Carbon bubble will plunge the world into another financial crisis – report

Trillions of dollars at risk as stock markets inflate value of fossil fuels that may have to remain buried forever, experts warn
Carbon bubble : carbon dioxide polluting power plant : coal-fired Bruce Mansfield Power Plant
Global stock markets are betting on countries failing to adhere to legally binding carbon emission targets. Photograph: Robert Nickelsberg/Getty Images
The world could be heading for a major economic crisis as stock markets inflate an investment bubble in fossil fuels to the tune of trillions of dollars, according to leading economists.
"The financial crisis has shown what happens when risks accumulate unnoticed," said Lord (Nicholas) Stern, a professor at the London School of Economics. He said the risk was "very big indeed" and that almost all investors and regulators were failing to address it.
The so-called "carbon bubble" is the result of an over-valuation of oil, coal and gas reserves held by fossil fuel companies. According to a report published on Friday, at least two-thirds of these reserves will have to remain underground if the world is to meet existing internationally agreed targets to avoid the threshold for "dangerous" climate change. If the agreements hold, these reserves will be in effect unburnable and so worthless – leading to massive market losses. But the stock markets are betting on countries' inaction on climate change.
The stark report is by Stern and the thinktank Carbon Tracker. Their warning is supported by organisations including HSBC, Citi, Standard and Poor's and the International Energy Agency. The Bank of England has also recognised that a collapse in the value of oil, gas and coal assets as nations tackle global warming is a potential systemic risk to the economy, with London being particularly at risk owing to its huge listings of coal.
Stern said that far from reducing efforts to develop fossil fuels, the top 200 companies spent $674bn (£441bn) in 2012 to find and exploit even more new resources, a sum equivalent to 1% of global GDP, which could end up as "stranded" or valueless assets. Stern's landmark 2006 report on the economic impact of climate change – commissioned by the then chancellor, Gordon Brown – concluded that spending 1% of GDP would pay for a transition to a clean and sustainable economy.
The world's governments have agreed to restrict the global temperature rise to 2C, beyond which the impacts become severe and unpredictable. But Stern said the investors clearly did not believe action to curb climate change was going to be taken. "They can't believe that and also believe that the markets are sensibly valued now."
"They only believe environmental regulation when they see it," said James Leaton, from Carbon Tracker and a former PwC consultant. He said short-termism in financial markets was the other major reason for the carbon bubble. "Analysts say you should ride the train until just before it goes off the cliff. Each thinks they are smart enough to get off in time, but not everyone can get out of the door at the same time. That is why you get bubbles and crashes."
Paul Spedding, an oil and gas analyst at HSBC, said: "The scale of 'listed' unburnable carbon revealed in this report is astonishing. This report makes it clear that 'business as usual' is not a viable option for the fossil fuel industry in the long term. [The market] is assuming it will get early warning, but my worry is that things often happen suddenly in the oil and gas sector."
HSBC warned that 40-60% of the market capitalisation of oil and gas companies was at risk from the carbon bubble, with the top 200 fossil fuel companies alone having a current value of $4tn, along with $1.5tn debt.
Lord McFall, who chaired the Commons Treasury select committee for a decade, said: "Despite its devastating scale, the banking crisis was at its heart an avoidable crisis: the threat of significant carbon writedown has the unmistakable characteristics of the same endemic problems."
The report calculates that the world's currently indicated fossil fuel reserves equate to 2,860bn tonnes of carbon dioxide, but that just 31% could be burned for an 80% chance of keeping below a 2C temperature rise. For a 50% chance of 2C or less, just 38% could be burned.
Carbon capture and storage technology, which buries emissions underground, can play a role in the future, but even an optimistic scenario which sees 3,800 commercial projects worldwide would allow only an extra 4% of fossil fuel reserves to be burned. There are currently no commercial projects up and running. The normally conservative International Energy Agency has also concluded that a major part of fossil fuel reserves is unburnable.
Citi bank warned investors in Australia's vast coal industry that little could be done to avoid the future loss of value in the face of action on climate change. "If the unburnable carbon scenario does occur, it is difficult to see how the value of fossil fuel reserves can be maintained, so we see few options for risk mitigation."
Ratings agencies have expressed concerns, with Standard and Poor's concluding that the risk could lead to the downgrading of the credit ratings of oil companies within a few years.
Steven Oman, senior vice-president at Moody's, said: "It behoves us as investors and as a society to know the true cost of something so that intelligent and constructive policy and investment decisions can be made. Too often the true costs are treated as unquantifiable or even ignored."
Jens Peers, who manages €4bn (£3bn) for Mirova, part of €300bn asset managers Natixis, said: "It is shocking to see the report's numbers, as they are worse than people realise. The risk is massive, but a lot of asset managers think they have a lot of time. I think they are wrong." He said a key moment will come in 2015, the date when the world's governments have pledged to strike a global deal to limit carbon emissions. But he said that fund managers need to move now. If they wait till 2015, "it will be too late for them to take action."
Pension funds are also concerned. "Every pension fund manager needs to ask themselves have we incorporated climate change and carbon risk into our investment strategy? If the answer is no, they need to start to now," said Howard Pearce, head of pension fund management at the Environment Agency, which holds £2bn in assets.
Stern and Leaton both point to China as evidence that carbon cuts are likely to be delivered. China's leaders have said its coal use will peak in the next five years, said Leaton, but this has not been priced in. "I don't know why the market does not believe China," he said. "When it says it is going to do something, it usually does." He said the US and Australia were banking on selling coal to China but that this "doesn't add up".
Jeremy Grantham, a billionaire fund manager who oversees $106bn of assets, said his company was on the verge of pulling out of all coal and unconventional fossil fuels, such as oil from tar sands. "The probability of them running into trouble is too high for me to take that risk as an investor." He said: "If we mean to burn all the coal and any appreciable percentage of the tar sands, or other unconventional oil and gas then we're cooked. [There are] terrible consequences that we will lay at the door of our grandchildren."

Fossil fuels and vested interests: a society in denial

We need to get used to the idea that we can't burn most of what we already have
Oil refinery
Almost all the fossil fuel reserves will have to be written off to provide a decent chance of keeping the planet safe. Photograph: Shawn Baldwin/Corbis
The report released by Lord Stern and thinktank Carbon Tracker paints a picture of society in denial. It shows we're pumping almost $700bn (£458bn) of hard-earned savings and pensions annually into finding new reserves of fossil fuels, even though it's clear that almost all of those reserves will have to be written off to provide a decent chance of keeping the planet safe.
The ever-inflating "carbon bubble" is only part of the bigger picture, because most of the world's fuel – around three-quarters in total and almost all the oil and gas – is owned not by listed companies but by governments. And we don't need only to stop expanding the world's fossil fuel reserves; we also need to get used to the idea that we can't burn most of what we already have.
That is a much trickier problem, because with Carbon Tracker's detailed analysis and growing awareness of the carbon bubble, investors will surely soon start waking up to the madness of putting capital into expanding fuel reserves. But there's little self-interest – only planetary interest – in leaving existing fuel assets in the ground.
The need to write off existing reserves shines a revealing light on global climate politics, because when you map out the world's fossil fuel reserves, a striking correlation emerges between the amount of carbon a country has in the ground and its keenness for – or resistance to – a global climate deal.
Take Britain. Sure, there's lots wrong with our green policies but nonetheless the UK's climate laws are world-leading. Why? Partly because we have good campaigners, perhaps. But also perhaps because we have virtually no fossil fuels – and therefore nothing much to lose. According to BP, the UK's proven economically viable reserves would run out at current production rates in just seven years for oil, four years for gas and 12 years for coal.
Similar is true for Europe as a whole and indeed Africa. So it's perhaps no surprise that these two continents – along with the low-lying island nations – have pushed hardest for a global climate deal. They collectively own less than a tenth of the carbon. Even if you factor in all the nations involved in the Cartagena Dialogue – a loose-knit body of countries proactively engaging in efforts to push for a global deal – you get to only a fifth of the total.
By contrast, those countries with the biggest fossil fuel reserves – such as the US, China, Saudi Arabia and Canada – tend to be much more recalcitrant when it comes to climate politics. The US has 18% of the total and therefore plenty of assets that might need to be written off if the world agreed to tackle climate change. And it's surely no coincidence that of all the South American nations it was oil-rich Venezuela that did its best to block the last-minute progress at the 2011 talks in Durban.

Why can't we quit fossil fuels?

Despite the clean technology of the past decade, we continue to extract and burn fossil fuels more than ever before
A coal-fired power station in Gelsenkirchen, Germany dwarfs a wind turbine in the foreground.
A coal-fired power station in Gelsenkirchen, Germany dwarfs a wind turbine in the foreground. Photograph: Image Broker/Rex Features
We have far more oil, coal and gas than we can safely burn. For all the millions of words written about climate change, the challenge really comes down to this: fuel is enormously useful, massively valuable and hugely important geopolitically, but tackling global warming means leaving most of it in the ground – by choice. Although we often hear more about green technology, consumption levels or population growth, leaving fuel in the ground is the crux of the issue. After all, the climate doesn't know or care how much renewable or nuclear energy we've got, how efficient our cars and homes are, how many people there are, or even how we run the economy. It only cares how much globe-warming pollution we emit – and that may be curiously immune to the measures we usually assume will help.
  1. The Burning Question: We can’t burn half the world’s oil, coal and gas. So how do we quit?
  2. by Duncan Clark, Mike Berners-Lee

  1. Tell us what you think: Star-rate and review this book
There are three facts that tell you all you really need to know about climate science and politics. One: for all the uncertainty about the detail, every science academy in the world accepts the mainstream view of man-made global warming. Two: virtually every government, recognising the profound danger of tampering with the climate that allowed human society to thrive, has agreed the world must limit the global temperature increase to 2C – a level which isn't by any means "safe" but may be enough to avoid the worst impacts. Three: the amount of warming we will experience goes up roughly in proportion to the total amount of carbon that global society emits – cumulatively.
Here is the rub. Even if we gave up on all the obscure and unconventional fossil fuel resources that companies are spending billions trying to access and just burned the "proven" oil, coal and gas reserves – the ones that are already economically viable – we would emit almost 3tn tonnes of carbon dioxide. No one can say exactly how much warming that would cause, but it is overwhelmingly likely that we would shoot well past 2C and towards 3C or even 4C of warming.
Four degrees might not sound much but at the planetary level it is. It is about the same as the temperature increase observed since the ice age's "last glacial maximum", when much of the northern hemisphere was trapped under ice as thick as the world's five tallest skyscrapers stacked on top of each other. It is impossible to say what changes another three or four degrees would bring, but the impacts could very plausibly include a collapse in global food production, catastrophic droughts and floods, heatwaves and the beginning of ice-sheet melt that could eventually raise the sea level enough to wipe out many of the world's great cities.
Impact of climate change: flooding in India. Impact of climate change: flooding in India. Photograph: Gideon Mendel/Corbis for Actionaid
Sceptics argue that this doomsday scenario might not come to pass – and they are right. If we are lucky, the impact of burning all that oil, coal and gas could turn out to be at the less severe end of the plausible spectrum. But that is hardly reassuring: it's akin to saying that it is fine to walk blindfolded into a main road since you can't be sure there are any cars coming. After less than 1C of temperature increase so far, we are already seeing some profound changes, including a collapse in Arctic sea ice coverage more severe than even the most pessimistic predictions from just a few years ago. (Brits secretly hoping for a hotter future, be warned: that collapsing sea ice may have caused the freakish jet stream behaviour that made 2012 the wettest English year on record and obliterated this year's spring, both mere amuse-bouche for the feast of climate impacts expected in coming decades, even from the carbon we've emitted so far.)
Given what is at stake, it is no wonder that governments agree global warming must be stopped. But that is where the common sense ends and the cognitive dissonance begins. Because to have a decent chance of not exceeding the already risky global target, we need to start phasing out fossil fuels now at a fast enough rate to bring down emissions globally by a few percent a year, and continue doing so for decades to come.
Now compare that with what is actually happening. As with the climate, to understand the situation properly it is necessary to zoom right out to see the long-term trend. Doing so reveals something fascinating, worrying and oddly overlooked. As scientists from Lancaster University pointed out last year, if you plot a graph showing all the carbon emissions that humans have pumped into the air, the result is a remarkably clear exponential curve stretching all the way back to the mid-19th century. Zoom back in on the past decade and it is clear that for all the mounting scientific concern, the political rhetoric and the clean technology, nothing has made a jot of difference to the long-term trend at the global level – the system level. The growth rate in total carbon emissions in the past decade, at around 2% a year, was the same as that of the 1850s.
C02 emissions since 1850 (red); exponential growth (blue); cuts to hit climate target (dashed). CO2 emissions since 1850 (red); exponential growth (blue); cuts to hit climate target (dashed). Photograph:
That might sound hard to believe. After all, thanks to green policies and technologies, emissions have been falling in Europe, the US and many other countries. Wind turbines and solar panels are ever-more common, not just in the west but in fast-growing China. And the energy efficiency of cars, light bulbs, homes and whole economies has been improving globally for decades. So why isn't the carbon curve showing any let up? Some might instinctively want to blame the growing population but that doesn't stack up. The rate of population growth has dropped like a stone since the 1960s and is no longer exponential, but the carbon curve doesn't appear to have noticed that any more than it has noticed the Kyoto protocol or whether you cycled to work this morning. For whatever reason, cutting carbon has so far been like squeezing a balloon: gains made in one place have been cancelled out by increases elsewhere.
To understand what is going wrong, it is necessary to consider the nature of exponential growth. This type of accelerating trend crops up when there is a feedback loop at work. For example, a credit card debt grows exponentially because interest gets applied to ever more interest. The number of algae in a jar grows in the same way: as long as there is food and air, there will be more algae and so they can breed faster.The fact that our carbon emissions have followed the same accelerating trend suggests that our use of energy is driven by a similar kind of feedback loop which is cancelling out apparent green gains.
That certainly fits with history. The industrial revolution that kick-started the human impact on the climate was driven by just such a feedback. The steam engine enabled us to drain coal mines, providing access to more coal that could power more steam engines capable of extracting yet more coal. That led to better technologies and materials that eventually helped ramp up production of oil as well. But oil didn't displace coal, it helped us mine it more effectively and stimulated more technologies that raised energy demand overall. So coal use kept rising too – and oil use in turn kept increasing as cleaner gas, nuclear and hydro came on stream, helping power the digital age, which unlocked more advanced technologies capable of opening up harder-to-read fossil-fuel reserves.
Seen as a technology-driven feedback loop, it is not surprising that nothing has yet tamed the global emissions curve, because so far nothing has cut off its food supply: fossil fuels. Indeed, though our governments now subsidise clean-power sources and efficient cars and buildings – and encourage us all to use less energy – they are continuing to undermine all that by ripping as much oil, coal and gas out of the ground as possible. And if their own green policies mean there isn't a market for these fuels at home, then no matter: they can just be exported instead.
Impact of climate change: ice melt in Antarctica. Impact of climate change: ice melt in Antarctica. Photograph: Peter McBride/Barcroft Media
This extraordinary double-think is everywhere to be seen. Take the US. Obama boasts that American emissions are now falling due to rising auto efficiency standards and gas displacing dirtier coal in the energy mix. But the US is extracting carbon and flowing it into the global energy system faster than ever before. Its gas boom has simply allowed it to export more of the coal to other countries such as China – which of course uses it partly to produce goods for US markets. Not happy with increasing US carbon extraction, Obama is also set to approve the Keystone XL Pipeline that will enable Canada to flood the global markets with crude produced from dirty tar sands. So much for carbon cuts.
Or take Australia, which in the same year introduced a carbon tax and started debating plans for a series of "mega-mines" that would massively increase its coal exports, helping build confidence among the companies and governments planning no fewer than 1,200 new coal-fired power stations around the world. Even the UK, with its world-leading carbon targets, gives tax-breaks to encourage oil and gas recovery and has been growing its total carbon footprint by relying ever more on Chinese factories – and therefore indirectly its reliance on American and Australian coal. And not just that. Although it rarely gets commented on, Britain – along with other supposedly green nations such as Germany – regularly begs Saudi Arabia and the other Opec nations to produce not less oil, but more. As journalist George Monbiot once put it, nations are trying simultaneously to "reduce demand for fossil fuels and increase supply".
It is not just governments that are in near-universal denial about what needs to happen to the fossil fuel sector. Blithely ignoring the fact that there is already far more accessible fuel than can be safely burned, pension fund managers and other investors are allowing listed fossil fuel companies to spend the best part of $1tn a year (comparable to the US defence budget, or more than $100 for every person on the planet) to find and develop yet more reserves.
If and when we emerge from this insanity, the carbon bubble will burst and those investments will turn out to have been as toxic as sub-prime mortgages. Don't take my word for it. HSBC analysts recently concluded that oil giants such as BP – beloved of UK pension funds – could have their value cut in half if the world decides to tackle climate change. Coal companies can expect an even rougher ride, and yet our financial regulators still allow them to float on stock markets without mentioning in their share prospectuses that their assets may soon need to be written off.
But for now, the fuel is still flowing freely. And for as long as that continues, the global energy feedback loop will ensure that many of the things we assume will help may be ineffective – or even counterproductive. More efficient engines may simply enable more people to drive more cars over greater distances, triggering more road building, more trade and indeed more big suburban houses that take more energy to heat. New renewable or nuclear power sources might just lead to more economic activity, increasing demand and supply of all energy sources, including fossil fuels. And local carbon cuts caused by green choices, population decline or even new economic models may simply free up more fuel for use elsewhere.
Of course, oil, coal and gas use will level off eventually no matter what we do. Fossil fuels are a finite resource and each year they get more expensive relative to renewables and nuclear. But given the continued acceleration not just in fossil fuel extraction but in the production of cars, boilers, furnaces and power plants that need oil, coal and gas to function, there is zero prospect of that happening of its own accord any time soon. Forget peak oil caused by dwindling supplies. At least until we've cracked cheap carbon capture, we need to bring about peak fossil fuels. Voluntarily. And soon.
We know how to do it. A properly designed global cap and trade scheme is one option. Stiff taxes on the production or sale of carbon-based fuels is another. Or we could simply oblige companies taking carbon out of the ground to arrange for a rising share of what they extract to be buried again. Any of these models could bring down global emissions and stimulate an explosion of investment and innovation in clean and efficient energy systems. But there is no avoiding the unpalatable side-effects: spiralling fuel and energy prices; a write-off of fuel reserves worth many trillions of dollars; and a fierce global squabble about how to share out the fuels we do decide to burn.
How would all this affect the global economy, or pension funds, or the financial health of the Middle East, the US and other carbon-rich nations doing most to resist a global climate deal? For all the confident opinion on both sides, no one can say for sure, just as no one can be certain how human society will fare in a warming world. But with so much money and power bound up with oil, coal and gas, one thing seems clear: constraining global fossil fuel supplies will take bigger thinking, harder politics and – crucially – a whole lot more public pressure. Voluntary carbon cuts are a great start but they are no match for a system-level feedback in human energy use.
Globally, the vast majority of people want climate change dealt with. But can we bring ourselves to prioritise a safe planet over cheap fuels, flights, power and goods? Can we face calling on our leaders to end the double-think and constrain oil, coal and gas supplies on our behalf? Can humanity muster the restraint and cooperation needed to leave assets worth trillions in the ground?
This article is based on the book The Burning Question by Mike Berners-Lee and Duncan Clark, which is published on 20 April by Profile Books, price £9.99. To order a copy for £7.99 with free UK p&p, go to or call  [masked]