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The Actuary The magazine of the Institute & Faculty of Actuaries

Environmental: Stranded assets

Take an organisation with £100bn 
in assets. Now suppose that there are compelling reasons why only 20% of those assets can ever be utilised. What are those assets truly worth? This is the basic question behind the Carbon Tracker Initiative’s report, ‘Unburnable Carbon’.

Despite the clamour from denialists, the lobbying from energy-intensive industries and outrage from politicians on a bandwagon, there is no government in the world without a policy on carbon reduction.

The Intergovernmental Panel on Climate Change (IPCC) recommends a 25-40% reduction by 2020 and 80-95% by 2050. Increasingly, this is backed by legislation. Looking at it from another angle, the Potsdam Institute calculates that between 2000 and 2050 we must limit total emissions to 886 gigatonnes of carbon dioxide (GtCO2) to avoid the 2ºC rise that will trigger the floods, fire, famine and other catastrophes that will destroy civilisation as we know it. Of those 886 GtCO2, we have already emitted 321 in the first decade of the century. That means that we have only 565 GtCO2 for the years remaining until 2050 — or that we will breach the limit in about 2026 if we continue with business as usual.

The analysis goes on to look at global fossil fuel reserves and assesses their CO2 potential at 2795 GtCO2 — some five times the remaining carbon budget until 2050. 
Of this they estimate that 745 GtCO2 are held by the top listed oil, gas and coal companies and the rest are nationalised government assets. If only 20% of these reserves can be used, to avoid breaching the 2ºC limit, the private sector must be limited to 149 GtCO2 for the next 40 years.

So if companies across the world are valuing assets of which only 20% can be used, can that valuation be justified? And if not, what are the consequences? 
Are we facing, as the authors suggest, a carbon bubble every bit as toxic as the sub-prime bubble that devastated the financial landscape only a few short years ago?

The report looks at the special situation of the London market. The value of investments in oil, gas and coal held in London is totally disproportionate to the size of the British economy; only the Russian and US markets are larger. The carbon dioxide potential of the reserves listed in London account for 18.7% of the remaining global carbon budget. 
The authors make the point that two thirds of the £4.1 trillion under management in London is represented by the pensions 
and life assurance policies of UK citizens.

The dominance of the FTSE 100 by mining, oil and gas companies means these investments are open to commodity risk — and now to carbon risk. These risks are almost totally dependent on operations far beyond UK borders.

Arguably, a lack of effective regulation contributed to the 2008 financial crisis. Currently, there is no regulation of 
carbon risk.

The authors’ recommendation is to strengthen regulation, abandon 
short-termism and take the long view. 
The accounting profession and auditors 
must look at whether assets can truly be exploited. IPO documentation must take clear account of climate change issues; banks must assess their exposure to unrealisable assets. Every effort must be made to manage all this without triggering another financial meltdown.

The next step 
from all this, 
which the report does not address, is the consequence of not burning fossil fuels. Quite simply, it will be a reduction in energy supplies, affecting every industry and virtually every human activity. It is not just the asset values of mining and resource companies that will need to be cut, but the values of many other industries as well.

Many will claim that all this ignores technological advances and government regulations , but time is very short and the true effect of regulation is so far relatively tiny. Carbon Capture and Storage is at least 10 years away and new nuclear power stations take a similar time, even without the uncertainty of the Fukushima situation. Wind and solar are increasingly constrained by shortages of rare earth metals and cleaning up transport emissions will take decades. With business as usual taking us over the 2ºC threshold in only 16 years, we are coming very close to the wire.

Maybe we have identified a new class of toxic assets. Maybe this time someone will recognise the danger before it’s too late.

The full text of the report can be found at 

Anthony Day

Anthony Day is an associate of the Institute of Environmental Management and Assessment