Thursday, May 16, 2013

The Carbon Bubble

Here's a fascinating report...authored by Nicholas Stern (London School of Economics and author of The Stern Review on the Economics of Climate Change) and institutions like HSBC, Citi, Standard and Poor's and the International Energy Agency as well as the Bank of England. I'll summarize for you:

The share price of oil, gas, and coal companies (quite a few of which are nationalized - owned by governments, that is) depends to a large extent on their stated reserves. Governments make money off of the companies (royalties) and use it to fund public services. Companies traded on the stock markets form part of many people's RRSPs and pension funds, especially here in Canada. We are all heavily financially dependent on these stated reserves. Now, the important point is that whether or not those reserves can actually be extracted is apparently not part of their valuation.

What would happen if these reserves could not actually be used, and this were somehow to be captured in the financial statements of the companies? This is what the report explores. These assets would then be "stranded", and companies would take a huge hit to their share values - the report finds the total amount is somewhere in the neighborhood of 4 trillion dollars. This is an alarmingly large number. Such a bursting bubble would have a huge - and negative - effect on economies all around the world. Think the current financial crisis is bad? You ain't seen nothin' yet.

But why worry? Why wouldn't we dig up and burn all this carbon? Well, it turns out that if you add up all the stated coal, gas, and oil reserves of all the companies that trade publicly (and hence make such figures available), you wind up with a figure that is far, far larger than would be allowed if we were to limit ourselves to the 2C temperature rise that scientists deem prudent, and that most governments have pledged to stay below.

The maximum amount of carbon that can be allowed into the atmosphere while keeping below this temperature increase is about 1000 Gigatonnes. The total declared reserves of carbon (currently safely sequestered)? 2860 Gigatonnes.

So, clearly there is something amiss. Someone is not connecting the dots. Companies and governments alike appear to be betting that climate policies will fail, and that their stated reserves can and will be developed, so that the current market valuation is correct and that their financial planning is hunky-dory. The corollary is, of course, that the global climate is basically screwed.

Of course, this is not what any government or energy company says, publicly. All claim to be green, and the big oil companies say they are using "carbon pricing" to help make investment decisions. But the market is very clearly not pricing carbon assets in this way.

The bottom line is this:
  • either we burn up all the reserves we've got (and some of us get stinkin' rich in the process!), signing the planet up for a trip back to the Eoceneor
  • the valuation of these reserves gets adjusted through a combination of government action (ie. declaring that nationalized firms will leave the assets in the ground, rendering them valueless) and regulation (ie. forcing independent publicly traded firms to disclose the amount of carbon in their reserves and instituting some kind of carbon-limit-driven pricing scheme), which will lead to the bursting of a financial bubble of gargantuan proportions. Your Canadian RRSPs? Provincial resource royalties? Kiss them goodbye.
Either way, this is looking really, really ugly.

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