The Looming Fossil Fuel Crash

In 2018's It Isn't About The Technology I wrote about Charlie Stross' concept that corporations are "Slow AIs":

Stross uses the Paperclip Maximizer thought experiment to discuss how the goal of these "slow AIs", which is to maximize profit growth, makes them a threat to humanity. The myth is that these genius tech billionaire CEOs are "in charge", decision makers. But in reality, their decisions are tightly constrained by the logic embedded in their profit growth maximizing "slow AIs".

Below the fold, I apply this insight to the impact of climate change on "the market".

In It Isn't About The Technology I illustrated the problem from personal experience:

In the late 80s I foresaw a bleak future for Sun Microsystems. Its profits were based on two key pieces of intellectual property, the SPARC architecture and the Solaris operating system. In each case they had a competitor (Intel and Microsoft) whose strategy was to make owning that kind of IP too expensive for Sun to compete. I came up with a strategy for Sun to undergo a radical transformation into something analogous to a combination of Canonical and an App Store. I spent years promoting and prototyping this idea within Sun.

One of the reasons I have great respect for Scott McNealy is that he gave me, an engineer talking about business, a very fair hearing before rejecting the idea, saying "Its too risky to do with a Fortune 100 company". Another way of saying this is "too big to pivot to a new, more “sustainable” business model". In the terms set by Sun's "slow AI" Scott was right and I was wrong. Sun was taken over by Oracle in 2009; their "slow AI" had no answer for the problems I identified two decades earlier. But in those two decades Sun made its shareholders unbelievable amounts of money.

David Shuckman reports for the BBC that:

At the moment, projections suggest that even with recent pledges to cut emissions of greenhouse gases, the world is on course to heat up by up to 3C.

To limit warming to 1.5°C, huge amounts of fossil fuels need to go unused by Doug Johnson explains the problem facing the "Slow AIs" of fossil fuel companies:

According to the new research, nearly 60 percent of existing oil and fossil methane gas and 90 percent of global coal reserves need to go unused through at least 2050—and this action would only yield a 50 percent chance of limiting global warming to 1.5ºC. These reductions mean that many fossil fuel projects around the world, both planned and existing, would need to be halted. Further, oil and gas production needs to decline by 3 percent every year until 2050. This also means that most regions in the world need to reach their peak production now or within the next decade.

The article is based upon Unextractable fossil fuels in a 1.5 °C world by Dan Welsby et al from University College, London. In other words, the fossil fuel companies need to take two decisions in the near future:

• To ramp down their production at 3%/yr.
• To abandon the development plans for the majority of their reserves.

The problem their "Slow AIs" face is that their stock market valuations are based upon their profits, which would be reduced by the -3% ramp, and their assets, the reserves that should not be developed.

For their long-term survival these companies need to "pivot" to more sustainable businesses, for example renewable energy, accepting the short-term hit to their stock price. But this is precisely the kind of decision that corporate "Slow AIs" cannot take. Two examples of their reaction are:

• Geoff Dembecki's CEOs Who Called for Climate Action Now Scrambling to Block Climate Action recounts Pat Gelsinger's "road to Damascus" moment:
  

  Sheltering at home in California with his family, Gelsinger watched a nearby wildfire spew smoke and ash and turn the sky orange. Never before had society experienced crises at this scale, he realized, a “global triple threat” of climate chaos, racial inequality, and an out-of-control pandemic. Gelsinger, who is now CEO of Intel, felt a moral duty to get the climate emergency under control while bridging social divisions.

  But Intel's "Slow AI" disagreed with the new CEO:
  

  “Make no mistake, these policies are a step backward for the U.S. economy that will harm all Americans,” reads a statement earlier this month from the Business Roundtable, a lobby group that Gelsinger belongs to along with top executives at corporations like Apple, Microsoft, BlackRock, and Disney. The Roundtable is reportedly waging “a significant, multifaceted campaign” costing potentially millions of dollars to defeat the corporate tax hikes which would help fund and make possible Biden’s Build Back Better plan — even as its individual members say there is nothing more important than stabilizing greenhouse gas emissions.

  Intel's "Slow AI" explained why it over-ruled the CEO:
  

  A spokesperson for Intel said in a statement to Rolling Stone that “we believe climate change is a serious environmental, economic, and social challenge.” The statement explained that while groups like the Roundtable might not align with the company “100 percent on every topic,” Intel believes “the overall benefits of our membership in these organizations outweighs our differences on some issues.”

• Coral Davenport's This Powerful Democrat Linked to Fossil Fuels Will Craft the U.S. Climate Plan describes the effect of this lobbying:
  

  Joe Manchin, the powerful West Virginia Democrat who chairs the Senate energy panel and earned half a million dollars last year from coal production, is preparing to remake President Biden’s climate legislation in a way that tosses a lifeline to the fossil fuel industry — despite urgent calls from scientists that countries need to quickly pivot away from coal, gas and oil to avoid a climate catastrophe.

If the fossil fuel "Slow AIs" had taken the long view and accepted a gradual but substantial decrease in their profits and stock price then the effects on the broader market would have been manageable. A gradual accumulation of events such as Climate Change: Update on Harvard Action:

For some time now, Harvard Management Company (HMC) has been reducing its exposure to fossil fuels. As we reported last February, HMC has no direct investments in companies that explore for or develop further reserves of fossil fuels. Moreover, HMC does not intend to make such investments in the future. Given the need to decarbonize the economy and our responsibility as fiduciaries to make long-term investment decisions that support our teaching and research mission, we do not believe such investments are prudent.

and other financial institutions following suit will depress fossil fuel stock prices, but not enough to avoid others seeing this as an investment opportunity. But, with statements like The Saudi Prince of Oil Prices Vows to Drill ‘Every Last Molecule’, that isn't what the "Slow AIs" are going to do.

So, one of two things is going to happen. Either the world is going to head for 3°C and society collapses, in which case the "Slow AIs" profits, stock prices and reserve assets are irrelevant. Or there will be a discontinuous drop in their stock prices and bond ratings as they are forced to cut production and restate the value of their reserves.

Although it is 6 years since fossil fuel companies were counted in the top ten most valuable companies, as a group they are still very large. For example, as I write BP, Chevron, ConocoPhillips, Exxon Mobil, PetroChina, Royal Dutch Shell and Total Energy are together worth $1.1T, or a bit more than Facebook.

Assuming society doesn't collapse, here are three reasons why the stock price and bond ratings of the fossil fuel industry will crash:

• The world cannot indefinitely absorb the externalities of their operation. Peter Coy's New York Times op-ed ‘The Most Important Number You’ve Never Heard Of’ reports on The Social Cost of Carbon: Advances in Long-Term Probabilistic Projections of Population, GDP, Emissions, and Discount Rates by Rennert et al, which describes a sophisticated model for the "social cost of carbon", i.e. the externalities of the fossil fuel industry:
  

  But with certain plausible assumptions, the model spits out a social cost of carbon of $56 a ton on average at a 3 percent discount rate, and $171 a ton on average at a 2 percent discount rate. The 2 percent figure is more in line with the relevant current interest rates
  ...
  It’s terrible news for the planet and humanity if greenhouse gas emissions create $171 in damages per ton. (Keep in mind that burning 113 gallons of gasoline is enough to generate a ton of carbon dioxide or the equivalent in other greenhouse gases, according to the Environmental Protection Agency, so that would be a cost to the planet of more than $1 per gallon consumed.) The higher figure implies that even very costly measures to reduce emissions should be implemented immediately.

• The competitors to fossil fuels are already cheaper and their advantage is increasing. Empirically grounded technology forecasts and the energy transition by Way et al shows that:
  

  The prices of fossil fuels such as coal, oil and gas are volatile, but after adjusting for inflation, prices now are very similar to what they were 140 years ago, and there is no obvious long range trend. In contrast, for several decades the costs of solar photovoltaics (PV), wind, and batteries have dropped (roughly) exponentially at a rate near 10% per year. The cost of solar PV has decreased by more than three orders of magnitude since its first commercial use in 1958.

  and that:
  

  if solar photovoltaics, wind, batteries and hydrogen electrolyzers continue to follow their current exponentially increasing deployment trends for another decade, we achieve a near-net-zero emissions energy system within twenty-five years. In contrast, a slower transition (which involves deployment growth trends that are lower than current rates) is more expensive and a nuclear driven transition is far more expensive.

• Fossil fuels are massively subsidized at taxpayer expense:
  

  Conservative estimates put U.S. direct subsidies to the fossil fuel industry at roughly $20 billion per year; with 20 percent currently allocated to coal and 80 percent to natural gas and crude oil. European Union subsidies are estimated to total 55 billion euros annually.

  Between the US and the EU that's $84B/yr, and they're not the only ones.

The fossil fuel industry can't stave off all of these indefinitely, but they are clearly going to try to postpone the inevitable. The result will be to magnify the eventual crash. The crash will thus be big enough to crash the stocks of related industries. How much have the banks lent to the fossil fuel industries and their suppliers, for example?

Update 20^th October 2021

Source

Damian Carrington's Planned fossil fuel output ‘vastly exceeds’ climate limits, says UN supports the argument of this post:

Fossil fuel production planned by the world’s governments “vastly exceeds” the limit needed to keep the rise in global heating to 1.5C and avoid the worst impacts of the climate crisis, a UN report has found.

Despite increasing pledges of action from many nations, governments have not yet made plans to wind down fossil fuel production, the report said. The gap between planned extraction of coal, oil and gas and safe limits remains as large as in 2019, when the UN first reported on the issue. The UN secretary general, António Guterres, called the disparity “stark”.

The report, produced by the UN Environment Programme (Unep) and other researchers, found global production of oil and gas is on track to rise over the next two decades, with coal production projected to fall only slightly. This results in double the fossil fuel production in 2030 that is consistent with a 1.5C rise.

And:

The report also found that countries have directed more than $300bn (£217bn) of new public finance to fossil fuel activities since the beginning of the Covid-19 pandemic, more than that provided for clean energy.