The REALLY Big Short: The Jig is Up with Oil Companies

Bill McKibben

[UPDATE October 31, 2013:  Al Gore seems to agree with me that the carbon bubble is the next big thing. Scar(r)y indeed!]

I've been intrigued ever since hearing Bill McKibben talk last year at this time about his article in Rolling Stone (Global Warming's Terrifying New Math: Three simple numbers that add up to global catastrophe - and that make clear who the real enemy is) and the ensuing "Do the Math!" tour -- is it possible that world energy companies (especially including the "big seven") have a "valuation problem"?

The campaign by McKibben and 350.org to get universities (and others) to divest their oil investments seemed to sag in the ensuing months -- in part, I think, because of the analogy that they made to the campaign to divest from South Africa in the '70s*. This new campaign has sounded a bit too much like a morality play and not enough like a financial move.  Let's be clear: it is most decidedly the latter.

I noticed an article in the New York Times a few weeks back (A New Divestment Focus on Campus: Fossil Fuels) that indicated that the the notion of the divestment campaign seems to be getting some attention -- but unfortunately the emphasis is still principally on divestment as a "socially responsible" stance and not enough on the financial fundamentals.

Here's how it seems to me (and Bill): Oil companies are valued by the market based on their reserves. The problem with this approach is that the total reserves claimed by the oil companies is FIVE TIMES what can possibly be burned without driving up the temperature of the atmosphere up by a catastrophic amount and, as McKibben puts it, "breaking the planet." How can the value of oil companies be a function of reserves that can never be used?

I thought that perhaps I (together with Bill) was oversimplifying the situation. A quick Google search, however, confirmed that there are plenty of people who really understand these things who see it the same way. (e.g. Climate News Network, April 19, 2013 - "Fossil fuels ‘risk being wasted assets’"; The Guardian, August 2, 2013 - "This gamble on carbon and the climate could trigger a new financial crisis: There is little evidence that institutional investors have recognised that they are sitting on a carbon-asset timebomb)

Harvard Management Company, Inc.

So, quite apart from any moral stance on owning oil company shares, it seems that, at a minimum, institutions should be seeking to protect themselves from the risk that their investments are - ahem - overvalued, and, at a maximum, seeking to profit from the coming reckoning in energy stocks. Perhaps even a short selling strategy of the sort described by Michael Lewis in The Big Short?

Of course, as Lewis makes clear, one of the difficulties of forging a short strategy is that, no matter how manifest the current wrongheadedness of the market and current valuations, it can still be a devil of a problem to determine when the world at large will wake up and the market will make a massive "correction" (i.e. crash).

But getting it right would sure pay for a lot of dorms and test tubes.

And what's intriguing is that one would think that universities would be in a unique position to pioneer breakthrough theories of valuation of the sort that would be needed to correctly deal with energy stocks in the new era we face.

So I ask: isn't 2013-2014 the year that university investment funds should get the jump on the coming shake-up in energy stocks? Will this be the year of the REALLY "big short"?

*    *   *

* PS - Not that I have anything against campus demonstrations for socially responsible investing . . .

student protesters at Harvard . . .

There were demonstrations like that, full of long-haired kids demanding divestment from South Africa, when I was in college . . .

long-haired radical . . .

In fact, I was one of those long-haired kids demanding divestment from South Africa when I was in college . . . 

:-)







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