Is There Really a Carbon Bubble?

Al Gore was interviewed by Yahoo Daily Ticker’s Aaron Task today, and said that the oil/gas/carbon industry is experiencing a bubble. While the report notes that Gore is no fan of this industry for obvious ideological reasons,* I wanted to unpack his idea a little more, as it seems to have some merits but ultimately fails as a comparison to some more classic examples of a bubble. If he’s right, it might have some of the major economic impacts as a true bubble would, as three of the top ten companies with the greatest market capitalization are all fossil fuel companies, with much of that capitalization based on their carbon assets. There are surely other obvious connections to this industry in the commodities market, and these sorts of assets likely touch a lot of investment portfolios. So again, I think it’s worth looking at more closely.

Gore’s argument seems to be packaged in two parts:

1) “Bubbles by definition involve a lot of asset owners and investors who don’t see what in retrospect becomes blindingly obvious”

2) We can’t burn that much carbon without destroying the earth. Thus, much of these assets should be discounted/undervalued.

The problem is, if you believe his statements, you need to go and buy carbon assets right away (creating a true carbon bubble, ironically).

Basically, consider what would happen to oil prices if two-thirds of its supply were wiped away in a major accident one day? The price of oil would skyrocket the next day, yet Gore thinks this scarcity would depress their value. While that kind of accident would hurt the long term profitability of some companies, everyone would become filthy rich the next day. Indeed, oil countries often try to limit the supply in order to inflate the price of oil. We’ve done that job for them. And note that this analysis holds true even if we play this out a little more realistically and don’t know exactly when that point of no return for carbon burning is reached- that’s the beauty of pricing assets- they encompass all the information we know about them today, and potentials for major risks etc. In fact, no commodity is traded or priced probably quite so carefully in some ways, and it likely already includes the expected technological breakthroughs down the line limiting its demand (a far more likely scenario at making those assets worthless).

I also criticize his characterization for an entirely different reason though: technology of burning oil itself. Even as we slowly reach the maximum efficiency of an internal combustion engine, I think it’s ludicrous to say that once we give a strong economic incentive, engineers won’t find better and more environmentally friendly ways to use those resources. The pressures just don’t exist today to pursue those efforts strongly.

* A little ad-hominem, but it’s worth noting he stands to gain a lot financially by convincing people to buy less carbon assets and implicitly more alternative-energy.