Are we on the verge of "the largest bubble ever", as the former United States vice president Al Gore puts it? He argued this month that to meet environmental goals, trillions of dollars of assets worldwide – particularly oil, gas and coal reserves – were "unburnable carbon".
Action on climate change would mean at least two-thirds of those reserves would have to be left in the ground. And a collapse in the value of major fossil fuel companies could trigger another financial crisis.
He called on companies and investors to assess and disclose the carbon risks in their investments, diversify into renewable energy and stop investing in new carbon-intensive projects.
Greenpeace, of course, goes further and argues that since current fossil fuel reserves are already enough to cause catastrophic climate change, exploration for new resources should stop entirely.
Should companies assess the impact of climate policy on their assets? Of course, and many already do so. Major oil companies such as BP and Shell have included carbon in their assessments since the late 1990s. The slow pace of global climate policy to date just does not suggest stringent reductions in emissions are likely any time soon – and investors know that.
Of course, a series of natural disasters linked to climate change, or a sudden rapid warming of the climate, might change the political situation and lead to stringent policies to reduce carbon dioxide emissions. But that would have a major impact on the whole economy, not just the fossil fuel sector.
More likely, a slow strengthening of climate regulations – carbon taxes, renewables targets and so on – is already included in projections for demand and prices of fossil fuels. Even in the International Energy Agency’s scenario for tight restrictions on carbon, fossil fuel consumption falls by just 11 per cent by 2035.
In 1986, the oil price collapsed to US$14 a barrel from $30 almost overnight – and while oil companies and countries were badly hit, the global economy grew strongly. So incremental changes in climate policy are well within the range of normal business risks faced by companies.
Events in 2035 contribute almost nothing to the valuation of an oil or gas company. At a typical discount rate of 10 per cent, a dollar earned in 2035 is worth just 12 cents today. And Shell’s “reserves life” – its reserves divided by the annual production rate – is just 11 years, showing that the majority of its current reserves will have been produced long before 2035. The vast bulk of fossil fuel reserves are held by coal giants such as India and China, and state oil and gas producers in Saudi Arabia, Qatar and Iran, not by publicly traded companies.
The concept of a “carbon bubble” also assumes that fossil fuels cannot be part of a climate-friendly future. But oil is still essential in cars and planes, and has no real current competitor. Gas is a low-carbon fuel anyway and by 2035, its use is likely to increase substantially to replace coal and support renewable energy. And coal power plants, though the dirtiest source of electricity, can be fitted with carbon capture and storage to eliminate most of their emissions – as can gas plants.
But for one class of investors – major petroleum exporters – the “carbon bubble” is more serious. These countries depend on their oil and gas earnings to power their economies, and they have long reserve lives, up to a century. Though not doomed by Mr Gore’s “bubble”, concerted global action on climate change does present them with serious, albeit long-term, challenges. This is one more reason for the Opec states, including the UAE, to diversify their economies, move to lower-carbon and more efficient systems at home, and advocate stringent but sensible climate policy abroad.
Robin Mills is Manaar Energy's head of consulting, and the author of The Myth of the Oil Crisis
