“Stranded” fossil fuel assets may prompt $4 trillion crisis


Report finds fossil fuel investment in the face of decreasing demand is potentially a recipe for economic chaos. Jeff Glorfeld reports.


Stranded: fossil fuel assets are likely to become strongly devalued, a report finds.
Stranded: fossil fuel assets are likely to become strongly devalued, a report finds.
Monty Rakusen/Getty Images

The world could be heading for fiscal havoc on a scale not seen since the 2008 financial crisis, erasing as much as $US4 trillion from the global economy, with fossil fuel industries at the centre of the upheaval, and the United States, Russia and Canada tipped as big losers, according to a new study published in the journal Nature Climate Change.

The study is by an international team of scientists led by Jean-Francois Mercure, from Radboud University, The Netherlands, and includes researchers from the University of Macau and Britain’s Cambridge University. It blames several factors for the impending economic slide.

Some of the world’s biggest economies rely on fossil fuel production and exports, just as the movement towards energy efficiency, low-carbon, renewable energy production and various national climate policy initiatives substantially reduce global demand for coal, oil and gas.

Meanwhile, according to reports by bodies such as the International Energy Agency, investment in fossil fuel ventures is surging, and production remains high, even while interest in renewable energy also grows.

The result, the researchers say, is a global glut of “stranded fossil fuel assets”, where net carbon importers such as China and the European Union emerge as “winners”.

The study cites a 2015 report by the Bank of England’s Prudential Regulation Authority that separates fossil fuels into two groups:

Tier 1 includes coal, oil and gas extraction companies, and conventional utilities; as well as firms that are energy-intensive, which might be affected indirectly via an increase in energy costs.

Tier 2 includes chemicals, forestry and paper, metals and mining, construction and industrial production.

“Between them, these two tiers of assets account for around a third of global equity and fixed-income assets,” the bank’s report says.

The Paris Agreement, the study notes, aims to limit the increase in global average temperature to “well below two degrees Celsius above pre-industrial levels”, which means a portion of existing reserves of fossil fuels and production capacity will remain unused, becoming stranded.

If investors assume that these reserves will be commercialised, the stocks of listed fossil fuel companies may be overvalued. “This gives rise to a ‘carbon bubble’, which has been emphasised or downplayed by reference to the credibility of climate policy”, the Mercure study says.

It says stranding results from an ongoing technological transition, which remains robust even if big fossil fuel producers – the US, for example – fail to adopt climate mitigation policies.

The economic impact on big fossil fuel producers would be aggravated by such failures because their exposure to stranding would be increased as global demand for their products decreases, potentially amplified by a likely asset sell-off by lower-cost fossil fuel producers and new climate policies.

For importing countries, the report says, stranding has moderate positive effects on gross domestic product and employment levels.

The researchers say their conclusions support the existence of a carbon bubble that, “if not deflated early, could lead to a discounted global wealth loss of $US1 trillion to $US4 trillion, a loss comparable to the 2008 financial crisis”. However, they say further economic damage from a potential bubble burst could be avoided by “decarbonising” early.

They acknowledge that the existence of a carbon bubble has been questioned on grounds of credibility or of timing of climate policies, which would explain investors’ relative confidence in fossil fuel stocks and the projected increase in fossil fuel prices until 2040. “But there is evidence that climate mitigation policies may intensify in the future,” they note.

A 2016 report by the London School of Economics and Political Science, and the Grantham Research Institute on Climate Change and the Environment, cited by this new study, says that more than 75% of global emissions from 99 countries surveyed are subject to economy-wide emissions-reduction or climate policy schemes.

Moreover, Mercure and his colleagues say, the ratification of the Paris Agreement and its reaffirmation at the 22nd Conference of the Parties (COP22) in 2016 have added momentum to climate action, “despite the position of the new US administration”.

“Furthermore,” the researchers write, “low fossil fuel prices may reflect the intention of producer countries to sell out their assets – that is, to maintain or increase their level of production despite declining demand for fossil fuel assets.”

But irrespective of whether new climate policies are adopted, global demand for fossil fuels is already slowing in the current technological transition, they say. The question then is whether, under the current pace of low-carbon technology diffusion, fossil fuel assets are bound to become stranded, owing to the growth in renewable-energy use, improved fuel efficiency in transport, and growing acceptance of electric-powered transport vehicles.

“Indeed, the technological transition currently under way has major implications for the value of fossil fuels, due to investment and policy decisions made in the past,” Mercure and colleagues conclude.

“Faced with stranded fossil fuel assets of potentially massive proportions, the financial sector’s response to the low-carbon transition will largely determine whether the carbon bubble burst will prompt a 2008-like crisis.”

Jeff Glorfeld is a former senior editor of The Age newspaper in Australia, and is now a freelance journalist based in California, US.
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  2. https://www.iea.org/publications/wei2017/
  3. https://www.iea.org/newsroom/news/2016/november/world-energy-outlook-2016.html
  4. https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/publication/impact-of-climate-change-on-the-uk-insurance-sector.pdf
  5. https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement
  6. http://carbontracker.live.kiln.digital/Unburnable-Carbon-2-Web-Version.pdf
  7. https://www.bankofengland.co.uk/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability
  8. http://www.lse.ac.uk/GranthamInstitute/publication/2015-global-climate-legislation-study/
  9. https://www.carbonbrief.org/cop22-key-outcomes-agreed-at-un-climate-talks-in-marrakech
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