Why we should worry about the ‘carbon bubble’

Two years ago, Carbon Tracker’s Unburnable Carbon report captured the attention of the global financial community. The report revealed the existence of a “carbon bubble” on the world’s stock exchanges. Put simply, listed companies already hold more coal, oil and gas reserves than can possibly be used if we are to stay within internationally agreed targets for reducing CO2 emissions.

The data is striking: if the planet is to have an 80% chance of avoiding a 2°C temperature increase, then we can release no more than 565 gigatons of CO2 (GtCO2) into the atmosphere by 2050. However, governments and corporations already hold fossil fuel reserves that would release 2,795 GtCO2 into the atmosphere. The top 100 listed coal, oil and gas companies alone hold reserves that represent total emissions of 745 GtCO2. Assuming state-owned companies, governments and listed companies all divide their holdings proportionally, then only 20% of fossil fuel reserves can ever be used if we are to stay within a carbon budget of 565 GtCO2. The remaining 80% of reserves will become stranded assets.

The implications are enormous: if the supposed value of a company is based in part on carbon “assets” that can never actually be used, the true value of the company will be greatly below market assumptions. It’s a classic market bubble. Just as investors in US subprime mortgage derivatives believed their assets were worth more than they actually were, pension funds and other institutional investors could now be holding assets underpinned by fossil fuels that are equally worthless.

So how can investors assess the true value of their energy holdings and which countries are most exposed?

The map above uses data from the Unburnable Carbon report to show the distribution of fossil fuel reserves across the world’s stock exchanges, with the dark green showing where fossil fuel reserves are most concentrated. It’s perhaps no surprise that Russia, the United States, the United Kingdom and China all hold significant amounts of fossil fuels. Hovering over the map reveals the total amount of carbon reserves held on each exchange.

The report’s data also goes further. Clicking on the anchor points on the map below reveals how fossil fuels are distributed across oil, gas and coal. Again, it may be no surprise that Russia is heavily weighted towards oil (holding 75.39 GtCO2), while China holds more coal (58.69 GtCO2). The map also shows the amount of “burnable” carbon. It’s a simplified figure based on the aforementioned assumption that only 20% of fossil fuels can be used, but it illustrates the scale of the problem each country faces.

So are the world’s markets taking the issues seriously? It appears legislators and central bankers have recognized there is a problem, and the Bank of England has set out its criteria for what constitutes a threat to financial stability in relation to the carbon bubble.

Other global financial institutions have also been convinced of the need to take the carbon bubble seriously. Ratings agencies have expressed concerns, as have fund managers and pension funds.

However, in the two years since Carbon Tracker’s report was recognized at the Sustainability Awards, the FTSE 350 oil and gas sector has fallen only slightly, down from around 8,852 points in March 2012 to 8,206 points in mid-February 2014, suggesting it is business as usual for UK investors in the sector. It’s a similar story in the United States, where the oil, gas and consumable fuel sector has also been performing well for the past two years.

The latest Unburnable Carbon report estimates that the top 200 oil, gas and mining companies allocated up to $674 billion in 2013 to find more carbon reserves and develop new ways of extracting them; it’s understandable why markets are still attracted to such a heavily backed sector.

However, more worryingly, investment in clean energy fell to the lowest level in four years in 2013, suggesting investors’ focus on carbon-based energy is also having a detrimental effect on the transition to a more sustainable economy.

But there is cause for hope. Just as data revealed the existence of the carbon bubble, it can also be used to educate investors so they can make informed choices about where they should be allocating funds if they want to avoid exposure to stranded, unburnable-carbon assets.

Bloomberg Money recently launched a Carbon Risk Valuation Tool, which aims to provide investors with data and analytics on the concept of stranded assets and other emerging risks. If such tools attract the attention of investors, who in turn begin to avoid companies overexposed to carbon-based fuels, then market forces dictate the same firms will have to diversify their holdings.

Let’s hope it won’t be too late to avoid another financial crisis. As the Carbon Tracker’s James Leaton noted: “Analysts say you should ride the train until just before it goes off the cliff. Each thinks they are smart enough to get off in time, but not everyone can get out of the door at the same time. That is why you get bubbles and crashes.”

Read more blogs on the environment and finance.

Author: Craig Scott is a data journalist.

Image: A labourer works at a coal factory in northwest China, January 7, 2007. REUTERS/China Daily