Internet, housing, banking, we have come across quite a few bubbles in the past decade, but now we are faced with the unfolding of possibly the biggest bubble of them all. The carbon bubble, created and sustained by the systematic over valuation of carbon intensive firms and their assets.
Energy firms populate the top echelons of most of the world’s indices due to valuations largely determined by the fossil fuel assets they hold. Yet scientists are constantly warning us of the dangers of climate change, and governments are continuously bringing out new legislation to enforce their climate policies. It is now time that we acknowledge the inherent risks of slapping triple A ratings on carbon intensive firms and assets that are incompatible with governments' climate policies and scientists' climate warnings. In order to maintain an average global temperature rise of less than two percent, only 20% of the total reserves held by the top 100 listed coal companies and the top 100 listed oil and gas companies can be burnt. So why do we insist on valuing them so high, surely their valuations should correspond to the 20% of assets that they are actually able to exploit.
“The valuations of 200 of the world's largest companies - companies who underpin our pensions and dominate global markets - are based to a huge extent on fossil fuel reserves that according to the stated climate change goals of the international community cannot be accessed.” James Murray of BusinessGreen
As we transition into a low carbon economy we could face some serious problems due to the depth and breadth of our collective financial exposure to environmentally unsustainable investments. In the FTSE 100, five of the top ten companies, which account for 25% of the entire market capitalisation, are very carbon intensive.
Some firms have realised that in order to maintain their high valuation they must decarbonise their production process; but this is a highly risky procedure. Transforming from a fossil fuel based business model to a low carbon business model requires huge organisational restructuring and therefore the company that emerges at the end could be significantly different and not necessarily as competitive as before. Yet these risks are still not represented in the valuation or rating agency assessments.
Short-sighted rating agencies, analysts, investors and firms who control the market do not seem to believe that the low carbon economies, which politicians are striving for, will ever be realised. Those that aren’t convinced by this view that carbon intensive firms ignore the risks they face in the future need only look at the announcement made last week by BP that global greenhouse gases will rise by 28% by 2030. No one seemed to take any notice. “One of the world's largest firms tells investors its plans are largely based on a scenario that the vast majority of climate scientists believe will result in global catastrophe, and no one bats an eyelid.” James Murray of BusinessGreen
The only way to avoid the sudden collapse of this carbon bubble, which could cripple world economies, is to carefully deflate it. Consistent campaigning is needed in order to convince the market that high carbon assets are loaded with risks that investors may not be aware of.
By. James Burgess of Oilprice.com