There is an aspect to climate change that I have been aware of but have not given much thought to – the potential for climate change action to trigger a financial crisis through stranded carbon assets. The problem has been explored by Carbon Tracker’s Unburnable Carbon reports, and I’ve just been reading their 2013 update. Let me summarise the argument.
- Oil companies count their reserves as assets. If they win the rights to a new oilfield or make a new discovery, those reserves are added as assets and the value of the company rises.
- This means that the value of an oil company on the stock market depends substantially on the oil, coal or gas reserves that they control.
- If we are to prevent serious climate change, we cannot use all those reserves. To keep below 2 degrees of warming, we can really only burn a fifth of them.
- Action to limit the burning of fossil fuels would make those fossil fuel reserves into stranded assets – assets that cannot be bought, sold, or used.
- With their underlying assets now worthless, the value of oil companies would plummet on the stock market. It would be the bursting of an enormous ‘carbon bubble’.
- Since oil companies are among the largest companies in the world, the loss of value would be in the order of trillions of dollars. The London Stock Exchange could lose 20-30% of its value.
- It would not just be the oil companies and their investors that suffered. A multi-trillion dollar black hole in the global economy would be a major financial crisis, with knock-on effects for banking, pensions and public spending.
This is a major problem, because for those not inclined to take climate change very seriously, it’s a powerful argument for the status quo. It’s a particularly thorny problem for those countries that run stock exchanges overloaded with fossil fuels – Russia, Britain, the US and Canada being the largest. The more serious we get about climate change, the greater the risk that investors will begin to worry about those carbon assets.
It’s little wonder that the government talk up climate action while simultaneously creating tax incentives for shale gas. The carbon bubble may also explain, in part at least, the creakingly slow progress on an international agreement. If asked to choose between the risk of climate change and the risk of financial crisis, we all know which way the government would go.
The answer is of course not to let things get to that kind of choice, but to begin to revalue carbon ahead of time. The first step is to recognise the systemic risk that the carbon bubble poses, rather than ignoring it as we’re doing at the moment. Those stock exchanges that are heavily weighted towards fossil fuels need to diversify – something that Boris Johnson has already highlighted in London. Investors need to look at their exposure to the carbon bubble and respond accordingly. Companies could pursue ‘integrated accounting’ practices that account for their carbon, allowing investors to make better decisions. There aren’t any big obvious solutions – it will take a change of mindset across regulators, accountants, the extractive industry and their investors together.
Ultimately, the financial market is pricing carbon as an asset when it ought to be a liability. That needs to change. “There are more fossil fuels listed on the world’s capital markets than we can afford to burn if we are to prevent dangerous climate change” say Mark Campanale and Jeremy Leggett in the 2013 update.” The missing element in creating a low carbon future is a financial system which will enable that to happen.”