Climate change: energy companies face $25tn risk from carbon bubble

Ruth Green, IBA Multimedia Journalist

As the world faces major floods, heatwaves and droughts, the scientific case for slashing carbon emissions grows ever stronger. Businesses are now taking notice as mounting evidence points towards a new carbon bubble. Bubbles – financial, dotcom, housing or otherwise – are great for investors, until they burst. Should the carbon bubble burst, as is expected, it would wipe trillions of dollars from the global economy.

The term ‘carbon bubble’ was coined after the founders of the Carbon Tracker Initiative emerged from the 2009 Copenhagen climate talks disappointed by the international community’s response. Seeking to engage the financial markets, the London-based think tank did its research.

The results were staggering: by their reckoning, fossil fuel-based companies stand to lose trillions of dollars in ‘stranded assets’ – from coal mines to oil wells, power stations and conventional vehicles – as the world makes the long overdue, and increasingly urgent, shift to a low-carbon economy.

James Thornton, CEO of Client Earth, discusses moves by companies and countries to divest from fossil fuels

Initially dismissed by major energy sector companies, the think tank’s claims have gradually gained traction, receiving a ringing endorsement from Governor of the Bank of England, Mark Carney. Anthony Hobley, Carbon Tracker’s chief executive, says the challenge facing companies continues to rise as they shutter operations and shift their investment towards clean energy projects. ‘There’s a huge risk as the energy sector probably has the biggest number and value of fixed assets of any industry – about $25tn worth of fixed assets,’ says Hobley. ‘If those are high carbon and fossil-fuel based, there is a risk there.’

Hobley, who previously led the Sustainability & Climate Finance Practice at Norton Rose Fulbright and served as general counsel to the Climate Change Capital Carbon Fund, says understanding this risk may help motivate businesses to develop a sustainable approach to divestment. ‘Value is mostly based on growth not decline,’ he says. ‘It’s understanding when that decline is about to start that’s critical. Many investors may run a big risk of losing money.’

James Thornton, CEO of ClientEarth, says companies and investors have a huge task ahead of them. ‘The first ones who will be caught by it are coal companies,’ he tells Global Insight. ‘We’ve seen the world’s largest coal company [Peabody Energy] go bankrupt, and why? Because despite whatever Donald Trump may want to believe, the economy is already moving beyond coal. Will that happen with other fossil fuels? Many very serious analysts think the answer is ‘yes’ and believe trillions in investment needs to be written off. If you were a very smart investor, even for these companies – look at the Saudis, they’re looking into renewable energy – you would be the same if you’re Shell and BP and so on and trying to get away from stranded assets.’

There’s a huge risk as the energy sector probably has the biggest number and value of fixed assets of any industry – about $25tn worth of fixed assets

Anthony Hobley
Chief executive, Carbon Tracker

This thinking is already catching on. In July, the Republic of Ireland became the first country in the world to commit to divesting from fossil fuels. The country’s lower house of parliament passed a bill that will force the state-owned Ireland Strategic Investment Fund to withdraw €8.9bn currently invested in oil, gas and coal operations. The bill is slated to become law by the end of 2018 and divestment is expected to take place over the next five years.

There’s growing consensus that business has a responsibility to help the transition towards a decarbonised economy. A 2015 UN report Principles for Responsible Investment suggested companies and investors had a legal duty to take environmental, social and governance risks into consideration when managing their portfolios.

Conor Linehan, Vice-Chair of the IBA Climate Change Justice and Human Rights Task Force, believes the carbon bubble shows it’s high time for companies to come clean on climate risk. ‘It’s not like these property bubbles where people can agree or disagree on whether the conditions are there,’ he says. ‘The conditions of the bubble are there, unquestionably. Ultimately, there needs to be increased regulation and to force companies to disclose and report regulatory exposure to climate change risk in the same way that they have to disclose and report hard financial information. Different countries have different approaches, but for most companies it’s not really being policed or enforced in any meaningful sense.’

In the US, publicly listed companies are already required to disclose material business risks and there’s growing pressure on companies to include climate change in this list. In May 2017, 62% of ExxonMobil’s shareholders voted for the company to be more transparent about the potential impact of climate policies on the company’s bottom line. Bowing to this pressure, in December Exxon said it would introduce ‘enhancements’, including ‘energy demand sensitivities, implications of two degree Celsius scenarios, and positioning for a lower-carbon future.’

The oil giant has been hit by lawsuits for allegedly deceiving shareholders and employees about the risks climate change poses to the business. The US Securities and Exchange Commission (SEC) recently dropped an investigation into whether Exxon had misled investors by not factoring in climate change regulations when it calculated the value of its assets. However, it faces ongoing inquiries in New York and Massachusetts into whether it withheld research on the potential impact of climate change on the business from investors and the public. Global Insight approached Exxon for comment, but the company declined, saying it doesn’t ‘have anything to share on this’.

It’s unclear what chances the states have of success. Earlier this year a California court dismissed a lawsuit filed by the cities of San Francisco and Oakland to sue Chevron, ExxonMobil, Royal Dutch Shell and BP for damages associated with flooding they alleged was caused by climate change.

‘Exxon has brought several lawsuits to try to stop them, but none have succeeded,’ says Michael Gerrard, director of the Sabin Center for Climate Change Law. ‘In neither state has the attorney general brought any charges yet, so we’ll see what happens. We don’t know what kind of claims, if any, will be made by the attorney generals. The minimum is likely to be more disclosures, but whether beyond that there would be penalties it’s much too early to say.’

New York and Massachusetts are two of a growing number of US states that have pledged to fulfil the Nationally Determined Contributions at the heart of the Paris Agreement, despite the Trump Administration’s decision to renege on the accord. Gerrard says the Exxon investigations are indicative of the initiative many states are taking to combat climate risk. ‘The US SEC issued guidance under Obama, but took very little enforcement action, and the SEC under Trump is even less likely to take action,’ he says. ‘So for now it’s fallen to the states.’

Join the IBA

Expand your international network, gain new business and learn about the latest legal developments through IBA digital content and events, with IBA membership. Available for individuals, students, law firms, bar associations and corporations.

Find out more