The carbon bubble and stranded assets

Carbon-Bubble-5

The carbon bubble and stranded assets

Carbon-Bubble-5

The Carbon Bubble refers to the potential for fossil fuel industries valuations to be overstated, due to their fossil fuel assets not being  able to be burned to stay within safe limits to avoid dangerous climate change. Research by Carbon Tracker measuring how much fossil fuels are listed on stock exchanges around the world suggests that two thirds of the carbon, currently making up the value of companies share price, cant be burned, and their share price is therefore over stated.

World-Map-1_Carbon_Tracker

Carbon Tracker pioneered the concept of a ‘Carbon Bubble‘, representing fossil fuel reserves worth $6 trillion that cannot be used if the world is to seriously deal with climate change, and are therefore worth less.

In 2014, credit rating agency ‘Standard and Poor’s’ and Carbon Tracker published ‘Carbon Constraints Cast a Shadow Over the Future of the Coal Industry’ which shows that coal producers with higher production costs are at growing risk of having their assets becoming stranded.

Two reports looking at oil have been published in 2014. The first, Carbon Supply Cost Curves: Evaluating Financial Risk to Capital Expenditures is a risk analysis which provides a tool for the majority of investors who cannot simply divest, so they can understand their risk exposure and start directing capital away from high cost, excess carbon projects. The second, Oil and Gas Majors Fact Sheet, goes one step further, ranking oil majors according to their capex exposure to undeveloped high cost projects and revealing those with the highest risk.  

Alerting investors to the long term risks for their investments, of being exposed to fossil fuel companies may allow them to  divert their funds into lower risk investments with comparable returns and volatility according to MSCI and also the Responsible Investment Association of Australia (RIAA) in their 2014 Responsible Investment Benchmark report.

Conversely, the notion that pension and superannuation funds have a fiduciary duty to include fossil fuel assets to maximise returns are not borne out when looking at the numbers. This is becoming an old-guard view, and current legal opinion from Baker & McKenzie and others, holds that fund trustees not taking account of climate change represents a legal risk to them.

Demand for energy is likely to increase substantially in the next two decades. Under the International Energy Agencies most climate friendly policy scenario the use of coal, oil and gas will rise until at least 2020.

But provided governments agree a proposed United Nations emissions reduction treaty in Paris in 2015, the longer term prospects of fossil fuel investments appear uncertain.

See below infographic on the Australian Stock Exchange coal exposure versus the global situation.

Coal-budgets_Global

Major investment banks and research houses are publishing research giving credence to the divestment movement UBS and Bloomberg New Energy Finance have both put out research on this and believe that it is ‘a movement with legs, because of a view that came up several times in different ways: interns and young professionals feel very strongly about the need to move away from fossil fuels. . And institutions like ANU that are divesting from fossil fuels are receiving backlash – because the fossil fuel industry has gotten worried about the stigmatisation of their sector, the drying up of capital and their loss of social license to operate.