Are fossil fuels the sub-prime assets of the future? The debate about the long term risk of investments in fossil fuel businesses is moving from a fringe moral debate initiated by the CarbonTracker team in 2011 into a mainstream investment risk debate. Recently, powerful interventions from Bank of England Governor Mark Carney, Energy Secretary Ed Davey and even former BP CEO John Browne have highlighted the issue. Climate change negotiations for Paris 2015 could be pivotal.
Analysis completed by the IPCC indicates that if we burn all the oil, gas and coal reserves already discovered the average global temperatures would increase significantly beyond the 2 degrees Celsius limit, which is the generally accepted tipping point after which significant climate change risk exists. In fact with a “business as usual scenario” of energy use and emissions development, this limit will be reached as soon as 2031 in less than 16 years’ time.
Niche investors including Stanford University have elected to divest from fossil fuel shareholdings, to focus on sustainable investments and send a message to the wider investment community. More recently, and somewhat ironically, the Rockefeller Brothers Fund and has done likewise, following Storebrand, a Scandinavian financial services company managing $74 bn of assets, which announced its divestment from 35 fossil fuel related companies. The University of Oxford says that this divestment campaign has grown faster than any previous divestment movement.
Bank of England Statements
The Bank of England recently indicated it is to examine formally, for the first time, the risks fossil fuel companies pose to financial stability. Mark Carney, Bank of England Governor, has written to MPs informing them that his officials have discussed the idea that most of the world’s proven coal, oil and gas reserves may be “unburnable” if global warming is to be kept within safe limits. “In light of these discussions, we will be deepening and widening our inquiry into the topic,” he said. “I expect the Financial Policy Committee [responsible for identifying and reducing systemic financial risks] to also consider this issue as part of its regular horizon-scanning work on financial stability risks,” (Financial Times, November 30th).
Lima to Paris
Climate negotiations in December 2014 at the UN Climate Change Conference in Lima include several options for 2050 decarbonisation targets consistent with constraining global warming to the 2 degree C limit. One such option is having a ‘zero net emissions target by 2050’. This would require any fossil fuel emissions to be captured and stored or offset with other CO2 capture options. Given that the Paris 2015 UN Climate Change Conference objective is ‘to achieve, for the first time in over 20 years of UN negotiations, a binding and universal agreement on climate, from all nations of the world’, we can look forward to some interesting debate in 2015.
Some investors have started to ask big oil and gas companies for details of the impact if their reserves were to become affected by tougher climate policies. With this in mind, it would appear prudent, and may be considered a fiduciary duty, for oil and gas companies to comment on the potential risks of climate policies on their reserves in their annual reports. Best practice may involve calculation of the potential CO2 emissions (volumes and phasing) associated with reserves and assessment of the risks faced under different climate policy scenarios. Indications to date suggest that oil and gas companies such as BP, Shell, Exxon and Chevron do not publicly recognise any investment risk due to stranded assets resulting from emerging climate policy, which leaves the onus on investors, auditors and regulators to ensure that the risk is adequately communicated.
Ed Davey, UK Secretary of State for Energy and Climate Change, joined the debate saying, “We now need to see financial regulators, stock exchanges, listing authorities, in the UK and around the world focusing in on the risk that may well be under-assessed and undervalued in terms of investment in fossil fuels.” (Financial Times, December 11th).
In another related move, Germany’s biggest utility E.ON has announced it will spin off its fossil fuel and nuclear generation business into a new company to focus its core business on renewables. Whilst this may not directly impact CO2 emissions it will neatly separate the stranded asset climate risks in E.ON’s current business from its other operations. This may be an indicator of the future challenges that fossil fuel businesses face to separate the higher risk “fossil assets” from other parts of their business.
The application of Carbon Capture and Storage (CCS), to enable the use of fossil fuels whilst not emitting CO2, is likely to move up the political and business agenda. Politically, CCS provides a real means to enable continued thermal power generation and industrial activity whilst reducing CO2 emissions. Large utilities will be under increasing regulatory pressure to move fossil fuel electricity generation in this direction. Holders of fossil fuel reserves will increasingly look to CCS to assure future reserves value and investor confidence and even license to operate.
The debate on the risk of investment in fossil fuel businesses has a long way to go, but is gathering pace fast and has entered the mainstream energy debate. Whilst some would argue that there is no risk to fossil fuel investments, it is certain that the call to articulate the investment risk will intensify and that effective reporting and consideration of potential risk will be required. 2015 could be a pivotal year.
This article was written by Sam Gomersall.