Is the investment world making a mistake in its valuation of companies holding significant quantities of fossil fuels? Former Vice President Al Gore and his partner David Blood have been making the rounds to argue that case. Their position is summarized in an opinion piece published in the October 29, 2013, Wall Street Journal.
Underpinning Gore and Blood’s argument is the contention that, while the market is valuing companies based on their proven reserves of fossil fuels, much of that inventory will not be used. A vast amount of it will be “stranded assets” that never generate the anticipated revenue. If that notion proves correct, the current valuations assigned to those companies are far too high. In their article, Gore and Blood liken that overvaluation to a bubble.
The former vice president (and Nobel Laureate) is adamant that his view must be correct. While investors assume these oil and natural gas assets will eventually be produced, sold, and burned, Gore takes a completely opposite view. He has stated that “they are not going to be burned. They cannot be burned and will not be burned. No more than one-third can ever possibly be burned without destroying the future.”
It is not surprising that various voices have arisen from the financial community in opposition to Gore and Blood. Typical is this piece in Forbes and this one written by Matthew DiLallo.
I believe his critics are misunderstanding Gore’s point. His argument, as I understand it, is not about morality, market forces, or even man’s ultimate decision to take the wiser path. Rather, it is a matter of science and logic. The former vice president is simply pointing out that it is impossible for humans to burn all the existing fossil fuel.
An analogy can be found in our old high school chemistry notes about the process of fermentation:
With unlimited sugar, the alcohol level increases during fermentation until it reaches a concentration between 12-18%. Levels of alcohol above 18 or 19% are usually toxic to the yeast and leads to the death of the cells. This tolerance limit laces an upper value on the % of alcohol produced solely by fermentation.
A destructive part of the process increases until it begins to kill off a necessary player.
Imagine a twelve-foot deep swimming pool with a man standing at the bottom. He is gripping a valve located at the deepest part of the pool. As long as he squeezes hard on a handle, water pours in to fill the pool up. But if he releases pressure on the valve handle the water ceases to flow in. Is it not fair to say that the pool will never be completely filled? As the water reaches a level that submerges the man, he will let go of the valve to swim to the surface. Or, if he is particularly stubborn and foolish, he will tie himself to the bottom and continue to squeeze the handle until he drowns. At that point, though, his corpse will release its grip and the flow will stop.
Although horrible to contemplate, it is surely true that oil consumption in New York will drop dramatically when the city is submerged under sea water.
I think our friends from the world of finance and investments have missed the larger point that Gore and Blood are trying to make. There will come a point at which the self-destruction involved with the excessive burning of fossil fuels will necessarily become a self-limiting factor. Even if financial markets currently say otherwise.