The emerging carbon risk
Carbon risk is systemic in nature. Tied to the future availability of carbon assets and triggered by environmental-related risks, the risk of a carbon “bubble” collapse has the potential to cause large fossil fuel companies (coal, oil and gas) to fail. Such an impact to the carbon-intensive energy exporting countries would also result in cascading effects on the global economy. When the concept of carbon risk was first introduced by Al Gore in 2013, he reported that more than $7 trillion (£4.4 trillion) in invested carbon assets could be at threat of wider industry failure to properly incorporate carbon risk into business.
A 2013 report from the Grantham Research Institute at the London School of Economics states that fossil fuel companies currently face an oncoming carbon deficit. If these companies were to adhere to a pro-rata allocation of the remaining global carbon budget, they would only be able to burn around 125 – 275 gigatons of embedded carbon dioxide emission (GtCO2), or 20 to 40 percent of the total underground carbon reserves, so as to attain the best chance of achieving a liveable future within the two-degree Celsius limit.
However, this estimate is not reflected in share prices: total underground reserves were valued at $27 trillion in 2012, equivalent to 2,795 GtCO2, suggesting that the market generally expects business-as-usual to continue into the next decade without adequately addressing the threat of carbon risk. As a result, If we were to assume the 2012 figures and if 80 percent of the world’s carbon reserves were to remain trapped underground, up to $20 trillion worth of fossil fuel would be converted into stranded assets as they suffer premature write-offs and downward devaluation or even liabilities for the companies that own them.
Theoretically, these fossil fuel companies could suffer direct losses in their inventory valuation, devaluing them from assets into liabilities. As seen in the past six months, oil prices have been driven to record lows, providing strong evidence for the inherent riskiness of oil-based assets. Should fossil fuel companies continue to hold large untapped reserves of carbon-based fossil fuels as a major asset class on their balance sheet and not take steps to diversify their business models, the potential carbon bubble could present an emerging risk just waiting to pop.
Divesting from fossil fuels
The process of fossil fuel divestment either reduces or totally eliminates fossil fuel assets from investment portfolios. The aims of the current divestment campaign seen in parts of the United States and United Kingdom are twofold: (1) directly shifting investment funds to alternative energy options, limiting the availability of investment capital for fossil fuel companies by reducing their ability to leverage existing equity and therefore minimising future expansion capabilities, and (2) indirectly stigmatising fossil fuel companies and provoking global awareness and debate surrounding climate change and the emerging carbon risks.
Is divestment enough?
For a start, the divestment campaign ought to be credited for bringing about wider media coverage on and sparking international debate over climate change, stranded assets and emerging carbon risk. Raising the awareness of fossil fuel based investments has been mainly attributed to the high profile campaigning bodies who have since pledged the divestment of $50 billion worth of fossil fuel based assets in 2014. These prominent institutions include Standard University, University of Glasgow, Oxford City Council and the cities of San Francisco and Seattle, to name just a few.
But in the long-run, for greater effects to be felt, much more needs to be done. Action from divestment alone will not have an immediate, seismic impact on fossil fuel companies as compared to pure economic forces.
The divestment movement started in 2012 and has gained international coverage ever since, but the true impact of its actions on fossil fuel companies remains an issue of doubt. The campaign’s effectiveness is dwarfed in comparison to the recent event of downward spiralling oil prices: with prices now below $50 a barrel, major oil companies have suspended some expansion projects indefinitely and laid off a multitude of workers, limiting future access to assets.. Undoubtedly, the level of investment or divestment in carbon reserves will determine future business models, but the divestment campaign by itself is not the most impactful force currently changing the practices and policies of fossil fuel extraction to mitigate for carbon risk.
Realistic expectations and continuous actions
There is no single silver bullet that will solve the problem of emerging carbon risk or mitigate climate change. Divestment practices alone may never grow large or widespread enough to impact share prices sufficiently enough to prompt fossil fuel companies to explore alternative energy sources. It is also unlikely that an overnight change in investment capital or equity prices of fossil fuel companies from endowment funds will convert the unburned carbon reserves into stranded sub-prime assets and trigger a potential carbon bubble catastrophe anytime soon.
Nonetheless, we have to acknowledge that divestment is capable of being an important catalyst in addressing climate change mitigation. It provides a convenient platform to allow continuous international debate over climate change and its solutions. It draws attention to systemic carbon risk and encourages the pursuit of alternative technologies for mitigation. It also serves as a timely reminder for individuals to align investments or daily actions with personal environmental principles. One can easily find online media articles and news updates on the mantras of the fossil fuel divestment movement. The voices of campaigners with whole cities on their side are becoming difficult for companies to ignore.
One cannot expect a single route of solution to resolve the complexities of likely irreversible climate change. Similarly, one cannot neglect the synergistic effect that can be brought about by every possible solution. Until we have found a set of holistic and robust solutions to address climate change and its emerging risks, it will continue to be an uphill battle for all campaigners, climate scientists, and climate change advocates alike, along with all of those who are concerned enough about our planet’s well-being to inspired to action. We can use science, economics and politics to about the benefits or disadvantages about the different course of actions. But ultimately, mitigating climate change remains an ethical decision; a decision about doing what we think is right for the environment and for our future generations. One can argue that these decisions may come at great economic or financial costs, but as long as we are able to address and incorporate the carbon risk into our investment portfolio analysis, we will be able to manage this emerging risk.
Jaclyn Zhiyi Yeo
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