Brian Fallow: Global heat and the carbon bubble

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Govt oil tender could be threatened by constraints we signed up to on world use of known reserves by 2050.

The oil scramble could be stymied by the need to control global warming. Photo / AP
The oil scramble could be stymied by the need to control global warming. Photo / AP

The Government has put 189,000 square kilometres of the continental shelf up for tender for drilling by the oil industry.

At one level it is easy to understand why. We spend around $8 billion a year importing crude oil and refined products, roughly what exports of meat and forest products between them bring in, while we are running an annual current account deficit of $10 billion.

And an oil bonanza would mean jobs, and royalties and other tax revenues.

So it's a no-brainer, right?

Well, there is another point of view from which those considerations are insular and myopic.

It questions the wisdom of devoting resources to the quest for more oil and gas when we already have - we, humankind this time - more of them than we can possibly ever burn if we are to have a fighting chance of keeping global warming to 2 degrees celsius above pre-industrial levels.

And that is the goal the world's Governments, including ours, signed up to in Cancun in 2010.

From this point of view there is a carbon bubble inflating in the world's sharemarkets, where the market capitalisation of the top 200 listed oil and gas companies is of the order of US$4 trillion and their debt around US$1.5 trillion.

That is a lot of people's retirement savings at stake, to say nothing of the exposure of banks and revenue authorities.

The International Energy Agency is one of the bodies which takes this issue seriously.

Its 2012 World Energy Outlook, released six months ago, says: "No more than a third of proven reserves of fossil fuels can be consumed prior to 2050 if the world is to achieve the 2C goal, unless carbon capture and storage technology is widely deployed."

The IEA estimates about two-thirds of those carbon reserves is coal, 22 per cent oil and 15 per cent gas.

In other words, if the world is to achieve the 2C limit and also wants to burn all the oil and gas already in its proven (not merely probable) reserves, it would have to stop burning coal altogether, immediately.

Not another tonne for the world's coal-fired power stations, iron and steel works, cement factories and so on. Clearly that is not going to happen.

Instead the oil industry spends around $700 billion a year looking for more hydrocarbons and bringing them on stream.

And Governments, especially in poor countries, spend US$550 billion on consumer subsidies for transport fuels and cooking gas, which is six times what rich countries spend subsidising renewables.

The IEA estimates the oil and gas industry will spend a cumulative US$19 trillion by 2035 to meet growing demand and replace existing fields which become exhausted. Money talks, and what that much money says is a great big "yeah right" to the Cancun agreement's 2Cgoal. But there is such a thing as naive cynicism.

The financial markets may be be badly mispricing the risk that governments will, eventually, be as good as their word and act to limit carbon emissions on the scale required to achieve their avowed collective goal. The stakes, after all, are pretty high.

What might that mean for the listed oil and gas companies?

A report earlier this year called "Unburnable Carbon", updating an influential report in 2011, from an outfit called Carbon Tracker Initiative in conjunction with the London School of Economics' Grantham Research Institute, compares the reported reserves of the listed fossil fuel companies with their pro rata share of a global "carbon budget" (how much fossil carbon can be burned consistent with various increases in global mean temperature).

It concludes that between 65 and 80 per cent of their present reserves are in effect stranded assets which cannot be burned. There are a lot of moving parts in a calculation like this.

They have to make assumptions about the outlook for greenhouse gases other than carbon dioxide, about the impact of deforestation and other land use change, and about climate sensitivity, which is the extent to which any given increase in emission will raise global temperatures.

So they express the carbon budget in probabilistic terms: 1.1 trillion tonnes gives a 50 per cent chance of keeping warming below 2C, 1.3 trillion gives an 80 per cent chance of staying under 3C, and so on.

They also have to take account of the fact that stock exchange-listed companies represent only a fraction of the world's carbon reserves. The great majority belong to state-owned national companies. The Carbon Tracker report puts the listed companies' share at 25 per cent. Other estimates are lower.

With those caveats, and assuming listed companies have a 25 per cent share of future global CO2 emissions, they already have three times as much carbon on their books as they would be allowed to use under a 50:50 chance of 2C scenario.

So large an overhang almost certainly dwarfs the margin of error around such calculations. Take a wider measure of their reserves which includes potential resources the companies are seeking to develop and it is six times their share of the carbon budget.

HSBC analysts in a report last January looked at the implications for the valuation of listed European oil and gas companies of a low-carbon scenario, which they defined as the IEA's "450 scenario" which limits the atmospheric concentration of CO2 to 450 parts per million, the level it believes is necessary to have a 50 per cent chance of limiting the long-term temperature rise to 2C. The level has just passed 400ppm.

The HSBC analysts concluded that the bigger financial risk is not unburnable carbon on their balance sheets, but the potential drop in oil prices to follow a policy-induced contraction in demand of that order.

If the oil price fell to US$50 a barrel the impact, coupled with the stranded assets effect, would be to wipe between a third and a half off the value of the companies they considered.

How likely is this? To a large extent it depends on China. It is investing large resources in clean technology.

And there were reports this month that its National Development and Reform Commission, evidently an influential part of its vast and opaque bureaucracy, has proposed that China adopt an absolute cap on its greenhouse gas emissions by 2016, which if followed through would be a major advance in the geopolitics of climate change.

So we appear to be at a beggar's crossroads, which leads to calamity in both directions. One way lies a potential carbon bubble in capital markets to continue the ignoble tradition of the tech wreck and the global financial crisis.

The other way the implicit cynicism in current pricing proves justified.

We will blast through the 2C limit.

And our place in history as the accursed generation is secure.

Debate on this issue is now closed.

- NZ Herald

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