Carbon bubble? What carbon bubble?

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Are investors finally taking notice of the threat of a carbon bubble – the valuation ascribed to listed equities for fossil fuel resources that remain in the ground, and may not be exploited in the transition to a low carbon economy? If there is a problem, the regulatory authorities are not letting on.

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It was interesting to hear in the past week that both BHP Billiton and Rio Tinto are reviewing investments in some major projects and are under pressure from fund managers to return some capital to shareholders, rather than splurge on new ventures.

It was, they said, all about managing risk. It might be tempting to think that fund managers are starting to wake up to the prospect that a low-carbon economy will result in stranded investments, particularly those made now on the assumption that little will change. It is likely that this episode of review is prompted by a review of world growth forecasts, or more particularly China’s.

Still, the idea that institutional investors are keeping a close tabs on the spending plans of the companies they invest in is reassuring. In an era of investments that amount to tens of billions of dollars, the prospect that an asset will prove stranded or sub-economic by changes in demand, is one to focus the mind.

The issue of stranded assets is a potent one in the climate change debate. We’re not just talking about coal-fired power stations that may be rendered uneconomic by emissions standards, a carbon price, or even the impact of solar energy, this is about in-ground resources that are yet to be exploited, and the tens of billions in infrastructure that needs to be built to support it.

Australian mining baron and aspiring ship builder Clive Palmer, in a revealing interview on the ABC TV show Australian Story earlier this week conceded that most of his assumed wealth of $5 billion lies in the ground – billions of tonnes of coal in the Galilee Basin that he is yet to dig up. He’d very much like to dig it up, and soon, because the opportunity may soon pass. Coal miners may have less difficulty finding finance for their operations, because the mine life is relatively short. Of more concern to investors is the longer life of the supporting infrastructure, such as the numerous port facilities planned for Queensland, required to deliver that coal to Asian customers.

Of even more concern to some investors is the fact that the valuations of many listed companies are also largely based on resources that have not been dug up, and are not likely to be for many years.

This has been the basis for concern of the Carbon Tracker initiative, working on the findings of the carbon budget estimates completed by the Potsdam Institute and cited by the International Energy Agency.

Based on that report, a group of 20 investors wrote to the Governor of the Bank of England earlier this year, asking if he shared their concerns about systemic risk to the financial system, because key financial indices such as the FTSE 100 relied so heavily on high-carbon investments. The governor, Mervyn King, said he would reflect on the question.

A similar query was also sent to Olin Rehn, the EU commissioner for economic and monetary affairs, by Reinhard Buetikofer, vice-chair of the Greens-European Free Alliance bloc in the European Parliament. Rehn was asked if he saw a systemic risk in the high concentration of high-carbon assets in major European stock exchanges.

“No,” was the short answer. And you’d hardly expect him to say otherwise. The Europeans have enough problems as it is without contemplating carbon bubbles.

“The claimed kind of mispricing should hardly be able to cause adjustments on stock prices that could trigger a systemic financial crisis,” Rehn wrote in a reply emailed to Buetikofer’s office and forwarded to Bloomberg.

However, as Bloomberg noted, banks, funds and institutional investors are increasingly seeking clarity from government and monetary authorities about carbon pricing and how greenhouse gas emissions may affect the value of their investments.

This has been underlined by landmark reports from the likes of Mercer and KPMG, who have suggested that climate and carbon issues will become increasingly important for investors in managing risk.

KPMG said climate change was one of 10 mega-forces that investors would need to deal with in the next two decades, while Mercer suggested that asset owners will need to migrate up to 40 per cent of their portfolio towards “climate-sensitive investments” to capture the upside of policy changes. And that their processes for managing carbon and climate risk were completely inadequate.

The UK investors had argued that they may end up with “stranded assets and poor returns” because of investments in industries with high carbon emissions. They noted that five of the 10 biggest companies on the UK stock exchange were “almost exclusively high-carbon” (and much of this was based in Australia).

In the response cited by Bloomberg, Rehn said a drop in the value of carbon-intensive companies seems “unlikely” because they are propped up by “rapidly” growing demand for commodities such as oil with limited proven reserves. He said that work to reform capital requirements for banks and insurance funds will improve their ability to absorb losses.

According to the Bloomberg article, Buetikofer was not impressed. “Foresight doesn’t seem to be the commission’s strong suit,” he said in an email to the news agency. “The systemic criticality of highly CO2-intense investment cannot be underrated if we don’t want to expose our economy to dangerous yet avoidable risk.”

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1 Comment
  1. Gillian 7 years ago

    Thanks Giles, very informative! I suspect that the role of banks and insurers in pricing climate risk could be the accelerant that really boosts the transition to clean energy.

    In my blog I have compared stranded assets with stranded whales.

    http://thisnessofathat.blogspot.com.au/2012/05/stranded-whales.html

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