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Unburnable Carbon – Are the world’s financial markets carrying a carbon bubble? (Report)

Introduction

The Carbon Tracker initiative is a new way of looking at the carbon emissions problem. It is focused on the fossil fuel reserves held by publically listed companies and the way they are valued and assessed by markets. Currently financial markets have an unlimited capacity to treat fossil fuel reserves as assets. As governments move to control carbon emissions, this market failure is creating systemic risks for institutional investors, notably the threat of fossil fuel assets becoming stranded as the shift to a low-carbon economy accelerates.

In the past decade investors have suffered considerable value destruction following the mispricing exhibited in the dot.com boom and the more recent credit crunch. The carbon bubble could be equally serious for institutional investors – including pension beneficiaries - and the value lost would be permanent.

We believe that today’s financial architecture is not fit for purpose to manage the transition to a low-carbon economy and serious reforms are required to key aspects of financial regulation and practice firstly to acknowledge the carbon risks inherent in fossil fuel assets and then take action to reduce these risks on the timeline needed to avoid catastrophic climate change.

Carbon Tracker’s goal is to prevent a carbon crash by:
• Working with capital market regulators and investors to assess systemic climate change risks and propose
practical measures to minimise these risks to market stability and the operation of an orderly market.
• Revisiting the way fossil fuel companies are valued including the accounting treatment of fossil fuel-based
reserves to ensure that carbon limits are fully integrated;
• Evaluating the concentration risk facing key global markets which are currently over-weight fossil fuels (such
as the UK), and how indices, benchmarks and tracking products can be reformed to protect investors
• Improving the quality and utility of disclosures required by regulators and listings authorities to ensure that
future carbon risks associated with fossil fuel reserves are fully dealt with to enable investors to make informed
decisions;
• Updating the way fossil fuel companies are brought to the capital markets by investment banks;

We believe the regulatory regimes covering the capital markets need realigning to provide transparency for investors on the assumptions behind valuing unburnable carbon. With the global economy following the fortunes
of the financial sector, it is essential to create capital markets which are robust enough to deliver an economy which can prevent dangerous climate change. Unless a more long-term approach is required by regulators, the shift in investment required to deliver a low carbon future will not occur.

From the summary page

This new analysis by Carbon Tracker discovers that:

- Already in 2011, the world has used over a third of its 50-year carbon budget of 886GtCO2, leaving 565GtCO2

- All of the proven reserves owned by private and public companies and governments are equivalent to 2,795 GtCO2

- Fossil fuel reserves owned by the top 100 listed coal and top 100 listed oil and gas companies represent total emissions of 745GtCO2

- Only 20% of the total reserves can be burned unabated, leaving up to 80% of assets technically unburnable

Distribution of reserves across exchanges
By allocating reserves to exchanges, it is possible to build up a picture of where reserves are listed. The map shows how the listings of coal, oil and gas reserves are distributed, indicating that capital markets are supporting the continued exploitation of fossil fuel reserves around the world.

Focus on the UK:
The analysis shows that London currently has 105.5 GtCO2 of fossil fuel reserves listed on its exchange, over ten times the UK’s domestic carbon budget for 2011 to 2050, of around 10 GtCO2. This amount is only growing with the addition of companies such as Glencore, Vallar and Vallares, and the predominance of mining companies amongst new listings – 70% in the first half of 2011.

Relevance for investors
Asset owners typically invest large amounts in passive funds which track the market, or active funds which are benchmarked against market indices. This means many investors are backing huge fossil fuel reserves purely as a result of the structure of the financial products they invest in. The continued focus on short term returns perpetuates the status quo.

Regulation needed
Carbon Tracker argues that the new Financial Policy Committee, set up to monitor risks and bubbles in the financial system, must urgently address the “carbon bubble” and ensure regulators require greater disclose on reserves and carbon emission in order to assess this material risk to financial stability. Carbon Tracker recommends that this market failure is also considered by the Kay review into the structure of Equity markets to deliver a more long-term, transparent system.

Download full report

Editorial Notes: Commentary in The Guardian and the FT Energy Source Blog.

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