Report: Unburnable Carbon – Are the world’s financial markets carrying a carbon bubble?

By Bhavani Prakash

In all the fear mongering about ‘peak oil’ , it is easy to forget that the world doesn’t have too little oil to burn, but way too much from a climate change perspective.

This point was brought out by a must-read report by the Carbon Tracker Initiative(CTI) last year. The Carbon Tracker initiative is a project of Investor Watch, a non-profit company set up to align the capital markets with efforts to tackle climate change.

According to CTI’s report entitled, “Carbon Bubble – Are the world’s financial markets carrying a carbon bubble?”  :

“Financial markets have an unlimited capacity to treat fossil fuel reserves
as assets. As governments move to control carbon emissions, this market
failure is creating systemic risks for institutional investors, notably the
threat of fossil fuel assets becoming stranded as the shift to a low-carbon
economy accelerates.”

An extract from the Executive Summary which highlights the climate change risk arising from fossil fuel reserves of listed companies:

Global carbon budget

Research by the Potsdam Institute calculates that to reduce the chance of exceeding 2°C warming to 20%, the global carbon budget for 2000-2050 is 886 GtCO2. Minus emissions from the first decade of this century, this leaves a budget of 565 GtCO2 for the remaining 40 years to 2050.

Global warming potential of proven reserves
The total carbon potential of the Earth’s known fossil fuel reserves comes to 2795 GtCO2. 65% of this is from coal, with oil providing 22% and gas 13%. This means that governments and global markets are currently treating as assets, reserves equivalent to nearly 5 times the carbon budget for the next 40 years. The investment consequences of using only 20% of these reserves have not yet been assessed.

Global warming potential of listed reserves
The fossil fuel reserves held by the top 100 listed coal companies and the top 100 listed oil and gas companies represent potential emissions of 745 GtCO2. This exceeds the remaining carbon budget of 565 GtCO2 by 180 GtCO2.This means that using just the listed proportion of reserves in the next 40 years is enough to take us beyond 2°C of global warming. On top of this further resources are held by state entities. Given only 20% of the total reserves can be used to stay below 2°C, if this is applied uniformly, then only 149 of the 745 GtCO2 held by listed companies can be used unabated. Investors are thus left exposed to the risk of unburnable carbon. If the 2°C target is rigorously applied, then up to 80% of declared reserves owned by the world’s largest listed coal, oil and gas companies and their investors would be subject to impairment as these assets become stranded.

The carbon intensity of stock exchanges
The top 100 coal and top 100 oil & gas companies have a combined value of $7.42 trillion as at February 2011. The countries with the largest greenhouse gas potential in reserves on their stock exchanges are Russia, (253 Gt CO2), the United States, (156.5 Gt CO2) and the United Kingdom, (105.5 Gt CO2). The stock exchanges of London, Sao Paulo, Moscow, Australia and Toronto all have an estimated 20-30% of their market capitalisation connected to fossil fuels.

Jeremy Leggett, one of the founders of CTI,  aptly sums up his concerns in the title of his Guardian UK article, ”Coal India IPO shows the mountain we have to climb”  The large public sector company’s IPO of last year was accompanied by a prospectus of 510 pages, with not a single mention of climate change risk. The IPO was still oversubscribed 15 times, with 484 foreign funds, 195 mutual funds, 44 insurance companies, and several banks owning a stake.

Mispricing of assets led to both the dot.com bust and the credit crisis. Is the carbon bubble going to be another déjà vu with financial institutions allowed to gamble with funds of ordinary people, by “bringing coal to the markets by the gigatonne, without the requirement for a single item of liability accounting on the global balance sheet?” in Leggett’s words.

How can various stakeholders prepare themselves to avoid a carbon bubble? The authors of the report rightly call upon regulators, asset owners, investment analysts and brokers, financial institutions, accountants and extractive companies to improve reporting of potential fossil fuel based emissions and assess systemic risks from the same.  CTI’s study should serve as a much needed clarion call.

What about potential for green job creation? If integrated reporting and disclosures of carbon emission potential of fossil fuel reserves are mandated, this should, in theory, lead to a demand for professionals offering such services, including financial analysts who specialise in assessing systemic, social and environmental risks arising from fossil fuel reserves laden balance sheets.

Jeremy Leggett also mentions in the aforementioned Guardian article, that around the time Coal India’s IPO came out, Enel, the Italian energy giant, had floated its renewables arm, Enel Green Power. Its IPO failed hugely due to lack of institutional investor support, with doubts cast on the viability of renewables. Mandatory disclosures of carbon emissions potential and right policy action should also lead to clarity for investors in renewable energy companies, and a demand for jobs therein, ideally.

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About the reviewer:

Bhavani Prakash is the founder of Green Collar Asia, a thought-leadership portal on developments in the green jobs sector, where macro-level trends, as well as insights from green professionals and entrepreneurs are brought together.

She is a recruiter, speaker, trainer and writer in the environment/sustainability sector. She has an MBA from Indian Institute of Management Calcutta and an M.Sc in Financial Economics from University of London. She is also a certified EQ Coach with Six Seconds.org

Connect with Green Collar Asia on LinkedInFacebook and Twitter.  Bhavani Prakash may be contacted via bp[at]greencollarasia.com or through LinkedIn.

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