The Impact of Climate Policy on Oil and Gas Investment: Evidence from Firm-Level Data

The Impact of Climate Policy on Oil and Gas Investment Evidence from Firm-Level Data Christian Bogmans, Andrea Pescatori, Ervin Prifti WP/23/140IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2023 JUN *The authors would like to thank Petya Koeva Brooks, Gita Gopinath, Pierre-Oliver Gourinchas, Rob Hart, Gerard van derMeijden, Marcos Poplawski Ribeiro, Balazs Stadler, Martin Stuermer, and Cees Withagen for their valuable suggestions, andRachel Brasier and Wenchuan Dong for their excellent research assistance. We are particularly grateful to Mehdi BenatiyaAndaloussi for his precious contribution to this work.© 2023 International Monetary Fund WP/23/140IMF Working Paper Research Department The Impact of Climate Policy on Oil and Gas Investment: Evidence from Firm-Level Data Prepared by Christian Bogmans, Andrea Pescatori, Ervin Prifti* Authorized for distribution by Petya Koeva Brooks June 2023 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: Using a text-based firm-level measure of climate policy exposure, we show that climate policies have led to a global decline of 6.5 percent in investment among publicly traded oil and gas companies between 2015 and 2019, with European companies experiencing the most significant impact. Similarly, climate policy uncertainty has also had a negative impact. Results support the Neoclassical investment model, which predicts a pre-emptive cut in investment in reaction to downward shifts in prospective demand, in contrast with the “green paradox” that predicts an increase in current investment to shift production toward the present. JEL Classification Numbers: C2, D2, Q4, Q54 Keywords: Fossil fuel phase out; Paris Agreement; energy transition; DiD Author’s E-Mail Address: apescatori@imf.org; cbogmans@imf.org; eprifti@imf.org WORKING PAPERS The Impact of Climate Policy on Oil and Gas Investment Evidence from Firm-Level Data Prepared by Christian Bogmans, Andrea Pescatori, Ervin Prifti1 1The authors would like to thank Petya Koeva Brooks, Gita Gopinath, Pierre-Oliver Gourinchas, Rob Hart, Gerard van der Meijden, Marcos Poplawski Ribeiro, Balazs Stadler, Martin Stuermer, and Cees Withagen for their valuable suggestions, and Rachel Brasier and Wenchuan Dong for their excellent research assistance. We are particularly grateful to Mehdi Benatiya Andaloussi for his precious contribution to this work. 1 IntroductionA smooth energy transition will require moving away from fossil fuels at a pace that iscommensurate with the adoption of renewable energy. This challenging balancing act iscomplicated by the forward-looking nature of energy investment and the intertemporal di-mension of extraction decisions, both of which make it difficult for companies and investorsto gauge future revenue streams in a potentially radically transformed environment. Thisposes a transition risk that is specific to each company and sector, but that for most oiland gas companies represents a downside (potentially existential) risk—that is, they mayexperience a substantial fall in revenues and in the value oftheir (physical and financial) as-sets (seevan der Ploeg and Rezai(2020) andCampiglio and van der Ploeg(2022)). Thesecompanies are, in fact, highlyexposedto climate transition and changes in climate policies.The current paper, using firm-level data, focuses on understanding the implications of thisexposure for investment by publicly-traded oil and gas firms.We employ firm-level measures of climate policy exposure andclimate policy risk, whichare derived from text analysis conducted bySautner et al.(2023), as sources of plausibleexogenous variation in companies’ investments, which are influenced by both current andexpected climate policies. These measures are based on transcripts of earning calls ofpublicly-listed firms which are analyzed using machine learning and keyword discoveryalgorithms to identify climate change conversations. Theexposuremeasure should capturerevisions in expectations of climate policies and their impact on the firm’s profitability whiletheriskmeasure should reflect the associated uncertainty.Using 117 publicly traded oil and gas firms (accounting for about 40 percent of globaloil production) and a control group made up by non-energy firms, a panel regression showsthat a one standard deviation increase in exposure to climate policy leads to a reduction ofaround 3 percent in investment in a typical oil and gas company. Climate policy risk has aneven stronger effect than exposure (i.e., the first