As the former head of a financial research team, I recall dealing with an exposure to a brown coal-fired power generator. At the time, evidence was mounting that climate change impacts were quite likely, but they seemed to be far enough into the future not to worry us that much. Our debt exposure to the power generator did not mature until 2027; and who could predict what might or might not happen over that period of time?
For this investment, it wasn’t so much the physical effects of climate change that I was concerned about — it was the risk that market or regulatory impacts could make or break the project in the meantime. If we’d factored in a sizeable carbon tax, even in 2015, it would have seriously affected the prospective performance of our investment. When the uncertainty of future cash flows increases, the market value of the investment generally falls.
The emergence of new research from the highly respected Potsdam Institute in Germany has made the issue of market and regulatory impacts resulting from climate change very real. The timeline for significant impacts on investment returns is now finite, with estimates of 2015 becoming a reality. As Paul Gilding and I argue in our forthcoming paper entitled Carbon-Induced Financial Disruption, the investment implications of this research are breathtaking.
The Potsdam Institute research says that, if we are to have a reasonable chance of containing global warming to within 2 degrees, we only have a “budget” of 890 billion tonnes of CO2 emissions. This is a fixed budget, because carbon stays in the atmosphere for hundreds of years. So what is important is how much we emit — not when we emit it. If we continue to burn fossil fuels in line with our current business-as-usual approach, then we use up our budgeted emissions by 2024!
To add insult to injury, the quantum of fossil fuels required to emit 890 billion tonnes of CO2 is equivalent to only 25% of proven, economically recoverable reserves. This means that, in theory, 75% of known proven and probable reserves have no economic value.
This has startling implications for investors because there will either be (a) some form of global action that will seek to limit warming to 2 degrees; or (b) no effective action, with the consequence being runaway climate change. These are the only two options we have. The first one severely devalues our fossil fuel reserves as we scramble to reconfigure global energy networks; and the second one, while possibly maintaining the market value of those reserves for longer, is like driving off the edge of a cliff.
Coming back to the brown coal-fired power generator for a moment — won’t carbon capture and storage (CCS) technology ride to the rescue? There is little doubt that CCS in combination with coal-fired power generation can work. The problem is that a carbon price of $US50-100 per tonne is required to make it commercially viable. Therefore it is not competitive with investment in energy efficiency and most renewable energy sources. Placing faith in CCS to mitigate carbon exposure is a very risky investment strategy.
There is a commitment by the world’s largest emitters — including the EU, US, China and India — to limit warming to 2 degrees. How this commitment will play out is anyone’s guess. We are, however, left with two clear conclusions:
- Governments will have to follow through on their commitments to act unless they, and their electorates, prefer more destructive outcomes in the future; and
- At some stage, markets will price in those policy implications, and they could do so ahead of policy actions.
Now that we have an emissions budget and we comprehend how meagre it is, it puts a sharp limit on the window of time we have for policy actions.
The prospect of large-scale, major change and energy transformation is not automatically bad for long-term economic activity. For example, the International Energy Agency forecasts that $US10.5 trillion in additional capital spending would be required for energy infrastructure under a proactive response to climate change between now and 2030. But we cannot escape the fact that large-scale change will produce a reasonable level of protracted disruption to economies and markets.
Investment in alternative technologies is happening at a reasonable rate, but our incumbent coal, oil and gas extractors have been slow to embrace change. The valuations of companies in these sectors are driven by their proven and probable reserves, so they have a lot of value at risk. To illustrate their significance to investors, they account for more than 25% of the value of the UK stock market (FTSE 100 Index).
If I was still involved in financial research today, I would be picking apart all existing exposures and subjecting new financing proposals to an intense level of carbon scrutiny. This is because the timeline for a significant policy response to climate change is now finite and much shorter dated than many of us originally expected.
Bookmakers have a strong financial incentive to constantly reassess their assets and liabilities. Likewise, investors constantly reassess the merits of their investments. The faintest whiff of widespread policy developments may be all that is required for a significant market re-rating of carbon-exposed stocks.
*Phil Preston is the principal of Seacliff Consulting, a firm offering specialised consulting services in the financial and responsible investment fields. His prior work includes 17 years of financial research and portfolio management in the funds management industry.
**This first appeared on Climate Spectator.
there’s no painless option, but the choice is obvious
Thanx for the analysis, which gives a different perspective on the issue.
What, however, if the big polluting countries chose the second option, taking no effective action? The consequence may be ‘runaway climate change . . . . like driving off the edge of a cliff’, but when would the world reach the cliff? Arguably there will be no big economic impact for over a century, which is beyond the horizon of most investors. Therefore it seems that pure self interest may result in no effective action being taken.
Capitalism since it emerged as the dominant economic system over 500 hundred years ago was based on accumulating capital through a combination of growth and the exploitation of labour and nature.
However, reluctantly capital has had to pays for labour as the result of labour shortages, labour skills, labour struggles and the convenient (or inconvenient) fact the workers are also consumers.
Capital has never paid for nature. Its been the longest free lunch of all time. As a result capitalist profitability and profits have been artificially high for hundreds of years. The average enterprise and industry sector profit has been perhaps double or more what it would be if capital was paying for nature.
To illustrate lets say the average profit, while not paying for nature, is 20%. or more The old and dominatcondition normal
After paying for nature this needs to be reduced to say 10% or less . The new condition normal.
Ironically, capitalism can still continue as the dominant economic system. The ‘animal spirits’ can still be stirred to do their thing. Its just that capital has to be ( and would be) motivated by smaller and more realistic profitability and profits.
This might also help to ‘save the planet’. What price might we put on that?
Stewart S
Fortunately, governments are not elected by corporations or by capitalism. Individual adults (electors) are well aware of the consequences of climate change – we’ve had our doubts for decades haven’t we? – and a dose of reality politics in Australia will bring with it stronger calls for decisive action. But the political actions required will bear little relation to the hard facts of the climate science. The electorate will mostly be moved by leadership of the kind that just may come from the complicated but essentially functional alliances that have now, at least for the time being, formed in the new federal government. I am optimistic about the new government. I want it to take risks and find a way. I don’t want posturing, spin and inaction.
[HUGH (CHARLIE) MCCOLL Posted Tuesday, 14 September 2010 at 3:38 pm |
Fortunately, governments are not elected by corporations or by capitalism]
Hmm, there is a strong case to be made that the mining industry brought down a sitting PM (Rudd) and opposition leader (Turnbull). Australia is a small pond dominated by largely off-shore owned large multinationals, mostly of the extraction industry, who have shown they know no bounds. The big ones count but the smaller fry (Clive Palmer, Twiggy Forrest, Gina Rhinehart et al) add to the cry of the special interests, rather than to the nation’s interest. And of course no roll call of (dis)honour can omit mention of our American major shareholder/CEO of 70% of the country’s print media. When the opposition political opportunism ignores the national interest and all these powerful forces combine we get …policy paralysis (or in the case of the CPRS, totally awful policy that brought down a PM). Does anyone expect anything to be done before Labor’s pre-election “promise” of 2012? Put your hand up…..then use the hand to slap yourself around the face a dozen times to come to your senses.
This article is OK though perhaps mainly for the significance of the apparent conversion of the author. Since he says nothing that dozens or hundreds of others (including myself and more prominent Crikey contributors like Clive Hamilton, Richard Denniss et al.) have not said years ago, including the Garnaut Report and before it the Stern Report, and before it, thousands of published scientific papers.
But ok I will not be cynical especially as these are the types that need to change. I believe Ian MacFarlane underwent a conversion in the past year or so (he finally realized the infeasibility of CCS), and here’s hoping Martin Ferguson might too. Penny Wong? No one has a clue what she really believes but Combet is both bright and perhaps has an ethical streak (that might be a rash judgement of an Australian politician or pure wishful thinking) but the bloke is young and no doubt harbors primeministerial ambitions so the timeframe means he might be inclined to act rather than delay?