This week has seen a new green meme bubbling up: the idea that investment in high-carbon companies is creating a “carbon bubble” that could leave the world exposed to another huge financial crash. The catalyst for this newly prominent discussion is a fascinating report by the Carbon Tracker Initiative that explores the obvious but usually overlooked mismatch between the world’s stated climate change targets and the market response – or lack thereof.
We’ve known for a long time that the world’s remaining carbon budget is tiny compared with the total amount of exploitable oil, coal and gas reserves. In other words, though issues such a deforestation and soot are important, our chance of tackling climate change mainly comes down to one thing: how much fossil fuel the world can be persuaded to leave in the ground.
Although that sounds obvious, it’s worth restating, because for all the crucial current debate over renewables and nuclear, it’s important to bear in mind that low-carbon technologies are necessary but not necessarily sufficient. Even if we had enough low-carbon power to match current energy consumption that wouldn’t in itself mean that the fossil fuels would stay in the ground; the world might simply use more energy.
Given that meeting the world’s agreed climate target – limiting global warming to 2 degrees Celsius – will almost certainly require huge quantities of valuable fossil fuels to be left untouched by their owners, it’s surprising that the environment community hasn’t been quicker to flag up what that might mean in terms of business risk for fossil fuel companies. If most oil, coal and gas reserves are effectively “unburnable”, could the primary assets of the world’s biggest energy companies be as toxic as the dodgy mortgage debts being traded in the run-up to the 2008 financial collapse?
Thanks to the Carbon Bubble report, we now have some better numbers to help us grapple with that question. Based on research by the Potsdam Institute, the report suggests that if the world wants an 80% chance of staying within the two-degrees limit, we should avoid emitting more than 565 gigatonnes (GT) of CO2 by 2050. That equates to just a fifth of the world’s total proven fossil fuel reserves, which contain enough carbon to produce a massive 2795GT of CO2, the report estimates.
Of course, a large proportion of the world’s fossil fuels are controlled by state-owned companies such as Saudi Aramco. But even if these states could somehow magically be persuaded to leave all their oil, coal and gas in the ground for the greater good, that wouldn’t solve the problem because, according to the report, even just the top couple of hundred private energy companies listed on world’s stock markets have significantly more carbon assets that the world can afford to burn. And yet fossil fuel companies – which are heavily invested in by our pension funds, as well as by private investors – are generally considered among the safest companies to put money into.
So what’s going on here? I’m not a financial expert, so apologies for the broad-brush assessment, but it seems there are four scenarios that could explain the apparent mismatch. The first is that the markets are in fact working properly and the cost of energy investments already reflect the considerable risks of unburnable assets. However, this doesn’t seem likely given that until the Carbon Bubble report came out there wasn’t even an easily available reference to compare the carbon content of reserves with the acceptable carbon budget. More fundamentally, it doesn’t seem likely when you consider that the big energy companies are openly prospecting for new reserves: if they and their investors really believed they were going to have to leave some of their existing fuels in the earth, why would they be spending large sums of money looking for new ones?
(The most recent BP annual report is typical of the industry’s public stance on this question: it softly acknowledges that carbon regulation could increase costs and reduce growth opportunities but also states emphatically that “BP’s future hydrocarbon production depends on our ability to renew and reposition our portfolio”.)
If that scenario doesn’t stack up, what about the next possibility: that the markets understand the big-picture risks of unburnable assets but believe these will be obviated by the development of technologies that allow us to inexpensively capture the CO2 released by fossil fuels – either at the point of use or through a massive rollout of ambient carbon scrubbers. But this doesn’t seem likely, either, given the painfully slow rate of development of all kinds of carbon-capture systems.
Which leads us to the two other possibilities: that the market is acting irrationally or on bad information and, as the report suggests, gradually inflating a carbon bubble; or, conversely, that the market believes simply that the risks of unburnable carbon are small because the world shows no sign of taking the two-degrees target seriously. The really worrying thing, I think, is that the second of those two scenarios seems just as plausible as the first – and will remain so until the UN process shows some progress on legally binding emissions cuts at the global level.
In other words, let’s hope that there does indeed turn out to be a carbon bubble, because at least a bubble can burst. The alternative – that the markets are correctly predicting there will never be enough political will to impose the two-degrees temperature limit – is even more worrying.