No escape from climate change tail risks

It is tough enough to calculate the current value of an asset with an income stream that stretches far into the future – a hotel, for example. It’s not enough simply to look at the full register and healthy profits today; operating costs might go up, fashions and tastes might change, taxes could rise or fall. For fossil fuel assets there is an added problem, now widely discussed under the heading of “stranded assets”: how much of this will I actually be able to sell?

The truth is – and this isn’t news, this has been out there for several years – that the answer to that question is “not all of it”. In 2015, a study in Nature pointed out that a third of all known oil reserves, half of known gas reserves and more than 80% of known coal reserves could never be used if the world is to stay below the Paris target of a two-degree rise in global temperature. The industry reaction, as reflected in their investment plans and their market valuations, has been to respond, “well, I expect that means I can still burn all of mine and you can’t burn any of yours”. Not a solution that applies universally.

Banks are starting to pay attention to this issue – but there are many problems still to surmount, as our feature discusses. The biggest is the problem of timescales: existing credit risk teams are used to operating on scales of a few years; the decisions around fossil fuel abatement and climate change mitigation will be taken over a scale of decades.

It is crucial for the energy sector, and the energy finance business, to realise one thing: there is no credible business-as-usual scenario for the second half of the 21st century

But whatever those decisions are, it is crucial for the energy sector, and the energy finance business, to realise one thing: there is no credible business-as-usual scenario for the second half of the 21st century. Either far more drastic legal and technological measures than hitherto employed will be put into place in order to keep net emissions below the Paris target; or unchecked climate change will cause economic and demographic upheavals on a scale to match the wars of the 20th century; or, if we’re very unlucky, both at once. In neither case will the energy sector survive without undergoing fundamental change. And these consequences will be on us within our lifetimes; there are not actually that many years in a decade.

Given this prospect, it would be folly for governments to delay the process of adaptation; going harsh early might produce economic costs, but it would also provide far more certainty than is currently available. And an obvious approach would be to attack the problem from all directions: promoting clean generation with quotas and guaranteed-purchase deals, encouraging clean consumption and discouraging fossil fuel use with subsidies and carbon pricing, and also restricting further output of fossil fuels with enforced bans on exploration and production.

If fossil fuel reserves must be left in the ground to avert disaster, governments should make it illegal to take them out. This will be legally problematic – but, again, there will be no such thing as business as usual after 2050.