Mark Carney has been turning heads lately. The Governor of the Bank of England and former governor of the Bank of Canada has been talking about the financial implications of global action on climate change. In a recent speech to the insurance market Lloyds of London he said, “policy action to promote the transition towards a low-carbon economy could spark a fundamental reassessment [of corporate bond values].”
That policy action is starting to happen. Both China and the United States have made significant commitments to curb carbon emissions. In Canada, British Columbia has a $30-per-tonne carbon tax, Quebec has implemented a cap-and-trade system, Ontario is following suit and Alberta is investigating its options. And last spring, the G20 asked the Financial Stability Board to investigate the risks associated with climate regulation.
That momentum is only going to build. This December, climate change will be in the spotlight globally thanks to the United Nations climate change conference in Paris.
Whether Canada implements stronger climate policies or not, it looks likely that our trade partners will do so. If the global market continues to move toward a low-carbon economy, this could leave us with a massive case of stranded assets — fossil fuel resources that can no longer turn a meaningful profit because of changes in the market and the regulatory environment.
Scientists generally agree that to avoid the worst effects of climate change we need to limit global warming to 2ºC. Governments pledged to meet this goal in Copenhagen in 2009, and it will drive the agenda in Paris later this month.
In 2011, Carbon Tracker — a group of financial, legal and energy experts — published the report Unburnable Carbon. They used the 2ºC limit to determine that 565 billion tonnes of carbon dioxide can be put into the atmosphere over the next 40 years. This became our global “carbon budget.” When Carbon Tracker compared it with the proven fossil fuel reserves of public companies and governments, they found that only 20 percent of known oil, gas and coal reserves can be burned.
This concept hit the mainstream with Bill McKibben’s 2012 article in Rolling Stone, “Global Warming’s Terrifying New Math.” And it started to gain more traction in financial circles when HSBC wrote about it in 2013.
This is where stranded assets become a particularly important financial risk for Canada. We have oil reserves that involve high costs and emissions to extract — not to mention a financial sector that is weighted toward the energy sector.
When this financial risk first entered the public conversation, it was viewed largely as a fringe issue for socially responsible investors. The dialogue focused on whether to divest from fossil fuel companies or engage with them.
Over the past few years the situation has rapidly changed. Research by HSBC, Mercer, Standard and Poor’s and Citi approaches the impact of climate action — and the inherent risk of stranded assets — from different directions. All of their reports support the view that climate change is a material risk that investors need to consider.
Their efforts are being supported by increasingly available tools to assess carbon exposure. These range from the ever-increasing coverage by the Carbon Disclosure Project to the Bloomberg Carbon Risk Valuation Tool, or simply the movement of investment portfolios to low-carbon indexes such as the MSCI Low Carbon Index. In Canada the TSX recently launched three new climate change related indexes. This opens up the door to companies offering exchange-traded funds that would allow Canadian investors to steer their money away from the most carbon intensive companies.
Sharing the emissions of their overall portfolio may become the norm for investment firms in the not-too-distant future. Last year, the United Nations Principles for Responsible Investment initiated the Montreal pledge, which requires signatories to “measure, disclose and reduce their portfolio carbon footprints.” And in May of this year, France passed a law that requires institutional investors to publish the carbon footprint of their portfolios.
As the saying goes, what gets measured gets managed. Given their impact, companies operating in the oil sands are likely to be sidelined or removed from portfolios and indexes trying to reduce their carbon exposure. A number of experts, including the UK Law Commission and Koskie Minsky LLP in Canada, are already asking if pension funds may be legally obligated to account for the long-term risks of climate change to their portfolios.
The interventions of activist shareholders — such as ShareAction, Arjuna Capital and coalitions of institutional investors — have brought the discussion of climate change and stranded assets to the front doors of oil companies. In 2014, Shell and ExxonMobil responded to pressure with similar public statements, arguing that their proven reserves would not become “stranded.” They made two arguments: first, that economic and population growth will continue to drive up energy demand, and second, that governments will never act strongly or quickly enough to force the 2ºC scenario, so those risks are overblown.
Many groups have taken issue with these claims. Carbon Tracker published detailed counterarguments to both Shell and ExxonMobil’s claims. On the population and economic growth argument, OECD countries are seeing their economies grow while energy demand declines, and developing countries may leapfrog to carbon-free technology in the electricity and transportation sectors.
The producers also seem to be changing their tune in the past year, as momentum builds around addressing climate change. On October 16 the Oil and Gas Climate Initiative released a joint statement that they “support the implementation of clear stable policy frameworks consistent with a 2°C future.” This group represents 10 global oil and gas companies, including Shell, Statoil, Total and BP.
Closer to home, the submissions to Alberta’s Climate Change Advisory Panel provide some insight into the evolving thinking of producers on this issue. For example, Suncor is arguing that “A carbon price is the single most effective way to change the investment and operating decisions that drive real emission reductions. The time is right for a higher level of ambition in carbon policy stringency in Alberta.” Similarly, Cenovus says it shares “the public’s concern that climate change is one of the greatest global challenges of our times. Our product is part of the problem. We will be part of the solution.”
The oil industry could be facing a shift similar to the changes that have occurred in the coal industry. Five years ago, many people thought coal was a good investment. Coal was trading upwards of $70 per tonne, China’s demand looked like it would rise for decades to come and climate regulations seemed like a far-off dream. Since then, coal prices have dropped by more than 50 percent, the US and China have struck a historic climate agreement and the industry has lost more than 75 percent of its value.
If any serious action is taken to achieve the 2ºC target, as governments have pledged and scientists say we must, most oil reserves will have to remain in the ground. The conversation around the financial risk of stranded assets has started, and it is drawing attention from the likes of Mark Carney, but producers may not act fast enough to adapt to the changing world.
This raises a question for anyone with fossil fuels in their investment portfolio: how confident are you that oil companies and investment managers are taking this risk as seriously as they should?