Popping the carbon bubble
How much ‘unburnable’ carbon is there on the world’s stock exchanges? Last year, the Carbon Tracker Initiative (CTI) published an analysis asking this question. CTI compared the global ‘carbon budget’ needed to stay below a rise of two degrees Celsius in average temperatures (above pre-industrial levels) with the emissions potential of the proven coal, oil and gas reserves owned by listed companies
James Leaton | Climate Spectator | 23 Mar 2012
The results showed that listed companies own more fossil fuels than can be burned between now and 2050 if we are to have an 80 per cent chance of staying within the two-degree Celsius limit, the international climate-change goal agreed at UN-led talks in Copenhagen in 2009.
The International Energy Agency’s (IEA’s) ‘World Energy Outlook 2011’ has since applied this thinking. It uses a more generous carbon budget, which only gives a 50 per cent chance of staying below a two degrees Celsius rise, but still total fossil-fuel reserves exceed the budget. Moreover, these calculations only look at proven reserves, which have a 90 per cent chance of being extracted economically. Beyond this, there are probable and potential reserves, as well as unconventional hydrocarbons, such as shale gas and tar sands, which do not yet fully appear on balance sheets.
The message is clear: even when you apply a generous carbon budget and a narrow scope of reserves, we can still only afford to burn a fraction of fossil-fuel reserves if we are serious about tackling global warming. This indicates that the financial system does not yet take climate-change targets seriously. If it did, then it wouldn’t sanction billions of dollars of capital investment in finding more reserves each year.
Climate-change policymakers need to use this as a barometer: if the capital hasn’t shifted from carbon intensive to low-carbon options, then the desired outcomes will not be delivered.
This is a different way of looking at climate change, which links together scientific analysis of the climate with companies’ and investors’ focus on reserves. These are the primary assets of extractive companies and there needs to be a market to burn them if they are to realise the expected revenue streams.
Looking at the stocks of carbon for this sector is much more informative than looking at last year’s direct operational flow of emissions. It also reflects the way global warming works: atmospheric concentrations of greenhouse gases are determined by cumulative emissions. For investors, it also provides a forward looking indicator of the level of emissions on which companies are basing their business models and strategies. With companies looking to increase the levels of unconventional gas and oil, the industry is re-carbonising at a time when policy discussion is focused on decarbonising.
A map of carbon reserves by the stock exchange on which they are listed, produced by CTI, makes clear the role of western capital in financing coal extraction around the world. Next time there is criticism of emerging economies for increasing carbon emissions, we would suggest people look at where the capital is coming from. While traditionally there is significant state ownership of assets in some countries, there is also a trend for partial listings as a way of sharing the risk and raising capital.
The state Mongolian coal company Erdenes Tavan Tolgoi is currently looking to conduct an Initial Public Offering (IPO), putting its shares on sale to the public for the first time. It has commissioned four investment banks to arrange the sale and is in discussions with the Mongolian, Hong Kong and London stock exchanges. The company has coal reserves of up to five billion tonnes and is expected to raise around US$3 billion (19 billion yuan) in order to start production for export to China.
This is a prime example of coal companies coming to London to raise capital for fossil-fuel ventures. In 2011, listed resources group Vallar bought a 75 per cent stake in Indonesian coal company Bumi, putting another major supplier of Chinese coal on the London stock exchange through the formation of Bumi plc. Glencore, the commodities trader, and Evraz, the Russian steel and coal producer, also came to list in London in 2011.
The fossil-fuel intensity of the London exchange keeps increasing, and as a result the carbon bubble issue has been raised with the Bank of England Committee, which reviews financial stability. The Bank has responded with the criteria it uses to assess financial stability risks and agreed to meet on the issue.
As a major global financial centre, many investors track the performance and composition of the FTSE indices with their funds. This means investors are following the herd towards re-carbonisation without even realising it. Many funds track an index passively to gain diversification in their portfolio. However, the rising concentration of coal, oil and gas companies in London eliminates diversification. The short-term approach applied by most analysts means they cannot factor in climate-change risk.
In January 2012, we produced a map of where the coal listed on the London stock exchange is located geographically. A third of coal listed in the United Kingdom is actually in Australia, where the Gillard Government has of course recently agreed to deliver a carbon tax and emissions-trading scheme. So ‘UK’ investors are potentially exposed to climate change regulatory risk in Australia. However, Australia and Indonesia export around three-quarters of their coal production. So, in fact, around half of the coal owned by UK-listed companies is supplying developing economies in China, Russia, India and South Africa.
The IEA has warned of carbon-lock in, where coal plants now under construction commit us to high carbon emissions over the next decades due to the lifetime of these facilities. However, this ignores the reality that stranded assets (assets worth less on the market than on the balance sheet) are regularly created when they are no longer economic. This is already happening in the United States, where a coal plant in Minnesota has never been turned on because emissions regulation and alternative fuels have rendered it uncompetitive.
Bets are already being placed on solar achieving grid parity in India and China in the next couple of years. This provides a cleaner alternative to coal and energy security using a technology in which these countries are leading the world. A recent study by the Massachusetts Institute of Technology (MIT) calculated that air-quality problems in Chinese cities cost the Chinese economy $US112 billion (708 billion yuan) in 2005. India’s reliance on imported coal has exposed it to rising commodity prices, while floods and droughts have disrupted coal supplies and water availability.
If that wasn’t enough to think about, Nicholas Stern, who advised the UK government on the economics of climate change in a landmark review, has identified a major contradiction arising from this analysis. If the world does not manage to limit its carbon emissions, there will be a major impact on sectors vulnerable to climate change such as agriculture, property, infrastructure and insurance. If the world does decide to limit carbon emissions, then fossil-fuel companies cannot continue business as usual.
At present, the financial markets are in denial: backing all sectors, despite the fact that they can’t all win.
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