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Popping the Carbon Bubble
By Holly Testa, Director, Shareowner Engagement

The next global financial market upheaval may well be the popping of the “carbon bubble.” The so-called carbon bubble is forming on top of the fossil fuel assets—coal deposits and oil and gas reserves—that are reported on corporate and government balance sheets worldwide. These reserves are highly valued and financial markets assume they will eventually be extracted and exploited.

But what would happen if these assets could not be developed? A new report from Carbon Tracker and the Grantham Research Institute on Climate Change and the Environment, Unburnable Carbon 2013: Wasted Capital and Stranded Assets provides us with a stark assessment of the potential impact.

The report evaluates the ramifications of world governments taking action to meet the internationally agreed targets confirmed in the Cancun Agreement of 2010 which stipulate that carbon omissions should be reduced to avoid a rise in global average temperature of more than 2°C above preindustrial levels.

The bottom line? At least two thirds of reserves currently held by fossil fuel companies would have to remain in the ground to avoid breaching this agreement. In this scenario, the value of these “unburnable” assets on company balance sheets could be close to zero.

The financial implications of this outcome could be staggering. A recent HSBC study estimates that oil and gas majors, including, BP, Shell, and Statoil, could face a loss in market value of up to 60% should the international community stick to its agreed emission reduction targets. Companies with substantial assets in the more carbon intensive reserves such as coal and oil sands are likely to be at most risk.

Are We Investing in Valueless Assets?

Given the continued strength of fossil fuel companies in global stock market trading, it is apparent that most investors are betting that governments won’t act to hold the global temperature change to less than 2 degrees centigrade.

Fossil fuel companies are also making a major bet with shareowner dollars—the Unburnable Carbon 2013 report estimates that the top 200 oil and gas and mining companies have invested up to $674 billion just in the past year to develop more reserves and find new ways of extracting them. If we are indeed going to live in a “carbon constrained world,” these investments are being wasted and should be redeployed to develop low carbon options.

Jeremy Grantham, a billionaire fund manager who oversees $106 billion of investment assets, said his company was on the verge of pulling out of all coal and unconventional fossil fuels, such as oil from tar sands. "The probability of them running into trouble is too high for me to take that risk as an investor." He said: "If we mean to burn all the coal and any appreciable percentage of the tar sands, or other unconventional oil and gas then we're cooked. [There are] terrible consequences that we will lay at the door of our grandchildren."

Mention of specific companies or securities should not be considered a recommendation to buy or sell that security. Past performance is no guarantee of future results.

Posted: June 24, 2013