular is no surprise and no accident.  

Schneiderman is just the most prominent of the prosecutors who have decided to use the climate/reserves valuation/”fraud” gambit as a vehicle in pursuit of higher office. That attorneys general, who, after all, are prosecutors, would play political games rather than simply enforce the law is distressing, but unsurprising in that they are elected and allowed to run for higher office, a reality that creates perverse incentives and attracts individuals with rather unattractive characteristics.

But what of the SEC, supposedly “scrupulously non-partisan [and] independent of political influence”?  What the “securities fraud” campaign illustrates is the reality that the bureaucracy is not merely a disinterested group of truth-seekers devoid of any agenda of its own, but instead is an interest group, with both ideological and budget-maximization incentives to expand its purview. 

The larger implication of the “securities fraud” argument on fossil fuel reserves is simple — someone must watch the watchers, the age-old problem of government power in a constitutional republic. Even if this is fine to you because you don't like the oil industry, you’ll like the government a good deal less when it comes after you.

 

Benjamin Zycher is the John G. Searle Chair and a resident scholar at the American Enterprise Institute (AEI), where he works on energy and environmental policy. 


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