Carbon bubble poses risk to financial system

Companies involved in fossil fuel extraction could see their value plummet overnight as the consequences of climate change become more apparent, a new report warns

A report by Scottish Environment LINK has warned that capitalisation of the oil and gas industry is largely based on the assumption that the world’s known reserves of oil, gas and coal can be extracted and burned.

However the International Energy Agency has warned that two thirds of the world’s fossil fuels must stay untapped in order to keep rising global temperatures to under two degrees and avoid ‘catastrophic’ climate change.

The report warns that when markets accept these reserves cannot be sold, the ‘carbon bubble’ created by overvalued assets will burst, creating global financial risk in the process – particularly for nations such as Scotland with heavy involvement in the fossil fuel industry.  

The report says: “The carbon bubble could burst at any time. It will burst when the market accepts that not all fossil fuels are going to be burned.  Carbon based assets could become stranded assets and lose value overnight, causing a financial shock which could pose a threat to economies whose financial sectors are heavily dependent on the fossil fuel industry.

“It could happen quickly in response to an international political agreement which commits governments to urgent action, but it may not necessarily depend on international agreement. It could happen as a reaction to extreme weather events which trigger national political commitments to action, or it may be that market forces, cheaper alternatives (for example solar energy reaching grid parity) or general behaviour change may influence it.”

The report also warns that a strong climate agreement in the Paris negotiations later this year could trigger a financial meltdown. Pension funds – often heavily invested in oil and gas assets – could be at particular risk.

Matthew Crighton, convener of the LINK's Economic Taskforce, said: “When investors catch up with the reality of a low carbon future, the bubble could burst with knock-on consequences for the whole economy”.

LINK also warns that the development of Carbon Capture and Storage technology could take more than a decade, meaning that by the time it starts to operate at an industrial scale targets for the amount of carbon that can affordably be burned may have been reached or even exceeded.

The report calls on government to send “strong, clear and certain signals that there is a change of direction towards a low carbon economy” in order to deflate the bubble, alongside a inquiry led by the Scottish Parliament’s Economy, Energy and Tourism Committee into the risks posed to Scotland.

Patrick Harvie, Scottish Green MSP for Glasgow and a member of Holyrood’s Economy, Energy and Tourism committee, backed Scottish Environment LINK in calling for an inquiry.

He said: “This report from LINK adds to the growing voices calling for action to head off another economic crash. The carbon bubble is a reality both the UK and Scottish Governments must face up to.

“In particular I welcome the call for the Economy, Energy and Tourism Committee to hold an inquiry into the issue. We're already seeing moves by pension funds to divest from fossil fuels given the enormous financial risk. Scotland is well placed to lead the way towards an economy that does not rest on the perceived value of what are clearly unburnable resources.”

The Scottish Government responded to say that it supports the transition to low carbon and renewables, with Scotland generating 46.4 per cent of its equivalent electricity needs from renewables in 2013.

A spokesperson said: “Hydrocarbon rich countries such as Scotland, Norway and Denmark certainly have an obligation – both moral and of economic opportunity – to lead the way to a low carbon economy. The skills and expertise that we have in our offshore oil and gas industry is crucial to mobilising low carbon technologies.

“Our approach is one of careful stewardship of finite resources. In Scotland we need a diverse and balanced energy portfolio to provide us with secure and affordable heat and electricity for decades to come. We are also championing carbon capture and storage (CCS), which is a critical technology that could play a significant role in the de-carbonisation of Scottish – and European - energy supplies.”