Conference Agenda

Currently proven oil reserves are largely excessive from a climate standpoint, raising concerns about the potential financial mispricing of carbon assets. This paper studies how large oil companies' financial valuation reflects the size of their economic oil reserves. To this end, we exploit changes in firms' economic oil reserves induced by oil-price variations, and we examine the relation between these reserve changes and firms' stock returns. Economic theory predicts that firm value is convex in the output price when price affects quantities. We exploit this prediction to extend the conventional analysis of firms' financial exposure to changes in the oil price, separating the intensive margin (economic reserves held constant) and the extensive margin (changes in economic reserves). First, we empirically validate that financial market movements are consistent with the extensive margin effect of the oil price. Second, we exploit fundamental reserve data to estimate the economic reserves' sensitivity to the oil price (RSP). Third, we show that our new metric explains a risk premium, accounting for up to half the industry's average cost of capital. This means that the risk associated with more sensitive economic reserves is material to investors who demand compensation from oil companies for the possibility of oil assets' reassessment.