Recently, there has been talk of a ‘carbon bubble’. The argument is that many energy companies are significantly overvalued on the basis of their reserves of coal, oil and gas, since climate change policy will make these reserves impossible to exploit and therefore ultimately worthless. This is part of the message in the KPMG report ‘Expect the Unexpected’ covered in last week’s newsletter, which considered the impact on businesses or a range of ‘sustainability megaforces’.
Last year, a group called the Carbon Tracker Initiative published a report (Unburnable Carbon – Are the world’s financial markets carrying a carbon bubble?) which argued that only 20% of proven reserves owned by private and public companies could be burned if the world is to keep below the arbitrary figure of a 2°C average temperature rise, beyond which climate change has been judged to be dangerous.
The Carbon Tracker Initiative is, according to the information on its website, the first project of Investor Watch, a not-for-profit company ‘established by its directors to align the capital markets with efforts to tackle climate change.’ Two of the directors of Investor Watch are Jeremy Leggett (former geologist and Greenpeace campaigner, founder and chairman of SolarCentury and Solar Aid) and Mark Campanale (co-founder of a number of responsible investment products and founder director of the UK Social Investment Forum). Leggett is Chairman of the Carbon Tracker Initiative and Campanale is a director. Cary Krosinsky (VP of Trucost) is the third founder director, while James Leaton (ex-PricewaterhouseCoopers and former senior policy adviser at WWF-UK) is project director.
This is clearly a serious initiative from people with a long-term commitment to renewable energy and climate change policy. Not only are they suggesting that the world’s major energy companies are significantly overvalued, they are also highlighting the reserves of companies being privatised and questioning the valuations the markets are placing on them.
But the Carbon Tracker Initiative is not the only game in town; it forms part of a broader coalition advocating change. In January, an open letter was sent to Sir Mervyn King, governor of the Bank of England, urging him to address the ‘carbon bubble’ issue. The letter was signed by a number of what the Business Green website described as ‘some of the UK’s most influential green business leaders and campaigners’, including Jeremy Leggett, Zac Goldsmith MP (who generally seems to be keeping a low public profile since his election), Sir David King, John Gummer, John Sauven of Greenpeace and James Cameron and Ben Caldecott of Climate Change Capital.
It was reported (Sir Mervyn King hints at possible ‘carbon bubble’ investigation) that this call could be taken seriously. In fact, the governor simply stated the conditions which would have to be met for the Financial Policy Committee to investigate: “First, he said the exposures of financial institutions to carbon-intensive sectors would have to be large relative to overall assets. Secondly, it would have to be demonstrated that ‘the impact of policy and technology working to reduce returns in high carbon areas is not already being priced into the market assets’. And finally, King argued evidence would have to be provided that any market correction would take place too quickly for financial institutions to adjust their portfolios.”
Since then, Graig Mackenzie, Head of Sustainability at Scottish Widows Investment Partnership, has argued that current valuations are based on revenue expectations rather than total reserves, and that most mining companies are anyway quite diversified (Climate change and systemic risk – the analysts make their case). In other words, the market is quite capable of adjusting when the time comes.
So, on the face of it, the carbon bubble might not be a serious one. The concept is, after all, based on the logic that a) the positive feedback mechanisms postulated by the IPCC view of climate are real, b) that the computer models can predict the average temperatures and regional weather patterns in coming decades reasonably reliably and c) that an average temperature rise of 2°C would result in significantly more problems than benefits. Currently, all of this is conjecture, and to re-engineer financial markets on this basis seems premature.
However, attempts have meanwhile been made to create a viable carbon market and a range of green investment vehicles. Large amounts of money are changing hands on the basis that carbon is a tradable commodity like any other and that the public subsidy necessary for the renewable energy sector to continue to grow is now permanent. Given that climate does not seem to be changing in the way models predict, despite the increasing use of fossil fuels, this must put the future of these markets in doubt. The carbon price is already too low to be a big enough driver of the sort of change the government would like to see.
Free markets place a value on a commodity based on its scarcity. That is why energy prices have risen in recent years: the growth in demand for oil is tending to outpace the increase in extraction rate. But there is no scarcity of carbon. The market has been created artificially, and an artificial market can just as easily be destroyed. This puts at risk the funds being invested in a range of green energy projects. The prospect of a green investment bubble currently seems greater than that of a carbon bubble.
The Scientific Alliance
St John's Innovation Centre, Cowley Road, Cambridge CB4 0WS