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Fossil Fuels Carbon bubble: $6 trillion of new investments at risk

Published on April 20th, 2013 | by Giles Parkinson

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Carbon Bubble: $6 Trillion Of New Investments At Risk

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This article first appeared on RenewEconomy.

Call it an act of the greatest folly, or simply one of greed. But it seems that the world’s energy companies are hell-bent on spending up to $6 trillion of shareholder funds and bank debt in the next decade on fossil fuel investments – assets that could well become stranded and worthless if the world acts to limit climate change.

This is the conclusion of a new report on the so-called “Carbon Bubble”, which highlights the fact that the bubble is getting bigger. It now estimates that between 60 and 80 per cent of the coal, oil and gas reserves of publicly listed companies could be classified as unburnable if the world is to achieve emissions reductions that offer the greatest chance of limiting average global warming to 2°C.

Research by Carbon Tracker and the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science shows that 200 major listed companies own 762 billion tonnes of carbon dioxide (CO2) through their reserves of coal, oil and gas. These reserves currently supports share value of $4 trillion and service $1.5 trillion in outstanding corporate debt.

But to achieve emissions reductions consistent with an 80 per cent chance of achieving the 2°C target, the fossil fuel reserves of these listed companies would likely have to comply with a budget of just 125 billion tonnes to 275 billion tonnes of CO2.  That means cutting them by three quarters or more, even more than that estimated last year by the International Energy Agency.

To make matters worse, a further $674 billion was invested in new fossil fuel investments in 2012, and at the current rate more than $6 trillion will be invested over the coming decade – much, or even all of which could become stranded assets.

The research is delivered as a warning to asset managers, shareholders and bankers, but it comes in the same week that the principal market signal on climate change action, the international carbon price, plunged to new lows in Europe after the failure of the EU parliament to solve the damaging impact of a huge surplus of free and unused carbon credits.

The collapse of the carbon price is being painted as a failure of the market based system, when in fact it is really a failure of political will. In Australia, true to form, the mainstream media has been led by the political spin-doctors to focus on what amounts to economic trivia – the impact that a lower carbon price could have on forward estimates of budget revenues.

The larger and most significant implications, that of the need for companies to have an incentive to invest in action to decarbonise one of the world’s most emissions-intensive economies, is largely ignored. And don’t think that corporate Australia is not stupid enough to ignore what is clearly one of the key global mega-trends. The speech by Tony Shepherd, the chair of the Business Council of Australia, was confirmation of that – recognizing that Australia’s response to climate change was somewhere between “half-hearted and non-existent”, but at the same time calling on the government to effectively dismantle the very schemes that encourage the required investment.

Too many in corporate Australia will use any excuse to avoid the inevitable, in the interest of short term returns, and this has become the de-facto policy of the Coalition government-in-waiting, which has upped its calls to scrap the whole idea of a carbon price. Analysts say this is a really bad idea, even if you are supposedly concerns about short term “competitiveness.” It was interesting that Chinese authorities were making clear overnight that the European price collapse would have no impact on its own plans for an ETS.

The Carbon Tracker research may appear dramatic, but the concept of a carbon bubble is steadily gaining traction among funds managers, analysts, and advisors. Apart from the IEA clarion call last year, Citi last month reached a similar conclusion about the potential impact of concerted climate action, depending on its timing. It noted that fossil fuel companies would be motivated to extract their assets as quickly as possible – an action that the BCA seems happy to endorse, and facilitate.

Professor Lord Stern of Brentford, chair of the Grantham Research Institute on Climate Change and the Environment, and he of the eponymous report on climate economics, said smart investors can already see that most fossil fuel reserves are essentially unburnable because of the need to reduce emissions in line with the global agreement by governments to avoid global warming of more than 2°C.

“They can see that investing in companies that rely solely or heavily on constantly replenishing reserves of fossil fuels is becoming a very risky decision. But I hope this report will mean that regulators also take note, because much of the embedded risk from these potentially toxic carbon assets is not openly recognized through current reporting requirements.”

Stern said that the report raises serious questions as to the ability of the financial system to act on industry-wide long term risk, since currently the only measure of risk is performance against industry benchmarks.

Paul Spedding, an oil and gas analyst at HSBC, said described the scale of unburnable carbon assets in listed companies as “astonishing”, and added ‘business-as-usual’ is not a viable option for the fossil fuel industry in the long term.

“Management should already be looking to new business models that reduce the risk of stranded assets destroying shareholder value, In future, capital allocation should emphasise shareholder returns rather than investing for growth,” he said

Jens Peers, chief investment officer for Sustainable Equities
 at MIROVA, was even more damming. “It is still shocking to see the numbers, as they are worse than people realise. It is frightening that risk is not properly distributed and this needs to be cleaned up.”

He said the research should act as a wakeup call for asset managers who put too much emphasis on the short term. “Asset managers who think they have time to adjust have the wrong attitude and our evaluation theory is too short term. They are either naïve and do not see this as an issue, or they know about it but wrongly assume a technology will clean it up, not taking responsibility or seeing this as a risk they have to pay for.”

Although the conclusions from the Carbon Tracker report seem bleak, it insists it applied an optimistic scenario to stress-test the carbon budgets. This assumed that more effort was applied to non-COemissions, (e.g. methane from waste and agriculture), which resulted in freeing up more CObudget for fossil fuels.

This approach indicates a carbon budget for an 80% chance of avoiding global warming of more than 2°C is about 900 billion tonnes up to 2050, and about 1,075 billion tonnes for a 50% chance. However under a more precautionary scenario, the carbon budget could be around half this amount – 500 billion tonnes. This results in the range of 60-80% of total reserves being in excess of the 2°C budget. Here are two tables to illustrate this, the first giving the allowable budget out to 2049 under various scenarios, and the second from 2050 to 2100.

Screen-Shot-2013-04-19-at-10.06.34-AM

Screen-Shot-2013-04-19-at-10.06.39-AM

But it found that even if CCS is deployed in line with an optimistic scenario by 2050, fossil fuel carbon budgets would only be extended by 125GtCO2, allowing the equivalent to 4% of current global reserves to be burned as long as their emissions are captured and stored. Beyond 2050, the total carbon budget is very small for a 2°C target, which means that reserves will remain unburnable during the second half of the century unless there is a dramatic development of CCS after 2050.

What’s more, the analysis found that even under a less ambitious climate goal, like a 3°C rise in average global temperature or more, would still imply significant constraints on the use of fossil fuel reserves between now and 2050.

“Current extractives sector business models are based on assumptions that there are no limits to emissions,” the report notes. “The current balance between funds being returned to shareholders, capital invested in low-carbon opportunities and capital used to develop more reserves, needs to change. The conventional business model of recycling fossil fuel revenues into replacing reserves is no longer valid.”

It also highlights which of the world’s stock exchanges may have the greatest exposure. The table below provides an illustration.  New York, Moscow and London have high concentrations of fossil fuels on their exchanges, and if the reserves on the Hong Kong, Shanghai and Shenzen exchanges are combined then China is not far behind.

But it also noted that Australia, Johannesburg, Tokyo, Indonesia, Bangkok and Amsterdam would all see their levels more than triple if the current prospects have more capital invested and are successfully developed into viable reserves. It said investors and regulators should start questioning the validity of new or secondary share issues by companies seeking to use the capital to develop further fossils, a call recently echoed by Moody’s and S&P, which questioned the credit quality of some of these companies.

Carbon bubble: $6 trillion of new investments at risk





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About the Author

is the founding editor of RenewEconomy.com.au, an Australian-based website that provides news and analysis on cleantech, carbon, and climate issues. Giles is based in Sydney and is watching the (slow, but quickening) transformation of Australia's energy grid with great interest.



  • Dimitar Mirchev

    help fill this page:

    https://en.wikipedia.org/wiki/Carbon_bubble

    with more information

    • Bob_Wallace

      If you want people to look at a linked page it’s best to describe what is on the page and why you think it important that they take a look.

      When I see a link with no additional information I assume it’s an ad that someone is spamming.

      • Dimitar Mirchev

        Its from wikipedia, obviously.

        A new article about he Carbon Bubble

        • Bob_Wallace

          Obviously, so what?

          I’m trying to help you out here.

          If you want people to do something and it’s important to you then put in a little energy to sell it.

          My attitude, when I see someone drop a link, it that either a) it’s not worth my time since is wasn’t that important to the person who posted, or 2) it’s spam.

          I almost never open a bare-posted link (except as my mod-job to check for spammers).

          • Dimitar Mirchev

            Yea, note taken. Thanks.

            I didnt expected teh link to be cut and since its from wikipedia I assumed its ok.

  • jburt56

    Not to mention the existing capital stock which would effectively become a sunk investment.

  • James Wimberley

    The good news is that when major banks – UBS, Deutsche, Citi – start plugging the transition to renewables, and reports like this one show that the long-term business model of the fossil industries is impossible, then financial markets will start thinking of these industries as inherently risky, and renewables as much safer. So the cost of capital will swing renewables’ way. Warren Buffett is a conservative investor, who looks at long-term fundamentals not short-term opportunities, and he is buying solar and wind. The shift will be amplified by ethical and reputational considerations, and noisy campaigns for divestment. So let’s keep going.

  • http://twitter.com/Kf_Lenz Karl-Friedrich Lenz

    There are two problems with the carbon tracker report.

    One is indisputable. They say that unburnable fossil fuel is worth zero. That clearly overlooks the fact that fossil fuels have value as raw materials for the petrochemical industry.

    The other may be open to debate. But I think that the fossil fuel companies will get large extra profits once we start to put 80% of the reserves off limits.

    One part of that comes from the fact that with supply going way down, unit prices will go up massively. That results in much larger margins assuming the same cost of production and transport.

    The bigger part comes from the fact that higher unit prices mean higher valuations for the reserves. For example, Wikipedia says World oil reserves are around 1.3 trillion barrels.

    Have oil prices go up a moderate $50 and the owners of those reserves get an extra $65 trillion in profit from the higher valuation before they sell even one barrel.

    I have a whole category on my blog called “Phaseout Profit Theory” where I discuss exactly this question.

    I agree with the report that it doesn’t make much sense to pay over $600 billion a year for developing new resources if it is clear that you can’t use most of those already found.

    • Bob_Wallace

      “One part of that comes from the fact that with supply going way down”

      Are you suggesting that we will get fossil fuels off our grids by limiting extraction? If so, I don’t think that’s how it will happen. More likely we will close plants that use fossil fuels and that will cut demand.

      As demand drops the price of fuel will drop, first forcing the highest cost producers out of business. Some production will continue for industrial feedstock, but at a lower price.

      “Have oil prices go up a moderate $50 and the owners of those reserves get an extra $65 trillion in profit from the higher valuation before they sell even one barrel.”

      No, their net worth on paper goes up. Their profits do not go up until the sale is completed.

      • http://twitter.com/Kf_Lenz Karl-Friedrich Lenz

        Of course eventually a transition to 100% renewable will displace fossil fuel completely.

        The trick is to make it happen faster, so as keep global warming from entering runaway feedback.

        What I am suggesting is that the fossil fuel companies reduce supply faster than demand will be reduced anyway. That will lead to higher prices.

        As to your other point: That is a question of accounting. One could debate it, but the Carbon Tracker report clearly assumes that the value of the reserves directly affects the owners’ bottom line. I agree with them.

        • Bob_Wallace

          I don’t think we’ll see anything like OPEC emerge which would coordinate supply tightening. There are too many players now.

          More likely individual extractors will start cutting prices in order to sell what they can. Anyone who holds out for a higher price is likely to sell nothing.

          • http://twitter.com/Kf_Lenz Karl-Friedrich Lenz

            We already have OPEC.

            And if CarbonTracker and 350.org get their way, 80% will stay unburned. My point is that this is good news for fossil fuel companies’ profits.

            If true, that would be a big deal. It would completely change the political power balance, including lobbying money.

          • Bob_Wallace

            OPEC has had its teeth pulled.

            I simply don’t see any way to limit the amount of fossil fuels extracted. To limit the supply. It’s not politically possible.

            If we leave “80%” in the ground it is most likely to be due to demand drop. Closing coal burning plants, moving to electricity for transportation – that’s what I see as the route we’ll likely take.

            You are entitled to your vision….

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