Carbon Bubbleheads

On Monday, November 17, the school of Business and Economics at the University of Melbourne convened a panel devoted to the proposition that fossil fuel-infected “stranded assets” might cause the next global financial crisis. If you’re not up to speed with the latest enviro-disaster greenspeak lingo, know that a stranded asset is an investment in some or other carbon-spewing industry or portfolio, and that the true believers consider it likely that it will be rendered near-worthless when the world switches abruptly to those “sustainable” sources we keep hearing are just around the corner.

You might think that the business faculty at one of Australia’s most august tertiary institutions would begin by considering just how likely such a sudden transition might be, then progress to a reasoned and logical examination of all the risks and rewards associated with what participants kept calling the “carbon bubble”. You would, alas, be hopelessly wrong.

The introduction on the university’s website:

“If coal, oil and gas companies are permitted to exploit all the resources they have currently discovered, the world’s climate will warm well beyond the 2C limit governments have agreed is necessary to avoid the worst effects of climate change.

An HSBC study found that removing the ‘stranded assets’ from the balance sheets of fossil fuel companies would halve their sharemarket value. Aggregating these losses is in the realm of $2 trillion: a greater impact on global sharemarkets than the 2008 Global Financial Crisis (GFC). Reports by Citibank, Standard & Poors, Bloomberg, the Bank of England, Oxford University, London School of Economics and others support the seriousness of the carbon bubble threat.

Meanwhile, the scientific evidence of climate change continues to pile up, the likelihood of a post-Kyoto global political agreement is increasing, and the divestment movement gathers momentum.

It is timely, therefore, to consider the economic implications of the carbon bubble. How should investors be responding to this issue? What can managers and shareholders of fossil fuel companies do in the face of this threat? And what can governments and policy makers do to avoid or reduce the impacts?”

So, having read the above, the panel of “experts” assembled for the evening’s exercise should come as no surprise:

• Peter Ryan, the ABC’s business editor, who served as the moderator
• Hon John Hewson, Chair, Asset Owners Disclosure Project
• Professor Ross Garnaut, University of Melbourne
• Jemma Green, Curtin University, formerly employed by J.P. Morgan
• Tony Wood, Energy Program Director, Grattan Institute

The event started with moderator Ryan demonstrating more of the even-handedness for which the ABC is infamous by quipping with evident satisfaction that Tony Abbott had just been “shirt-fronted” by Barrack Obama. If you believe the climate science is settled, this was no further example of that ABC bias, nor were Ryan’s references to  “dirty” coal, oil and gas, which were all quite proper by the national broadcaster’s standards. Ryan, who reproduced his opening remarks on his blog,  then repeated the key assertion that between $2 trillion and $3 is at risk. So much for moderators being impartial umpires.

John Hewson, who once failed to explain how cakes need to be taxed, was first to the microphone, introduced as the chair of the Asset Owners Disclosure Project (AODP), which bills itself as an independent, global, not-for-profit whose objective is to protect members’ retirement savings from the risks posed by climate change. This is to be achieved by redressing what it believes to be the typically huge imbalance between high-carbon assets (50-60% of a portfolio) and low-carbon assets (typically less than 2%). The group conducts an annual survey and assessment of the world’s 1000 largest asset owners to estimate their management of climate-change risks and opportunities.

Not surprisingly, Hewson disagreed with the present federal government’s approach to climate change but was willing to believe that all hope was not lost. Prime Minister Tony Abbott had once served as his press secretary, he explained, was reasonably bright and would surely come to his senses and follow the lead of other nations’ meaningful steps to combat climate change. The next phase of AODP’s crusade would be to “name and shame” those behaving badly, carbon-wise.

The thought may not have occurred to many in the 200-strong audience, but cynics could not have helped noticing that, while a switch to renewables was deemed the big threat to portfolios, there was no suggestion that funds invested in renewables might face more immediate peril if government subsidies were withdrawn.

Jemma Green continued the tale by reporting falling market valuations of companies in the US and Europe. Jemma is a former employee of J P Morgan and helped set up the bank’s environmental and social risk management office. She pointed to a 60% reduction in the market values of coal-mining and electricity-supply businesses. There was also a hint that the owners of some of the coal-fired power stations in Australia were facing asset write-downs. She also noted that South Australia had reached a point where renewables could supply 100% of demand. She forgot to add that there are times when renewables in South Australia supply only 1% or 2% of the state’s electricity demand. In the green imagination, the wind never stops blowing, neither are the skies darkened by clouds.

Any talk about the declining value Old Energy generating infrastructure is only part of the story. Green was not wrong in mentioning the reduction in asset values, but she neglected to mention it depends on your starting point. A long article in The Economist discusses European power plants losing half a trillion euros in value, as measured from the market peak at the time of the GFC in 2008.  But if assessed from, say, 2005, then no decline in share prices has been seen. There were three sources of trouble. First, based on growth expectations that were not met, there was over-investment in assets up to the GFC. Then the use of cheap natural gas in the US reduced the market for European coal. Finally, the growth of “intermittent” renewable power supplies made the suppliers of base-load power less profitable, as they had to cope with wild fluctuations from wind-farm supplies.

Next came Ross Garnaut, the brainiac Julia Gillard found so useful when pushing her now-repealed carbon tax. He stood so far from the microphone that much of what he said was no better than an inaudible mumble — although two words “Murdoch press” could be heard. His thesis was that Australia had over-invested in iron ore and coal mines in the period after 2000. Since these assets required long and productive lives to cover their initial costs, they would become money traps as the world turned away from coal. Thus, he concluded, major asset devaluations would be bound to occur. A splendid bit of hindsight, it skated lightly over the big miners’ determined efforts to ensure that their holes in the ground are in the bottom quartile of the cost curve. Sure, they suffer when prices drop and hard times descend, but the “asset stranding” Garnaut foresees would need a catastrophe of sudden and unimaginable proportions.

Finally and betraying a certain nervousness, Tony Wood emphatically asserted what should not have been necessary at such a gathering: “The science is real!” He then outlined the strategies to be followed by industries with low, medium or high energy needs. A switch for many from coal to gas would reduce their emissions. But depending on which country you are in, it might also increase costs. Many European manufacturers, for example, are looking seriously at re-locating to the US, where the fraking revolution has re-made the energy landscape and slashed energy costs.

On this happy note moderator Ryan then started what he described as a “Q & A” among the panel, followed by an opportunity for the audience to have its curiosity satisfied. The first question from the moderator went to Garnaut. Where did he think the first financial problem would erupt? Garnaut’s immediately reply, “Russia”. The fall in oil and gas prices must reduce Moscow’s foreign income and put great pressure on Vladimir Putin’s economy, he said. No sane person could fault this analysis, but the current fall in energy prices has nothing to do with CO2 emissions.

At this point, Hewson piped up with the thought that economists are no good at picking turning points and Jemma Green contributed the insight that the inclusion of a paragraph on climate change in the G20 communiqué reflected the “elephant in the room”. If cliches were responsible for raising temperatures, the air conditioner would have been working overtime.

At this stage your reporter left, having decided that the assembled wisdom on the stage would yield little in the way of insight.

On reflection, it is not clear who was in that “carbon bubble” I kept hearing about? The opening statement, quoted above, talks of the evidence for climate change piling up. What is piling up is the CO2 in the atmosphere while global temperatures, contrary to all predictions, remain dynamically stable.

If that carbon bubble exists, the panel was in it — and Jemma Green’s elephant as well. Thing is, the elephant is a white one.

Tom Quirk trained as a nuclear physicist at the University of Melbourne. He has been a Fellow of three Oxford Colleges