The idea that efforts to mitigate climate change expose fossil fuel assets to the risk of a bubble-like collapse has attracted some high-profile supporters. However, the notion of a “carbon bubble” depends on questionable assumptions concerning our current knowledge of climate change, the rate of adoption of renewable energy technology, and how such assets are valued.
In their recent Wall St. Journal op-ed, Al Gore and one of his business partners characterized the current market for investments in oil, gas and coal as an asset bubble. They also offered investors some advice for quantifying and managing the risks associated with such a bubble. This is a timely topic, because I have been seeing references to this concept with increasing frequency in venues such as the Financial Times, as well as in the growing literature around sustainability investing.
Although bubbles are best seen in retrospect, investors should always be alert to the potential, particularly after our experience just a few years ago. In this case, however, I see good reasons to believe that the case for a “carbon asset bubble” has been overstated and applied too broadly. The following five myths represent particular vulnerabilities for this notion:
1. The Quantity of Carbon That Can Be Burned Is Known Precisely
Mr. Gore is careful to differentiate uncertainties from risks, which he distinguishes for their amenability to quantification. For quantifying the climate risk to carbon-heavy assets, he refers to the widely cited 2°C threshold for irreversible damage from climate change, and to the resulting “carbon budget” determined by the International Energy Agency (IEA). As Mr. Gore interprets it, “at least two-thirds of fossil fuel reserves will not be monetized if we are to stay below 2° of warming.” That would have serious consequences for investors in oil, gas and coal.
The IEA’s calculation of a carbon budget depends on a factor called “climate sensitivity.” This figure estimates the total temperature change resulting from a doubling of atmospheric CO2 concentrations. The discussion of climate sensitivity in the recently released Fifth Assessment Review of the Intergovernmental Panel on Climate Change (IPCC) sheds more light on this parameter, which turns out not to be known with certainty. Their Summary for Policymakers includes an expanded range of climate sensitivity estimates, compared to the IPCC’s 2007 assessment, of 1.5°-4.5°C with a likelihood defined as 66-100% probability. It also states, “No best estimate for equilibrium climate sensitivity can now be given because of a lack of agreement on values across assessed lines of evidence and studies.”
The draft technical report that forms the basis for the Summary for Policy Makers provides more detail on this. It further assesses a probability of 1% or less that the climate sensitivity could be less than 1°C. That shouldn’t be surprising, since temperatures have already apparently risen by 0.8°C above pre-industrial levels. At the same time, the report indicates that recent observations of the climate — as distinct from the output of complex climate models — are consistent with “the lower part of the likely range.”
In other words, while continued increases in atmospheric CO2 resulting from increasing emissions are widely expected to result in warmer temperatures in the future, the extent of the warming from a given increase in CO2 can’t be determined precisely before the fact. For now, at least, the CO2 level necessary to reach a 2°C increase would be consistent with calculated carbon budgets both larger and smaller than the IEA’s estimate. That means that the basis of Mr. Gore’s suggested “material-risk factor” — as distinct from an uncertainty — is itself uncertain.