The magnitude of energy transition risk embedded in fossil fuel company valuations

Abstract

This paper examines ExxonMobil, a widely-followed, mature, large oil and gas producer using discounted cash flow valuation modeling under two scenarios: “Business as usual”; and an adequate climate policy response that would limit warming to 1.5C. The analysis across the last two decades shows the market continues to price in a “business as usual” future. ExxonMobil's overvaluation, relative to an adequate policy response scenario, has increased (pre-pandemic) from 50% to 70% of equity value at risk. Investors are taking significant energy transition risk without meaningful compensation. To avoid continued capital misallocation, negative externalities should be incorporated into underwriting.

Keywords

• Energy transition
• Asset pricing
• Valuation
• Carbon risk
• Climate change