The vast majority of known fossil fuel reserves will have to remain untapped if we are to avoid a rise in global temperature beyond the agreed 2°C target. Should this target be met and/or fossil fuel companies fail to introduce mitigating technology such as CO2 Capture and Storage (CCS), trillions of euros stand the chance of being wiped off stock markets with considerable consequences for the world’s economies. As of yet, however, markets are not taking this risk into account, as the implosion of the ‘carbon bubble’ remains pending.
Bellona has looked at the role of CCS to mitigate both climate change and the carbon bubble. CCS is the only low carbon technology that reduces the financial risk of a carbon bubble because it allows fossil fuels to be used in a way that is consistent with the aim of reducing emissions. But with Global CCS Institute’s (GCCSI) 2013 CCS status report finding the number of CCS projects reduced, investment and deployment will need to be stepped up. The latest carbon bubble analysis also reaffirms the need to rethink investments.
The carbon bubble has popularly been analyzed in the ‘Unburnable Carbon 2013: Wasted Capital and Stranded Assets’ report by Lord Stern and Carbon Tracker, a think tank working on the alignment of capital markets with climate change policy. Carbon Tracker has now teamed up with the Association of Chartered Certified Accountants (ACCA) and released a new report this month: ‘Carbon Avoidance: Accounting for the Emissions Hidden in Reserves’.
This latest publication investigates whether current market reporting standards send appropriate warning signals or ‘flag up’ the systemic risks of climate change to the fossil fuel industry. It finds that the current system does in fact struggle to do so. With an increasing risk that much of fossil fuel reserves will become stranded, these assets nonetheless consider to be recognized on companies’ accounts and remain incorporated into their stock market value. If these assets face an impending risk of becoming worthless, either in the face of irreversible climate change or due to climate policies being better adhered to, investors – and the overall economy – ought to know.
The report states a clear need for markets to become more ‘climate literate’, with investors needing “more complete, forward-looking and integrated information on greenhouse gas (GHG) emissions and fossil fuel reserves in order to understand better their exposure to climate change risks”.
The first step toward improved climate literacy is to get an accurate understanding of how much of fossil fuel companies’ revenues depend on their fossil fuel reserves. Or in other words, how much of their revenue will emit CO2.
The potential GHG emissions of a company should, according to the report’s suggestions, be integrated into company listing requirements. Not doing so is in effect denying investors critical information about the future of their investments. Standard accounting practices exist today that could be adapted to do so and incorporate the carbon bubble risk, for instance by applying an ‘impairment’ approach indicating when an asset is likely to later loose value.
Other suggestions in the report, to adequately include climate change in market analysis, include:
- Converting reserves into potential carbon dioxide emissions
- Producing sensitivity analysis of reserves levels in different price/demand scenarios
- Publishing valuations of reserves using a range of disclosed price/demand scenarios
- Discussing the implications of this data when explaining their capital expenditure strategy and risks to the business model.
Current company strategies and forecasts are increasingly at odds with emissions limits. Fossil fuel companies and their investors therefore need to fundamentally reconsider the way they value their assets, both today and looking into the future. Carbon reporting is not yet as systematic and integrated as it needs to be to fully account for the risks involved in holding an asset which is increasingly susceptible to a huge drop in demand, either as climate change intensifies or mitigating policies strengthen. Unless fossil fuel companies incorporate climate change mitigating technologies such as CO2 Capture and Storage (CCS), their value will inevitably decline. As the report states: “The risk of a ‘carbon bubble’, as a result of an excess of fossil fuel assets, is substantial.”