The Hidden Risk: Negative Price Momentum

Fossil fuel companies are becoming uneconomical and higher-risk investments

This trend is driven by the dynamic combination of the growing and still-unknown extent of climate change, the emergence of a strong and vocal social movement, and an accelerating renewable energy industry. The future of fossil fuels is full of complex, volatile risks and the flow of investor money is already reacting.

carbon-300x291A potential result of the change in money flow is negative price momentum. Climate-change-driven restrictions on fossil fuel use are expected to diminish the valuation of fossil fuel reserves and initiate a negative multiplier effect, beyond that of fundamental risk. Such a scenario would be expensive for investors.

The devaluation of stranded assets

Current business models are incompatible with the pledge by the world’s governments to tackle global warming.[1] Up to 80% of proven fossil fuel reserves will have to stay in the ground, effectively “stranding” the assets already committed to recovering them.[2] Carbon taxes and cap-and-trade systems are also making fossil fuels increasingly uneconomical to burn.

Investor behaviour & negative price momentum

Uncertainty around future renewable energy policy also contributes to financial instability for fossil fuel investments. Social demand is increasingly leading to new policy decisions aimed at mitigating climate change. New regulations and incentives accelerate the flow of funds to more sustainable forms of energy production and drive down the already depressed fossil fuel valuations.

We see a type of negative feedback loop feeding negative price momentum. The uncertainty of stranded assets causes a devaluation of reserves, and that devaluation fosters reactionary and constrictive policies that further hurt the fossil fuel industry.

Uneconomical and high risk—time to divest?

[1] Damian Carrington, “World’s biggest sovereign wealth fund dumps dozens of coal companies,” The, February 5, 2015.

[2] Fossil Fuels: Exploring the Stranded Assets Debate, Towers Watson, 2014, 3.