The (Untapped) Carbon Conundrum
If the world burned all of its fossil fuel reserves, would the world as we know it be the same?
The International Energy Agency, Intergovernmental Panel on Climate Change and other reputable groups say that the answer is no. Most of these reserves cannot be burned without tipping us into a climate catastrophe.
That's why we, on behalf of two of the world's largest pension funds, along with 70 leading investors representing $3 trillion in assets, earlier this fall asked the leaders of 45 of the world's largest fossil fuel companies to assess how their business plans fare in a low-carbon future.
It's prudent for investors, especially long term investors such as ourselves, to be asking what plans are in place for dealing with these trends and it's encouraging that many of the companies we have talked with so far are taking our request seriously.
The response from opponents who called our request "delusion and wishful thinking" was typical of those who see little risk in meeting the world's energy needs through fossil fuel extraction.
We as investors simply want to ensure that the companies we own are preparing for a future that will likely be very different from the present. It would be enormously risky to ignore the warning signs, continuing down a path of business-as-usual as the world changes around us.
For decades we have expected and realized strong investment returns from fossil fuel companies. But regional and national climate policies and new disruptive energy technologies are now impacting fossil fuel returns as global efforts to combat climate change continue to gain traction.
In the U.S., coal demand has fallen over 15 percent in the last five years due to several factors, including stricter EPA power plant standards, hydraulic fracturing and more cost-competitive renewable energy. The result? Coal reserves are going unused until global coal markets determine if new sources of demand will emerge. Meanwhile, coal company market valuations have plummeted by as much two thirds since 2011.
Oil is undergoing changes, too. Rising production costs and risks are the new reality for the oil industry, which is facing new challenges and fluctuating share prices. More expensive oil plays such as Canada's oil sands and deep-water drilling require high oil prices to break even, and may become economically unviable if oil prices do not continue to riseabove the current $100 a barrel. A recent HSBC Global Research report, for example, outlines specific climate scenarios where western oil majors such as BP and Statoil would see portions of their proven reserves become "unburnable," causing their markets capitalizations to fall.
Yet, despite these trends, the oil industry is still spending billions of our shareholder capital -- approximately $541 billion in 2012 alone, roughly double total clean energy investment worldwide -- to find and produce more reserves that may never be utilized, depending on how these market and regulatory scenarios play out.
We believe that oil and coal companies in our portfolios need to go back to the drawing board to determine the long-term financial risks that climate change poses to their business plans. For some companies, returning money to shareholders rather than spending it on increasingly challenging and expensive fossil fuel exploration may be the most sensible path forward.
For all companies, adopting best practices for analyzing climate change risk should strengthen their ability to adjust to our vastly changed world.
Thomas P. DiNapoli is trustee of the $160.7 billion New York State Common Retirement Fund. Anne Stausboll is CEO of the $275 billion California Public Employees' Retirement System. More details on the investors' effort, coordinated by Ceres and the Carbon Tracker Initiative, can be found at www.ceres.org