What’s a Carbon Bubble?

Nearly all climate scientists agree that the Earth has been getting warmer since industrialization began in the 18th century. Overwhelming data support the conclusion that burning so-called fossil fuels that ages ago were plants — coal, oil, and natural gas — releases the carbon that plants contain in the form of carbon dioxide (CO2). These emissions trap heat in our atmosphere by preventing some of the sun’s heat from dissipating into space. The trapped heat is causing Earth’s temperature to rise.

Last year at the Conference of the Parties (COP21) in Paris, almost 200 countries agreed to take measures to limit that temperature rise to two degrees Celsius (2°C), or just under four degrees Fahrenheit (4°F), which is the scale Americans use. All would cut back on fossil fuel use to limit the amount of CO2 spewed into the air.

While scientists are convinced that the Earth’s climate is changing and that this is largely due to human activities, many investors are still largely unaware of this circumstance. They still place high valuations on the assets of coal, oil, and natural gas companies.

In an article published on medium.com titled “Trump, Putin and the Pipelines to Nowhere,” author Alex Steffen explains why such valuations are unwarranted. As countries curtail their use of fossil fuels in favor of renewable sources of energy such as solar, wind, hydro, geothermal, fossil fuels will diminish in value. Untapped fossil fuel reserves increasingly become, not assets, but liabilities. As Steffens says, if we can’t burn oil, it isn’t worth much. Other assets besides fossil fuel are poised to be devalued: coastal real estate which can’t be insured because of rising sea levels, and companies newly vulnerable to climate litigation. Steffen writes: “when there’s a large difference between how markets think assets should be valued and what they are (or will) actually be worth, we call it a “bubble”.” Steffen cites Mark Carney, the Governor of the Bank of England and chair of the Financial Stability Board — the global institution charged with preventing market panics and crashes — who gave a bombshell talk at Lloyds last year. He warned that the Carbon Bubble would continue to grow and could lead to a global market crisis as big as or worse than the 2007 subprime mortgage crisis. When the Carbon Bubble bursts, he forecast, trillions of dollars of imaginary assets will quickly disappear.

It comes down to how investors assess risk. If they see their assets headed for a risky future, skittish investors will divest and seek safer investments. The herd will follow, causing share prices to plummet. Fossil fuel companies face a growing threat to investor confidence. They know this, and have spent millions of dollars lobbying to deny climate change and humanity’s responsibility for it. They have spun the notion that fossil fuels are vital to Earth’s current prosperity and that its future growth and well-being is assured. Their messages to the media have shifted in recent years from denying climate change, attacking global climate agreements, criticizing carbon alternatives, and opposing any tax on carbon, to now acknowledging that a mix of energy sources is essential.

While the environmental indictment of fossil fuels is strong, ultimately the economic argument will prevail. Eventually the Carbon Bubble will burst as the profits of the fossil fuel industry become to be seen as more uncertain; divestment and bankruptcies will ensue. Renewable energy sources are becoming cheaper than carbon-based sources. Several coal companies have gone bankrupt in the last few years. The price of oil has dropped due both to over-supply and cheap natural gas thanks to fracking. Industrial scale solar and wind energy are now cheaper than either oil or gas.

Experts have warned that the Carbon Bubble “is one of the biggest threats to the global economy.” To manage the deflation of the Carbon Bubble will entail cutting fossil fuel use and speeding adoption of measures to slow the  climate change trajectory. Such measures would, we can only hope, let the Carbon Bubble deflate slowly enough to allow markets to adjust and avert a global financial crisis.