April 12, 2013

Carbon Bubbles

A report last year from Carbontracker, in London, draws attention to the financial solvency of major fossil fuel producers. Its study, Unburnable Carbon, has had a big impact. Bill McKibben, of 350.org, has rallied students at the nation's leading colleges and universities, 250 at last count, to demand that their schools' endowments divest from the 200 companies listed on world stock exchanges that hold fossil fuel reserves. (The divestment would take place over a five year period.) The divestment movement raises a lot of questions, but here I want to focus on the Carbontracker report, both in the way of summarizing its conclusions and pointing to some weaknesses therein.   

According to Carbontracker, “The total carbon potential of the Earth’s known fossil fuel reserves comes to 2795 GtCO2 [gigatons of carbon dioxide]. 65% of this is from coal, with oil providing 22% and gas 13%. This means that governments and global markets are currently treating as assets, reserves equivalent to nearly 5 times the carbon budget for the next 40 years. . . .We estimate the fossil fuel reserves held by the top 100 listed coal companies and the top 100 listed oil and gas companies represent potential emissions of 745 GtCO2. This exceeds the remaining carbon budget of 565 GtCO2 by 180 GtCO2.”


Such reserves, the report notes, cannot be burned if the world is to stay within its carbon budget. "Only 20% of the total reserves can be burned unabated, leaving up to 80% of assets technically unburnable."
This has profound implications for the world’s energy finance structures and means that using just the reserves listed on the world’s stock markets in the next 40 years would be enough to take us beyond 2°C of global warming. This calculation also assumes that no new fossil fuel resources are added to reserves and burnt during this period – an assumption challenged by the harsh reality that fossil fuel companies are investing billions per annum to find and process new reserves. It is estimated that listed oil and gas companies had CAPEX budgets of $798 billion in 2010. In addition, over two-thirds of the world’s fossil fuels are held by privately or state owned oil, gas and coal corporations, which are also contributing even more carbon emissions.
Given that only one fifth of the total reserves can be used to stay below 2°C warming, if this is applied uniformly, then only 149 of the 745 GtCO2 listed can be used unmitigated. This is where the carbon asset bubble is located. If applied to the world’s stock markets, this could result in a repricing of assets on a scale that would dwarf past profit warnings and revaluation of reserves.
Let us extrapolate a bit from Carbontracker's figures, which are admittedly astounding in showing the scale of the challenge. If we are to stay below two degrees of warming, the world can burn only 886 GtCO2 from 2000 to 2050. That is “the global carbon budget.” But in the first decade of this century the world used up over a third of its budget, having burned, according to one calculation, some 282 GtCO2, with land use change adding another 39 GtCO2. So that reduces to 565 GtCO2 the carbon budget for the years 2011-2050. Ignoring the “land use change” factor for the moment, that basically indicates that 28.2 GtCO2 was the amount burned per year in the first decade. In the next four decades, the amount would have to fall by half (565/40), to average 14.125 GtCO2 per year. Barring catastrophe, of course, an immediate reduction of fossil fuel use by half is impossible, so one would have to imagine a sharply descending line like that projected by Greenpeace in a recent report, with emissions in 2050 far below the 14.125 figure. (See further here.)

Carbontracker then asks fossil fuel companies--together with regulators and pension funds--to consider the following questions in stating and understanding their financial accounts:  

• Which of the assets you have an interest in are amongst the 20% of fossil fuel reserves we can afford to burn in the next 40 years?

• If you sanction capital expenditure on finding and developing more reserves, just how likely is it that those new reserves can ever be burned?

• What discount rates would it be prudent for investors to use when valuing reserves? Are historical discount rates too optimistic given the likely haircut to reserves values that corporate owners of fossil fuels are likely to have to take?

Furthermore, as the regulators of the capital markets will need to look closely at disclosures and reporting requirements around how reserves are presented, accountants and auditors will need to revise guidelines on how value is recorded:

• If not all reserves that are exchange listed can be burnt, how should auditors account for these stranded assets?
• What assumptions need to be reviewed in order to create a reliable assessment of which assets are contingent or impaired?

* * *

Carbontracker undoubtedly raises a set of important questions, but its approach also has some serious limitations.

First, it mixes together the reserves situation for coal, oil, and gas in a way that is distorting. Coal reserves are enormous and constitute, as Carbontracker notes, some 65% of the carbon potential of proven fossil fuel reserves. But the "reserves to production" ratio for coal is far larger than for natural gas or for oil. BP pegs the reserves to production ratio for coal at 112 years, 63.6 for natural gas, and 54.2 for oil, and even those aggregate figures conceal important regional variations.

Second, the fossil fuel reserves of companies listed on stock exchanges account for only 26.6% of total fossil fuel reserves.

Both of those points are relevant to the movement to divest from fossil fuel companies. The former raises the question whether it makes sense to focus on all fossil fuels. There are trade-offs among all fuel sources in terms of environmental impact, but King Coal is undoubtedly the dirtiest and most productive of CO2 emissions. Surely some discrimination among fossil fuels is desirable: Is there really no room to replace coal with natural gas in electricity generation? Are we to build more dams, produce more biofuels, or build more nuclear reactors to make up for the lost production? I just don't see "no fossil fuels," never, ever, as a viable energy policy.

The second point reflects a sigificant real world conundrum: pressure on the western oil majors, if effective, could simply redound to the benefit of the National Oil Companies (or NOCs), which hold some seventy five percent of world oil reserves. (Some studies put the figure even larger, at 90 percent.) The majors are much diminished from their former days of glory in control of the world oil industry; the nationalizations of the 1970s saw to that. Aiming at them illuminates only a limited portion of the intended target.

But the biggest reservation about Carbontracker's approach--and the approach, as well, of those who have followed its methodology in the divestment movement--is its one-sided focus on the supply side.

Unless we make heroic assumptions about the complete transformation of energy infrastructure in a short period of time, the sectors of the economy that depend on energy consumption would clearly be greatly affected by a radical reduction in fossil fuel use, perhaps even more than the fossil fuel producers themselves. Leave aside that oil-service firms, like Halliburton, do not fall under the proscription of Carbontracker or the divestment movement; what about oil refineries, steel producers, automakers, airliners? What would be their enterprise value under the assumption (a radical reduction in fossil fuel use) that Carbontracker is applying to the 200 companies it singles out? Since the entire economy is fossil fuel dependent, it seems strange that Carbontracker, ostensibly concerned with such things as fiduciary responsibility and the accurate reporting of assets, should be so incurious about the implications of its projections for the larger financial structure.


The challenges posed by the energy transition are undoubtedly enormous, and Carbontracker's calculations have the merit of drawing attention to the contradiction between "business as usual" approaches and the forecasts of impending doom coming from climate scientists. If its financial analysis seems rather otherworldly (with no adequate discussion of alternative supply, likely demand, and expected price), it nevertheless raises vital questions.

Carbontracker does not call the fossil fuel companies evil, but rather actuarially unsound. However, the divestment movement, which has run with Carbontracker's report, has not hesitated to denominate them as such. By contrast, I object to any approach that draws a ring of fire around the fossil fuel companies and denominates them as wicked, while in effect leaving the consumers of energy off the hook. Such an approach seems to me unbalanced and myopic. It also ignores the fact that the provision of energy, in the modern industrial civilization we inhabit, provides indispensable contributions to human welfare. We have excellent grounds for believing that such consumption, on current trends, will likely produce grim environmental consequences in the future, but also ample reason to believe that going cold turkey from fossil fuels would produce delerium tremors in the patient, and probably kill him. A resolution to this profound dilemma, distant though such a resolution may now appear, is one of the great challenges of the coming century, but I resist the idea that absolutist strategies constitute progress in dealing with it.

April 13, 2013

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