Capital markets may be creating a so-called carbon bubble by mispricing known fossil fuel reserves as assets, leaving investors with a systematic risk to their portfolios, new research claims.
The research published by Carbon Tracker looks at the total known and listed fossil fuel reserves and compares them to what a possible global carbon budget would be if the world is to meet its current commitments to limit global warming.
It argues that the market is mispricing fossil fuel reserves because large amounts will be left “stranded” if the world economy is to move to a lower-carbon emitting model.
The report “Unburnable Carbon – Are the world’s financial markets carrying a carbon bubble?” also looked at the world’s stock markets and calculated that countries with the largest greenhouse gas potential in fossil fuel reserves on their stock exchanges were Russia, the United States and the United Kingdom.
The stock exchanges of London, Sao Paulo, Moscow, Australia and Toronto all have an estimated 20-30 per cent of their market capitalisation connected to fossil fuels, the report found.
The research takes as its starting point last year’s Cancun Agreement which saw an international commitment to limit global warming to 2 degrees Celsius.
Carbon tracker – an initiative which aims to work with capital market regulators and investors to assess systematic climate change risks – then builds into its own modelling research by the Potsdam Institute that calculated the carbon reduction necessary to not exceed this 2°C warming target.
The institute calculated that to reduce the chance of exceeding a 2°C warming by 20 per cent, the global carbon emission budget from 2000-2050 was 886 Gt CO2.
Carbon Tracker then looked at the world’s known fossil fuel reserves, which have a carbon potential of 2795 Gt CO2, and calculated that governments and global markets were currently treating these reserves as assets when in fact just 20 per cent could be burned if a 2°C target was to be achieved.
The report found these reserves were equivalent to nearly five times the carbon budget for the next 40 years.
“Currently financial markets have an unlimited capacity to treat fossil fuel reserves as assets,” report authors Mark Campanale and Jeremy Leggett write in their report.
“As governments move to control carbon emissions, this market failure is creating systematic risks for institutional investors, notably the threat of fossil fuel assets becoming stranded as the shift to a low-carbon economy accelerates.”
The report also analysed the fossil fuel reserves of the top 100 listed coal companies and the top 100 listed oil and gas companies and found their fossil fuel reserves alone represent 745 Gt CO2.
This is in excess of the 565 Gt CO2 the Potsdam Institute calculates as the remaining carbon budget for the next 40 years if the 2°C limit on global warming is likely to be achieved.
These coal and oil and gas companies represented $7.4 trillion in value as at February 2011, the report says.
The report notes that in addition to the reserves of established companies, new listings of fossil fuel companies as well as public listings of large state-owned energy companies in the developing world will further add substantially to listed fossil fuel reserves.
The report encourages investors to look at which stock markets they are exposed to that may have greater proportions of fossil fuel producing companies and would, therefore, be more prone to stranded assets.
Investors are also advised to examine if conventional indexes that are potentially fossil-fuel-heavy are the long-term performance benchmarks for their portfolios.
Finally, the report calls for investors to look at their asset allocation models to see if they are address risks associated with fossil fuel reserves and may be exposed to potentially stranded assets.
The full report can be viewed here