How much of the world’s fossil fuel reserves will eventually be burnt? This is not just a question for those concerned with climate policy. It is aLso a question for investors even if they believe (absurdly, in my view) that the science of climate change is a hoax.
What, they must ask themselves, would it mean for my investments in fossil fuel exploration and production if policy makers acted on their expressed belief in the science of climate change? Where would that leave investments in companies that own reserves today and are investing in exploration and additional production for tomorrow? Might all this spending prove a disastrous waste of resources that would be better deployed elsewhere?
Unburnable Carbon 2013, a report produced by London-based non-governmental organisation Carbon Tracker and the Grantham Research Institute on Climate Change and the Environment at the London School of Economics, raises precisely this question. The conclusion is quite simple: burning known reserves of fossil fuels is incompatible with meeting the climate targets governments have set themselves. This being so, prudent investors should apply a discount to both the value of those reserves and returns on new investments in this sector. It is possible that much of this additional spending would prove fruitless. At worst, these assets might be “stranded” forever.
In 2010, governments agreed that emissions should be kept at a level intended to prevent an increase in global average temperatures of more than 2C above pre-industrial levels. Using standard models, the report concludes that total emissions of carbon dioxide between 2013 and 2050 needed to deliver that outcome, at 80 per cent probability, would be 900 gigatonnes (billion tonnes) and 1,075 gigatonnes, even at 50 per cent probability. Then, between 2050 and 2100, emissions could be a further 75 gigatonnes, to stay below the 2C ceiling at 80 per cent probability, and 475 gigatonnes, to stay below it at 50 per cent probability. Carbon capture and storage would help, but not that much. Removing an annual flow of 8 gigatonnes of carbon dioxide in 2050 would require close to 3,800 such plants. Even so, unabated emissions must fall sharply. (See charts.)
According to the World Energy Outlook 2012, existing reserves of fossil fuels would, if burnt without capture of the carbon dioxide emissions, release 2,860 gigatonnes – roughly three times the global carbon budget. Burning this stock, without any further additions to it, would push the global average temperature up by well over 3C.
So what might this mean for the companies listed on the stock exchanges of the world? These hold reserves equivalent to 762 gigatonnes of emissions – about a quarter of the total, the rest being owned by non-listed entities, principally national oil companies. Listed companies are also seeking to develop potential reserves, to bring their total to over 1,500 gigatonnes. On its own the latter sum would exceed the limits on emissions until 2050 needed to keep the average temperature increase below 3C at a mere 50 per cent probability: thus there would be a 50 per cent chance that the rise would be greater. But listed companies would not be on their own: national companies would produce, too.
If instead the listed companies were allocated a quarter of the world’s carbon budget, in line with their share in global reserves, they could not exploit more than a third of their existing reserves of 762 gigatonnes, let alone any additional discoveries if the temperature rise is to be kept below 2C. Even going to a 3C limit would not help much. The listed companies could still not exploit even half of their reserves under that more generous ceiling.
Something then will have to give: either the world will abandon its pledge to keep emissions below the level thought to produce a temperature rise of 2C or the fossil fuel companies are holding stranded assets and investing in unusable ones. Investors are implicitly betting on the former possibility.
The oil companies are well aware of this issue. In its response to critics, ExxonMobil says that it does not envisage a low-carbon scenario of the kind many climate researchers advocate. The company believes that the costs this would entail, and “the damaging impact to accessible, reliable and affordable energy resulting from the policy changes . . . are beyond those that societies, especially the world’s poorest and most vulnerable, would be willing to bear”. Instead, the company envisages only that the flow of emissions will stop increasing some time around 2030. But it does not give projections of concentrations of greenhouse gases in the atmosphere. It also does not address temperature effects of those concentrations.
The explanation ExxonMobil gives for its optimism about demand for fossil fuels is the rising world demand for energy and the inertia in the global energy system. Even though renewable energy production will grow at a faster rate than other sources, its potential is limited by challenges of “scalability, geographic dispersion, intermittency (in the case of solar and wind), and cost relative to other sources”. The company expects that renewables will comprise only about 5 per cent of the energy mix by 2040.
The world has got itself into an extremely contradictory place. Governments have committed themselves to a view of the risks of climate change. That view implies a rapid revolution in the energy mix and correspondingly rapid reductions in emissions of greenhouse gases. But major energy producers do not believe governments will do what they promise. They envisage a very different and quite unrevolutionary energy future in which the reserves they now possess and those they plan to develop will all be burnt.
Investors have to guess not just who is more likely to be right, but what probabilities to put on the possible outcomes. I believe humanity is making risky bets in the climate casino. I think it is likely that humanity will continue to make these risky bets. In that case ExxonMobil will be proved right. But it is always possible that humanity will wake up and make the needed investments in rapid change, driven by the magic of the market and technological innovation. If that happened, fossil fuel reserves would indeed be stranded. Investors beware: the risk of that cannot be zero.
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