Stranded in Paris: Can COP pop the carbon bubble?

Stranded in Paris: Can COP pop the carbon bubble?

Will the potential risk of fossil fuel's stranded assets even be on the agenda at COP?

In preparation of the U.N. Climate Change Conference (COP21) in Paris this December, G7 leaders recently met in Bavaria to discuss the possibility of a decarbonized future.

But as leaders are becoming increasingly wary of their carbon output, how much attention will be paid to the emerging risk of fossil fuel’s stranded assets?

“There’s not going to be a whole stream of negotiations around stranded assets,” said Anthony Hobley, CEO of the Carbon Tracker Initiative. “But the risk of stranded assets in part comes from what comes out of Paris, and how the framework is created, how robust it is and how capable that framework is.”

Inflating the carbon asset bubble

According to the University of Oxford's Smith School of Enterprise and the Environment, “stranded assets” are “assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities and they can be caused by a variety of risks.”

While stranded assets can apply to anything at risk for premature write-downs, this concept has become particularly intertwined with the “stranding” of fossil fuels reserves.  

This association came about in part because of a report issued by the Carbon Tracker Initiative in 2012, which gained notoriety after environmental activist Bill McKibben mentioned the organization in an article in Rolling Stone later that year.  

The report explains that in order to stand by an agreed-upon promise made at the U.N. Climate Change Conference in Copenhagen in 2009 to prevent the earth’s temperatures from rising more than 2 degrees Celsius, 80 percent of the world’s carbon reserves must be left in the ground.

Fossil fuel companies count reserves in the ground as assets on their balance sheets. If 80 percent of these reserves are left unburnable, these companies as a whole will be forced to write off up to $20 trillion in losses. The resulting losses will lead to what the organization refers to as the “carbon asset bubble.”

“The stranded assets debate has created some plausible scenarios in which investors could lose a huge amount of money,” said James Hulse, CDP’s head of investor initiatives.

However, some energy analysts — along with the energy companies such as Shell and ExxonMobil — express doubts over the possibility that fossil fuel reserves will become stranded.

In a Wall Street Journal opinion piece, Nancy Meyer and Lysle Brinker of HIS consulting and research argue that while although only 24 percent of fossil fuels reserves by volume are proven, those proven reserves account for 81 percent of the company’s valuations by investors.

“A scenario that envisions a swift decarbonization of the economy that leaves most commercial hydrocarbon assets 'stranded' seems highly unrealistic,” argued Meyer and Brinker.

Yet, whether these assets will become stranded or actually will lead to carbon bubble, the risk increasingly has garnered attention from news outlets such as the BBC, the Financial Times and The Economist.

Why COP matters

Some media outlets and members of the investing world are becoming more wary of these potential risks, but what role does Paris play in addressing these possible risks?

Hobley explains that although a successful Paris could lead to tougher regulations on carbon — which might edge us closer to a carbon bubble — providing a clear framework ultimately could minimize these risks.

“A relatively successful Paris reduces the risk of stranded assets. In an orderly transition where everyone knows what the pathways to the next 30 years, you should actually get very little stranded assets,” said Hobley. “The longer you delay action, the more you’re inflating that carbon bubble and the greater that risk of stranded assets becomes.”

The risk of stranded assets and a carbon asset bubble go beyond looming global climate regulations or a potential carbon tax at Paris, as oil companies have begun to expand into volatile areas.

“I don’t think many of the major economic drivers are going to go away. I think COP is a stepping stone. I don’t think it’s anything more than that,” said Hulse.

In May, Shell gained permission from the U.S. government to begin drilling in the Chukchi Sea off the Alaskan coast.

According to The New York Times, the sea’s remoteness makes it a dangerous venture: “The closest Coast Guard station with equipment for responding to a spill is over 1,000 miles away. The weather is extreme, with major storms, icy waters and waves up to 50 feet high.”

If world leaders in Paris are serious about holding global temperatures from warming above 2 C, drilling in the arctic would be impossible as well as 75 percent of drilling of Canadian oil, according to a study by the University College of London.  

Adding to these economic drivers is that the price of crude oil as of June 29 sits at $58.39, down from $117.79 in March 2012.

In a Wall Street Journal Heard on the Street column, Liam Denning writes “that surveying 37 large oil companies, Citigroup estimates as much as 40 percent of the current investment cycle — about $1.4 trillion — may have gone into or be going into projects that struggle to generate acceptable returns at oil prices below $75 a barrel.” 

Meaning that if crude oil continues to stay below $75 for long, oil companies likely will suffer serious losses.

“It’s very clear that the underlying economics are deteriorating,” said Hulse.

The sunset industry 

As the potential losses for oil companies could lead toward perilous catastrophe for the fossil fuel industry, how will oil companies engage in preparation to COP21?

In a recent letter to the U.N., six European oil and energy company executives — BP, BG, Shell, Statoil, Italian oil company Eni and French oil company Total — have advocated for implementing a price on carbon, in part to provide a more stable guideline of what to expect.

“For us to do more, we need governments across the world to provide us with clear, stable, long-term, ambitious policy frameworks. We believe that a price on carbon should be a key element of these frameworks,” according to the letter.

However, U.S. energy companies Exxon and Chevron were not excluded in the letter and have yet to request a price on carbon.

The carbon price likely would affect coal the hardest, as it is highly carbon intensive, and likewise would benefit oil companies' transition to natural gas, which is less carbon intensive and wouldn’t be ravaged by a carbon price.

“I think it’s a very difficult topic for companies to deal with effectively, the long-term prognosis is that oil is kind of a sunset industry. The question is really how long?” said Hulse.