Plunging oil prices have punished energy stocks, and new measures to combat climate change could now present another underappreciated threat...
The proven reserves of oil and gas are a common metric that helps determine their stock price and overall market value, with the presumption being that an oil company may be able to access 100% of its reserves, over time, as long as it can profitably sell that oil given market prices. The more reserves a company has, the more valuable it is, and big drillers such as Exxon Mobil (XOM) deliberately seek new reserves as one way to boost their value. As oil prices go higher, drillers also have more incentive to find new reserves, and vice versa.
But oil firms may not be able to access all the reserves they claim, especially if many countries adopt new limits on carbon emissions, as seems likely following a new agreement last year among 195 nations to address climate change. “There’s carbon in the ground that might never be burned because of new agreements,” Matthew Weatherly-White, CEO of investing firm Caprock Group, tells Yahoo Finance in the video above. “If some portion of known reserves cannot actually be produced, it’s going to lead to really interesting repricing. There will be risk that could lead to lawsuits.”
Exxon has researched climate change for decades, including the possible effects it might have on Exxon’s own business. The New York attorney general is investigating whether Exxon committed fraud by downplaying the risks of climate change publicly even though its own private research demonstrated more concern.
Under current regulations, Exxon and other oil companies are not required to disclose research they conduct on climate change, or even assess the risks climate change might pose to their business. But there’s growing pressure on the SEC to change its rules and require energy firms to be more forthcoming. If the SEC were to decide that climate change could pose “material” risks to oil companies, they’d be required to disclose what they think those risks are, just as companies must disclose other types of material risk that could affect profitability and stock prices.
Exxon’s latest annual filing with the SEC makes a general reference to climate change, saying new rules on carbon emissions “could make our products more expensive, lengthen project implementation times, and reduce demand for hydrocarbons, as well as shift hydrocarbon demand toward relatively lower-carbon sources such as natural gas.” But Exxon provides no specifics.
The future of proven reserves
The company’s prior research on climate change was surprisingly detailed. As early as the late 1970s, Exxon was conducting cutting-edge research on climate change and how it might affect business. If Exxon were assessing risks the same way today—as, arguably, it should be—it would be reasonable for the company to examine whether its reserves might be overvalued. Exxon, the world’s biggest oil company, declared proven oil reserves of 8.1 billion barrels at the end of 2015, about 9% more than the prior year. At current prices, that’s about $380 billion worth of oil.
But what if Exxon will never be able to produce some of that oil? Many countries seem likely to adopt taxes on carbon emissions or other rules meant to discourage the use of fossil fuels and encourage cleaner alternatives. If stringent and widespread enough, such measures could effectively cap carbon emissions at a level considerably lower than the total amount of proven oil reserves, rendering some portion of reserves inaccessible. If Exxon or any oil company had to write off a portion of reserves, the company’s value would decline, perhaps by a lot.
If oil companies were forced to assess and quantify this sort of risk publicly, it could roil share prices throughout the industry. “The price discovery mechanism would be in a tailspin for a period of time as the market sorts it out,” Weatherly-White says. He places the odds of such a scenario playing out at 50% or better during the next three years or so.
Investors have already discounted Big Oil producers, with shares of Exxon, Chevron (CVX), BP (BP) and ConocoPhillips (COP) all down more than 10% during the last two years. Plunging oil prices are responsible for much of that decline, but investors also understand that the need to address climate change and a growing focus on renewable energy could harm oil profits over time. At the same time, some investors expect Big Oil share prices to rebound as global economic growth picks up and consumers burn more oil. Perhaps they should reassess.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.
original story HERE