Blowing carbon bubbles
Much has been made of the proclivity of financial markets to create investment bubbles that burst spectacularly, wiping billions off companies' balance sheets. However, a recent report suggests that the next big bubble may be made of carbon.
The report - Unburnable carbon - which was launched in mid-July sought to answer a simple question; if we burn all the fossil fuels that are currently in the reserves of companies listed on the world's stock exchanges, would we emit more carbon than the atmosphere can handle without exacerbating climate change?
As presented by the report, the maths is straightforward: add up company-level carbon (represented by reserves of coal, oil, gas etc.) on each of the world's exchanges and the sum of all of this gives the global total. This grand total is approximately 745 gigatonnes (Gt) of carbon dioxide (CO2). The world's scientists think we can emit 886Gt of CO2 without causing dangerous levels of climate change - but this includes the 321Gt that society has already produced - leaving just 565Gt CO2 to be emitted over the next 40 years before this global total is exceeded. In other words we can not use nearly 25% of the carbon that is already represented in company reserves of fossil fuels (and this does not include the carbon represented in the reserves of unlisted companies).
Meanwhile of course, financial markets are blissfully assuming that all of these reserves of fossil fuels will be used as they are already valuing the contribution that these reserves will make to the balance sheets of the oil, gas and coal companies who own them. And there is no sign that the capital markets' voracious appetite for fossil fuels is slowing - witness the ease with which Nat Rothschild was able to raise over $3 billion for investments in Indonesian coal companies at the end of 2010.
Carbon Tracker, the group behind the carbon report, also highlights the disproportionate risks facing investors in certain national indices. Nearly 15% of the world's 'listed carbon' is on the UK's stock exchanges. 33% of the FTSE 100 itself is in heavy carbon emitting natural resource companies like BP, Anglo American and BHP Billiton and Shell (4th, 9th, 10th and 11th respectively in the world league table of listed fossil fuel reserves). And with over 70% of recent initial public offerings (IPOs) on the London stock exchange being in mining companies, the carbon intensity of every passive fund in the FTSE has got significantly worse. Germany meanwhile doesn't even merit a mention in the report as its exchanges have got progressively lower carbon in recent years.
The growing carbon intensity of the FTSE - and the assumption that all of this fossil fuel will be used - represents a real risk for investors, but investors in passive funds are unlikely to be aware of these increased risks - partly because the very companies that hold these carbon risks are not required to disclose them. Glencore - the most recent and largest mining stock to find its way onto the FTSE 100 - famously did not even mention the words climate change in its full 1566 page prospectus.