The unintended market consequences of SEC-promoted decarbonization will be profound.
The unintended market consequences of SEC-promoted decarbonization will be profound.
I t is a good time to review what the Biden administration promised to do about energy policy. Back in 2021, President Biden and VP Harris promised a “whole-of-government” approach to such policy. And they’ve delivered, to the detriment of the nation and with no meaningful impact on global energy production or climate change. The administration has mobilized a phalanx of federal regulatory agencies to pass new rules aimed at both destroying U.S. demand and constricting future domestic production of hydrocarbons.
Leading the charge, the Environmental Protection Agency (EPA) has set stringent new emissions standards to eliminate coal- and natural-gas-fired power plants from the U.S. generation mix and depress the supply of internal-combustion-engine vehicles in the marketplace. The EPA has also levied a new methane tax — the first carbon (equivalent) tax to be implemented in the U.S. — on energy companies.
The Bureau of Land Management within the Department of the Interior has cut back sharply on both offshore and onshore oil and gas leasing on public lands, while also raising bonding costs and royalty rates for the industry. The Department of Energy has paused export-permit approvals for new liquefied-natural-gas (LNG) plants until it considers the global climate-change implications of additional U.S. LNG production.
Even the U.S. Fish & Wildlife Service has gotten into the act by adding the southern lesser-prairie chicken and the dunes sagebrush lizard to the endangered-species list. Since both obscure species are indigenous to the Permian Basin straddling West Texas and New Mexico, such designations risk constraining drilling activity in the most prolific oil and gas basin in the country.
Now financial regulators are joining the battle. In March 2024, the Securities and Exchange Commission (SEC) finalized new climate-disclosure rules that will require most public U.S. corporations to report in detail all the climate-related physical and transition risks faced by their businesses, along with the size of the carbon footprint of their operations.
Rather than simply improving disclosure for investors, the new SEC rules are designed to discourage investment in the traditional energy sector, mainly by highlighting the outsize regulatory, litigation, contingent liability, and reputational risks now facing the industry due to government climate policies. In this way, the SEC rules will catalyze the other anti-fossil-fuel regulations passed by the Biden administration by providing another legal avenue for litigious environmental activists to sue energy companies.
As the country’s top financial regulator sees it, the only way for companies to adequately manage and mitigate their exposure to “climate transition risks” is by reducing their greenhouse-gas emissions. For hydrocarbon producers, this is not possible short of going out of business, leaving divestment as the only option for investors.
The obvious effect of the SEC’s climate rules will be to redirect capital away from fossil fuels and other carbon-emitting industries, thereby co-opting the private sector into the climate fight. The clean-energy transition will cost trillions of dollars to implement — far outstripping the funding resources of the public sector — so it requires commandeering the investment flows of financial markets. Even though investment dollars have been flowing freely to government-subsidized renewable-energy projects for the past several years, this will not achieve the government’s climate targets. Defunding crude-oil, natural-gas, and coal companies to curtail domestic hydrocarbon supply is a logical next step.
Indeed, starving fossil-fuel companies of the capital needed for business growth is arguably a simple but elegant way to rein in American energy production, since the government-directed dirty work occurs in the opaque world of finance, well beyond the view of the American public. Importantly, the main defunding of fossil fuels will take place not in public-equity markets where retail investors are active but rather in the less transparent institutional credit markets. Bank loans and corporate bonds are the main source of liquidity for most companies and the cheapest source of capital. The SEC’s new disclosure rules will ratchet up borrowing costs for traditional energy companies to increasingly prohibitive levels. Targeted, carbon-based discrimination will soon become the norm for banks, insurance companies, pension funds, and asset managers.
By wading into matters of energy and economic policy that are constitutionally left to Congress, the SEC’s climate-disclosure rules clearly exceed the agency’s statutory purview and its mission “to protect investors, maintain fair, orderly, and efficient markets, and promote capital formation.” If the SEC’s new rules survive legal challenge and are ultimately implemented, the great irony will be that rather than protecting investors and reducing overall market risk, they will have the exact opposite effect by reinforcing a new form of systemic risk for the U.S. financial markets: decarbonization.
Contrary to the SEC’s regulatory view, cutting greenhouse-gas emissions will not create long-term financial value for the corporate sector as a whole or lead to improved portfolio returns for investors. At a macro level, there is no empirical proof that economic development can be decoupled from emissions or fossil fuels; in fact, the past 200 years of human history indicate that it can’t. Indeed, the current efforts of developing nations to grow their economies rest on crude oil, natural gas, and especially coal, not on wind farms and solar panels and the like. To be sure, that could change in time, but trying to force it to change with aggressive net-zero policies will result only in unreliable power grids, higher electricity and energy prices, a diminished manufacturing sector, and anemic U.S. economic growth. In turn, such a challenging macroeconomic outlook will translate into weaker U.S. corporate fundamentals and credit ratings, elevated bankruptcy and default rates, and increased volatility, all of which will have negative implications for financial markets. Investors will be left with fewer choices, portfolios will become less diversified, and market bets will become increasingly concentrated, resulting in sharper price swings when investor sentiment changes.
These unintended market consequences of SEC-promoted decarbonization will be profound.