Monday, April 22, 2013

Will the Carbon Bubble Burst?

By Nick Cunningham

methane flaring on offshore oil rig
(photo: Pacific Northwest Lab)
In 2010, participating nations in the UNFCCC negotiations on climate change agreed in Cancun to limit global warming to 2 degrees Celsius. In order to avoid breaching this threshold, according to the Carbon Tracker Initiative, all nations would have to limit greenhouse gas emissions to 565-886 billion tons (gigatons, or Gt) of carbon dioxide between now and 2050.

This so-called "carbon budget" stands in stark contrast to the 2,860 Gt of carbon dioxide that would be emitted by simply burning through known reserves of oil, coal and natural gas. Burning these known resources of fossil fuels would mean we would blow past our 2 degree target and careen towards a much more dire situation as climate change starts to slip out of control.

However, the Carbon Tracker Initiative does not believe humanity would condone such a scenario, and they argue that mounting public pressure as well as the determination of politicians and regulatory bodies to achieve the 2 degree target would result in a lot of fossil fuels that would have to stay in the ground. This "unburnable" carbon amounts to 60-80% of the reserves owned by companies listed on stock exchanges. In other words, major oil, coal and natural gas companies would be stuck with stranded assets. The Carbon Tracker Initiative estimated that $6 trillion will be spent on developing fossil fuels in the next decade, and if we are to stick to our carbon budget, much of this money will be wasted on "unburnable" fossil fuels.

As a result, many of the major fossil fuel companies present serious financial risks to investors, as the "carbon bubble" continues to inflate. Lord Nicholas Stern, a revered voice on climate change, warned that the carbon bubble could result in a massive financial crisis. The trillions of dollars invested in fossil fuels will have to be divested as the world begins to address climate change. However, investors and market watchers are thus far oblivious to the financial bloodshed that is coming down the road, putting more than fossil fuel companies at risk. The financial system is in peril, Lord Stern warns.

It is worth noting that not all financial entities are ignoring climate change. Standard and Poors, a credit rating agency, warned of credit downgrades for major oil companies in the future because of action on climate change.

Still, when you take a step back, it is remarkable at how poor the market is at handling such long-term risk. Investors only think about short-term profits. Long-term investments tend to mean making bets on quarterly earnings. Therefore, investors will ride the fossil fuel bubble until it becomes clear that it is on the way down. At that point, the bubble will burst as everyone scrambles for the exits.

Huntington coal plant, Utah (photo:
It is a sacrosanct axiom that the market allocates capital to its most efficient use. However, that can't be true if the market is allocating vast sums to assets that will inevitably become worthless. On the other hand, should these investments actually pay off, then what does that say about society's priorities? A small number of people make a lot of money engaging in an activity that puts the planet, and human existence, into peril.

New economic models may be needed, but in the meantime, capital flows towards profitable activities. But, policymakers play an integral part in outlining the parameters within which investors find profitable ventures. In other words, Congress could pass a steep carbon tax, and all of a sudden, oil and gas companies may not look like a safe bet. Climate-friendly policies in the near-term could begin to deflate the carbon bubble.

Seeing the writing on the wall, fossil fuel companies have activated a massive PR and lobbying campaign to stave off any attempts at dealing with greenhouse gases. In 2012, for example, according to Open Secrets, Royal Dutch Shell spent $14.5 million on lobbying, Exxon Mobil spent $12.9m, and Koch Industries spent $10.5m. This, in a year in which there was no prospect of Congress actually doing anything on climate change. Imagine what the industry will spend when climate legislation becomes more viable.

I am pessimistic about the ability of politicians to make decisions that are good for society over the long-term, especially when there is a lot of money to be made. I fear we will keep our heads in the sand until climate change becomes impossible to ignore - at which point, it will be a little late in the game. 

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