The financial threat of unburnable carbon

PeterMarkhamFlickr

The value of fossil fuel companies is directly linked to the amount of coal, oil and gas that control and can physically burn.

Climate policies established by governments to limit global warming restrict the amount of fossil fuels that can be safely burnt whilst remaining within planetary boundaries.

These policies reduce the volume of usable fossil fuel reserves and therefore the market value of fossil fuel companies. The resulting excess reserves are known as unburnable carbon.

According to calculations by research group Carbon Tracker up to 80 percent of oil, gas and coal reserves listed on stock exchanges are unburnable if we are to limit global warming to 2 degrees C. Naturally even more fossil fuels are unburnable if we are to reach the UN’s aspiration of limiting global warming to 1.5 degrees C.

Market values and the business models of fossil fuel companies do not reflect the limits established by policy commitments. Companies such as BP and Exxon Mobil are extracting fossil fuels for a world warming by 6 degrees C.

If and when a 2 (or 1.5) degree limit on warming is properly enforced this carbon bubble will burst and fossil fuel companies share value will plummet.

They will not be able to sell their unburnable carbon reserves, and they will be burdened with useless machinery and infrastructure, no longer required due to declines in fossil fuel valuations, extraction and consumption.

Climate change can be expected to burden fossil fuel companies with stranded assets in a number of ways:

  • Regulatory stranding: a change in policy or the law limits or bans extraction;
  • Economic stranding: the costs of extraction rise above the market price of a resource;
  • Physical stranding: longer transport distances, extreme weather effects, flooding of mines and wells, droughts etc;

Scientists, advocacy groups and environmentalists have known for decades of the threat runaway climate change poses to society and our environment.

What these new concepts, the carbon bubble, unburnable carbon, and stranded assets, articulate coherently for the first time the financial risk that climate change, and policies to limit its effects, poses to the value of fossil fuel companies and by extension those who invest in them, such as council pension funds.

Carbon risks and council pensions

Local government has a fiduciary duty to manage their workers’ pension fund investments in the best interests of fund members and to consider and develop strategies to actively manage or avoid risks that may reduce the value of pension fund assets, ensuring prudent management of the pension scheme.

Asset managers and other industry professionals have traditionally viewed climate change as a social and environmental risk, but not a financial one. Instead climate change has been seen as an ethical issue, a secondary consideration to maximising the financial strength of pension funds.

The carbon bubble has shifted the debate, forcing carbon risk onto the table as a key discussion point.

Mark Carney, Governor of the Bank of England gave a speech entitled ‘Breaking the Tragedy of the Horizon‘, stating:

“There is a growing international consensus that climate change is unequivocal” … “once climate change becomes a defining issue for financial stability, it may already be too late.”

Fund managers and investment professionals have been slow to change the way they invest to protect their investments from these risks.

Furthermore, as financial products have become more complex local council have managed fewer funds directly. Instead they outsource many investment decisions to external fund managers, who invest on their behalf based on a Statement of Investment Principles (SIP) drawn up by the council.

Council financial officers have been slow to brief their external fund managers to demand action on fossil fuels, leaving funds vulnerable to the carbon bubble.

Councils lose £683 million as coal crashes

During the 2015/16 financial year global oil prices slumped from $100 a barrel to less than $40 a barrel. 48 American oil and gas producers filed for bankruptcy in 2016 alone.

The price of coal was also hard hit. In April 2016, Peabody Energy, the world’s largest coal producer filed for bankruptcy protection in the USA.

Campaign group Platform analysed the investments of 61 council funds into BHP Billiton, Rio Tinto, Glencore and Anglo American over this period.

They found that across the UK local government pension funds lost up to £683 million from the coal slump. The  Greater Manchester Pension Fund alone lost £148 million.

Engagement as protection

Rather than supporting divestment from fossils fuels, many local authority pensions advocate shareholder engagement with fossil fuel companies. In the case of climate change this could mean trying to convince companies like BP and Shell to stop extracting fossil fuels and promote energy efficiency and renewable alternatives.

In 2000 major oil company BP ran a global advertising campaign giving itself the new slogan ‘Beyond Petroleum’. Yet BP’s marketing proved to be greenwash. Their last renewable energy division was unceremoniously dumped in 2013 to allow it to concentrate on its ‘core’ business: fossil fuels.

Investors like pension funds engaging with fossil fuel companies seems highly unlikely to drive a low carbon transition. True engagement needs the pressure created by divestment. “Engagement without divestment is like a criminal legal system without a police force.”

Most local government pension funds appear unwilling act to exclude fossil fuels from their investments. A spokesperson for the Worcestershire fund said:

“Our key aim [is to] continue to pay pensions as they fall due. Part of that trade-off involves ensuring our portfolio is diversified across sectors. This inevitably means we will invest across a range of industries and that will, at times, include fossil fuels.”

Effective action: divestment

Some are moving in a different direction. In October 2015, the Environment Agency Pension Fund became the first Local Government Pension Fund to formally commit to begin divesting from fossil fuels, agreeing to dump 90% of its coal assets and 50% of its oil and gas stocks by 2020.

Mark Mansley, the Fund’s Chief Investment Officer said:

“We believe it will help address the risks and opportunities as the impacts of climate change materialise and is entirely consistent with securing the long-term investment returns of the fund and our fiduciary [legal] duty.”

Since this time a further two funds have made formal commitments to divest from fossil fuels: Waltham Forrest, London and South Yorkshire.

Campaigners are encouraged to engage with the financial managers and councilors responsible for running and scrutinising council pensions, demanding action to reduce carbon risk and divest from coal, oil and gas holdings.

Find out how much your council pension fund invests in fossil fuels here.

The author acknowledge the work of the Carbon Tracker Initiative whose report “Unburnable Carbon” introduced the concept of the carbon bubble.

Joel Benjamin, Community Re:invest

Joel Benajmin is the Co-founder of Community Re:invest who are campaigning for more investment in community renewable energy.

Campaign Organisers