The ‘carbon bubble’

Overvalued fossil fuel assets reveal the ecological limitations of the economic recovery

Dan Bailey
Dan Bailey

It’s disconcerting that the return to GDP growth may have, for now at least, obfuscated the analysis of the unstable dynamics underpinning Britain’s pre-crash growth model.

The insights of numerous political economists have explicated that behind the GDP statistics lay a dysfunctional growth model with tendencies towards financial volatility, systemic risk, geographical and social inequalities and a reliance on asset price inflation and credit to sustain consumer spending.  It was conceptualised as ‘Anglo-liberal capitalism’ by Colin Hay and ‘privatised Keynesianism’ by Colin Crouch.

As recent data on house price inflation and credit expansion reveal, it is these very same dynamics upon which the current economic recovery has been predicated; if only due to the lack of alternatives available to Cameron, Osborne and Clegg who once spoke of the need for a ‘rebalancing’ of the British economy but are now increasingly mindful of the forthcoming general election.

There is a danger that the relevance of this analysis will only become apparent once Mark Carney raises the Bank of England base interest rate (likely to be shortly after the 2015 election) and the wealth that has been accumulated in assets and share prices is once again revealed to be a series of bubbles; with potentially dire electoral and policy consequences for which ever political party happens to be in office at the time.

The emergence of another troublesome bubble has been the subject of recent speculation after a publication on March 6th from the Environmental Audit Committee highlighted the existence of a potential ‘carbon bubble’.

The ‘carbon bubble’ hypothesis articulates the fear that stock markets may be over-valuing certain companies with fossil fuel assets (reserves of coal, oil and gas), which must remain untapped in order to mitigate climate change and allow many nations, including Britain, to meet their legally-binding carbon targets.

The idea stems from the Carbon Tracker Initiative which published a report arguing that only 31% of known fossil fuel reserves owned by private and public companies could be burned if the planet is to retain an 80% chance of remaining below a 2°C average temperature rise.   69% of known fossil fuel reserves, therefore, will be rendered ‘toxic assets’ by any actions designed to meet carbon reduction targets; the corollary of which would be wide-scale share price depreciation.

Ostensibly, the financial markets are banking on Western countries having no intention of meeting their legally-binding targets and caring little about making a transition towards sustainability. The Guardian estimate that ‘trillions of dollars’ could be at risk and the uncertainty has already led to some speculators pulling back on investment.

Whilst highlighting the glut of capital invested in carbon-intensive industries, the Environmental Audit Committee also noted the symmetrical under-investment in green capital investment projects. It states that ‘investments are currently running at less than half of the £200 billion needed in energy infrastructure alone by 2020 to deliver national and international emissions reduction targets’.

Even with the liberal use of the blunt tool of monetary policy, Quantitative Easing, which has generated a general excess of liquidity in the markets relative to the investment opportunities in the core economy – a trend which has led to the inflation of several asset and share price bubbles according to Ha-Joon Chang – green infrastructure is still being woefully under-financed by the private sector.

That this is occurring at the same time as the carbon bubble speaks to the long-held belief that free markets do not always direct resources in socially useful or economically advantageous ways.

There may turn out to be a painful irony to this, which is that this bubble may not be popped by governments committed to de-carbonisation, but rather by disruptions in the precarious international supply chains situated within geopolitically sensitive regions such as the Ukraine.  If these supply chains are disrupted for any reason, and the events of recent weeks suggest we should not exclude the possibility, then this may ultimately play a far greater role in the re-evaluation of these companies and its realisation not as gradual or managed.

It should come as little surprise that Britain’s high-risk economic strategy can be influenced so greatly by ecological factors.  It was the appreciation of Brent Crude from US$18.71 a barrel in December 2001 to US$132.72 in July 2008– related to the BRIC-driven 2.5% per annum growth in demand and the diminished supply caused by the unsustainable depletion of finite resources– which contributed to the inflationary pressures of the pre-crash period.  The raising of interest rates by Central Banks to control these inflationary pressures then precipitated the bursting of asset and credit bubbles and the financial crash of 2008.

The carbon bubble and simultaneous under-investment in clean energy demonstrate again the limits of a financial sector intent on maximising short-term profit.  This particular case epitomises how the capital formations underpinning the current economic recovery are difficult to reconcile with the desire to live within ecologically sustainable parameters.  Policy action is needed both to suppress the share price inflation generated by expectations of fossil fuel reserves and to press the Coalition Government’s Green Investment Bank to step up its provision of investment in renewable energies. If not, then the fragile economic recovery may be difficult to sustain; or, even worse, may stay on its course of unsustainability.

Joan Walley MP, Chair of the Environmental Audit Committee, offered the following warning:

The UK Government and Bank of England must not be complacent about the risks of carbon exposure in the world economy. Financial stability could be threatened if shares in fossil fuel companies turn out to be over-valued because the bulk of their oil, coal and gas reserves cannot be burnt without further destabilising the climate. The record-breaking extreme weather events causing chaos across the globe should be a wake-up call. The transition to a low carbon economy will be much more painful if we wait until there is a climate crisis before recognising that more than half of the world’s fossil fuel reserves will have to remain in the ground.