Overvalued oil, coal and gas reserves could lead to financial crash

Fossil fuel reserves owned by listed companies pose a threat to the global economy as well as the climate, warns a new report

A giant fossil-fuel investment bubble on the world’s stock markets could trigger future economic mayhem, economists have warned in a new report.

Lord Nicholas Stern, the British economist who shot to fame in 2006 after publishing a UK government commissioned review on the economics of climate change, is among the voices warning that oil, coal and gas reserves are seriously overvalued, creating risks of a further blow to the world’s already fragile economy.

He says far more fossil fuels are currently listed as assets by energy companies on global stock exchanges than can be used, if the world has any chance of meeting current climate change objectives.

“If we burn all current reserves of fossil fuels, we will emit enough CO2 to create a prehistoric climate,
 with Earth’s temperature elevated to levels not experienced for millions of years,” Stern wrote in the foreword to the report, a collaboration with the Carbon Tracker Initiative (CTI).

The study, supported by organisations including HSBC and the International Energy Agency, concluded that between 60-80% of coal, oil and gas reserves of publicly listed companies are “unburnable” if the world is to have a chance of warming by less than 2°C, the international climate-change goal agreed at UN talks in 2009.

Despite this fact, the fossil fuel reserves owned by listed companies have continued to rise. Oil, gas and coal mining companies spent US$674 billion trying to expand their reserves in the past year alone, said the report.

These aren’t the first warnings about the economic risks posed by “unburnable carbon” – essentially useless assets – on the stock exchange.  Writing on chinadialogue in March 2012, CTI’s James Leaton said financial markets were in denial about the realities of climate change:

The message is clear: even when you apply a generous carbon budget and a narrow scope of reserves, we can still only afford to burn a fraction of fossil-fuel reserves if we are serious about tackling global warming. This indicates that the financial system does not yet take climate-change targets seriously. If it did, then it wouldn’t sanction billions of dollars of capital investment in finding more reserves each year…At present, the financial markets are in denial: backing all sectors, despite the fact that they can’t all win.

Such comments are part of an increasingly popular school of thought that links the world’s economic outlook to its ecological fate. It is a discussion that goes beyond carbon emissions: the idea that the world’s stock of ecosystems – or “natural capital” – underpin the global economy and provide crucial benefits to business has started to infiltrate economic thinking.

The UNEP finance initiative, for example, said the failure to reflect the role of earth’s ecosystems in company balance sheets has created unstable markets, drawing comparisons with the risks inherent in the 2008 financial system in a chinadialogue article in February.

Nick Robins, now head of HSBC’s Climate Change Centre of Excellence has also called for a new approach to investment that goes beyond delivering short-term profits:

The duties of investors need to be brought into line with a carbon-constrained world. Managers of institutional investments – whether pension or mutual funds – are governed by the concept of fiduciary duty, ensuring that their decisions are prudently made in the best interests of the end-beneficiaries. This has commonly been interpreted as meaning the maximisation of short-term returns, without regard to wider social or environmental realities. The harsh facts of climate change – along with other sustainability threats – should prompt governments to modernise this interpretation.

By updating financial regulation and investor duties to take account of carbon, governments would not only make the achievement of climate goals more likely, but could also help secure stable investment returns at a time of a global pension crisis. The prize is clear, and it’s worth at least twenty trillion dollars.

The discussion is important, not least because it broadens the environmental debate beyond the usual suspects and includes groups such as financial institutions, investors and businesses. Convincing these players that their own interests are at stake is crucial to the climate change response.

But some of the warnings still require a leap of imagination. To make the idea of “unburnable carbon” meaningful, the world’s governments would actually have to do something concrete about global warming that would prevent humans burning our way to disaster. That still seems a long way off.