A regulator’s climate nightmare: carbon bubbles and market crashes

LIMA: The carbon bubble is no longer a concept promoted by environmental types, or a warning from progressive analysts in the mainstream investment banks. It is now officially recognized as a potential systemic risk to global financial markets.

The Bank of England has revealed that it will broaden its investigation into “unburnable carbon” – and the potential that continued investment in oil, coal and gas by global giants could precipitate a share market crash, and become of the sub-prime crisis of the current economic cycle.

BoE governor Mark Carney revealed the enquiry in a letter to the House of Commons environment audit committee. He noted that the BoE had already made preliminary discussions into the potential of stranded assets, and in light of these “we will be deepening and widening our enquiry into the topic.” He expects it will become a regular part of its “scanning” for financial stability risks.

The move is welcomed by financial analysts who suggest that other central banks and financial regulators should do the same.

The concept of a “carbon bubble” has gained rapid traction in financial markets over the last year. It is taken seriously by the likes of Citigroup, HSBC, Deutsch Bank and Kepler Chevreux, and ratings agencies such as Moody’s are also raising their concern.

The fear is that because Big Oil and Big Coal companies are so big, any sudden fall in their value could precipitate a global financial crisis in the same way as the property crash did in 2007. Big Oil doesn’t accept this, and Shell and ExxonMobil have protested to shareholders this year that the carbon bubble scenarios and the concept of stranded assets is overdone.

The BoE’s concerns have been raised just as the world resumes climate talks in Lima which is expected to result in a deal in Paris in a year’s time.

A global agreement to restrict global warming to 2C, or even 1.5C as advocated by some, will likely mean that the world would have to observe some sort of carbon budget, and leave up to two thirds of fossil fuels in the ground.

The issue has been heightened by the recent slump in oil prices, and the soaring cost of finding new fossil fuel reserves. The oil industry, meanwhile, is investing nearly one trillion dollar a year in new investments, with little reward. Up to $19 trillion of oil investments are considered at risk in a 2C scenario.

Carbon Tracker, an NGO that focuses on the issue, says the BoE move is the first major acknowledgement from a financial regulator that most of the world’s listed coal, oil and gas reserves could become “stranded assets” and have significant financial consequences.

“Poor disclosure practices from fossil fuel companies could be masking financial risks of fossil fuel asset,” said Mark Campanale, Founder and Executive Director of Carbon Tracker.

“This is in part due to inadequate signaling from capital market regulators that these issues are important, or indeed material, and are required by investors to effectively manage their exposure to this risk.

“Now is the time for guidance and direction to assist companies in preparing new risk disclosures that are fit for this purpose.”

In Australia, the issue is barely recognized in government circles. Peter Costello, the former Treasurer who heads the Future Fund, said recently he saw no reason to divert investments away from coal companies.

At a Senate hearing, Costello was asked by Greens senator Larissa Waters if he had heard of the concept of the “carbon bubble” and about research that suggested two-thirds of fossil fuel reserves needed to stay in the ground.

“I’m just going to make the point, whether I have or whether I haven’t, that’s not how the Future Fund makes its decisions,” Costello said. “If you, Senator, are saying there is no safe use of fossil fuel, so it is as poisonous as tobacco ‚Ķ I would look at that, but there obviously is safe use.”

The Abbott government says it “stands up for coal”, but this will mean little if there is no market for the commodity. The government has mocked the “divestment” movement which urges investors to protect themselves against such scenarios.

The issue is, however, getting traction in investment circles. Numerous banks have walked away from financing massive infrastucture that would be needed to extract and deliver Galilee basin coal to international markets. Their principal concern is that these long term assets could be left stranded.

Recently, Shell and other oil majors were taken to task by Climate Tracker and other analysts over the carbon risk to investors on tens of billions of high cost oil projects.

Carbon Tracker and Energy Transition Advisors (ETA) warned that up to $77 billion-worth of the company’s new fossil fuel projects will be stranded as climate change policies begin to bite.

Carbon Brief did a survey of major oil and coal companies about the carbon bubble issue, and found that while BP, Shell, ExxonMobil, ConocoPhillips, Statoil, and MOL all acknowledged climate change was real, and that climate policy posed a risk to their business, none of the companies saw climate action as a threat to their business in the coming decades.

“We’re aware of [the carbon bubble research], but believe the analysis we have seen oversimplifies the issue and overstates the potential financial impact on our investments,” BP said in response to the survey.

But it seems that at least the recent slump in the oil price to 5 year lows may help the oil companies save themselves, in that it should be obvious even to them that continued investment is unsustainable.

“At $70 a barrel for Brent, it is hard to imagine how any new major international project gets the green light from the majors,” Mark Lewis at Kepler Cheuvreux old bloomberg. Prices at these levels “will also put a huge squeeze on shale companies looking to drill new wells.”

Alliance Bernstein, which warned earlier this year of a potential flight of capital from the fossil fuel industry as the energy market suffered “price deflation” because of the impact of cost competitive solar and other renewables, said that at today’s prices, exploration spending is likely to fall 50 per cent, oil companies will  focus on high-margin projects, and not low-margin investments like oil sands and Arctic projects. That would be a good thing.

Originally Published at http://reneweconomy.com.au/2014/a-regulators-climate-nightmare-carbon-bubbles-and-market-crashes-73340

Leave a Reply

Your email address will not be published. Required fields are marked *