Unburnable Carbon

Simon Bullock

19 April 2013

Like the terms ‘peace offensive’, Wigan Athletic and Hyundai Excel, I thought ‘nice office’ was an oxymoron, until I visited Bloomberg’s headquarters yesterday. The business media company had tables full of fruit artfully displayed on immaculate porcelain, an art gallery, and a fish tank almost as big as a squash court.

It was also hosting an impressive event by finance experts Carbon Tracker, who were launching their new report on ‘Unburnable Carbon’. A collaboration with academics at the Grantham Research Institute  the report makes two main points.

First, that keeping to world Governments’ pledges on climate change means we can burn less than a third of the world’s proven fossil fuel reserves.

Second, this means that companies holding these reserves cannot use more than a small fraction of them, and so investors should steer clear of these companies, because they represent heavily overvalued assets.

At the report launch Lord Stern made the point that you can’t simultaneously believe we can stop climate change and also believe that hydrocarbon companies are not currently heavily over-valued.

Among the finance experts responding on the panel there was very little disagreement with the basic maths – as one oil and gas analyst said: “the sheer scale of unburnable carbon is astonishing”. But as Anthony Hobley and others participants pointed out - the analysis relies on the assumption that investors believe that Governments are genuinely serious about climate change, and that fossil fuels will therefore stay in the ground.

And there is real schizophrenia here – the UK Government for example has targets to cut emissions by 80% by 2050, yet at the same time has a fossil fuel strategy “to continue maximising the recovery of indigenous hydrocarbon resources”. As the Guardian’s Duncan Clark put it yesterday there is “near-universal denial about what needs to happen to the fossil fuel sector”.

Faced with this genuine policy uncertainty, why shouldn’t investors just wait and see if Governments are serious, and then there’ll be time to divest shares in fossil fuel companies in an orderly fashion later?

A blind gamble?

There are two problems with this approach.

The first is that investors are betting 100% that Governments will not take climate change seriously – but this is a seriously risky gamble. If there is, say, a 20% chance that Governments will act to keep warming to two degrees, then there’s a 20% chance that most carbon assets cannot be burned. Or, if there’s, say, a 40% chance that Governments will take some, but insufficient action – i.e. allow three degrees – then still, over half of fossil fuels cannot be burned.

As Carbon Tracker points out in chapter 5 of its report, investors should revalue fossil fuel assets reflecting the probabilities of Government action. This would protect investors better than their current de facto assumption that it is 100% likely that there will be inaction on climate change.

The second problem with a wait-and-see approach is that it assumes that it will be possible to divest fossil-fuel holdings in an orderly way. As one participant put it “the biggest risk is a tipping point – where the value of assets may go down very quickly”. In other words, like the housing market in the late 2000s, there is a real risk of a big carbon bubble in the 2010s. Fossil fuel investments are valuable now, but their worth will plummet when the World’s Governments mount a concerted response on climate change. This seems inevitable – the consequences of a three or four degree warming world are ultimately not something Governments will want to allow.

The overall implication of unburnable carbon for investors - to protect themselves both from over-valued assets and from sudden drops in value – is that they should start to reduce their exposure to fossil fuel companies.

There’s a critical role for the UK Government too. Continuing to oppose amendments to include a clean power target in the current Energy Bill will delay investment in critical energy infrastructure, and it is not credible for a Government wanting to lead on climate change to keep on giving tax breaks and subsidies for yet more fossil fuel extraction. Friends of the Earth believes the Government must give much clearer signals to investors that they are serious about tackling climate change.

**Join ShareAction's campaign - ask your pension provider what they are doing to reduce the risks of investing in unburnable carbon: http://www.shareaction.org/carbonbubble **

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