Stock market could be inflating a carbon bubble

In their new Green Finance report, the Environmental Audit Committee (EAC) have warned that stock markets could be inflating a ‘carbon bubble’ by over-valuing companies with fossil fuel assets that will have to be left unburned in order to limit climate change, reported the Guardian, BBC and Independent.

Carbon Tracker evidence underpins findings
Citing evidence given by Carbon Tracker’s Research Director, James Leaton, and Nicola Ranger from the London School of Economics, the EAC quotes our findings in the Wasted Capital and Stranded Assets report that ‘60-80% of coal, oil and gas reserves of listed firms are unburnable‘.

Carbon Tracker’s Founding Director, Mark Campanale summarised to the Committee the scale of risks from carbon exposure by revealing ‘two thirds of the FTSE350 are based on finance, oil and gas and mining. If these valuations are wrong then we are putting our banking system and the London capital markets at risk’.

The EAC asked the Bank of England (BoE) whether they thought there was a carbon bubble risk, to which the Financial Policy Committee (FPC) said they ‘had not identified risks to financial stability from a carbon bubble’. This follows an open letter from Carbon Tracker and 20 other investors urging an assessment of carbon bubble risk, to which Governor Mervyn King admitted ‘there is clearly a scope for further evaluation of these issues’.

Chair of the EAC, Joan Walley MP, said: “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.’

James Leaton said: “We welcome the recommendation to make a link between the Climate Change Committee and the Bank of England, this is essential to ensure we have a resilient financial system going forward”.

EAC recommendations echo those of Carbon Tracker
The EAC recommend the FPC and BoE should ‘regularly consult with the Committee on Climate Change to help it monitor the risks to financial stability associated with a carbon bubble’.

Significantly, they also recommend that, ‘the Government should ensure that company reporting requirements provide investors with the information required to assess carbon exposure’.

This directly echoes the recommendations we made in Wasted Capital and Stranded Assets for regulation that requires companies to disclose the potential emissions of CO2 embedded in reserves. This will allow accurate monitoring of carbon exposure. While the FPC say there is no immediate risk from the carbon bubble, regulators of capital markets must have the right information to enable them to make this assessment, which they do not have adequately at the moment.

James Leaton said: “London has an opportunity to lead financing the energy transition – at present it risks being left holding the toxic assets rather than having a significant stake in green growth”.

Carbon Tracker hope this report will help prioritise carbon bubble risk within the BoE and help them recognise the need to consider longer-term perspectives for climate change risks.

Carbon bubble warning from the UNFCCC
Coincidentally, the day before the EAC report launch, Christiana Figueres had been speaking of the risks associated with the carbon bubble at The Science Media Centre. She said: “We will move to a low-carbon world because nature will force us, or because policy will guide us. So it is in everybody’s interest to get the policy that will allow us to move in a structured way that does not call upon a systemic risk of falling off a cliff all of a sudden and that capital needs to be shifted overnight…which will be much more expensive and…very unpredictable”.