No escape from climate change tail risks
Harsh decisions need to be made on the future of energy financing now, before we run out of time
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.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Our take
Hedge funds must race the clock to check their dealer-rule status
Working out whether a firm is caught by SEC registration requirement could take months
Filling gaps in market data with optimal transport
Julius Baer quant proposes novel way to generate accurate prices for illiquid maturities
Why Europe still awaits a private credit CLO
Tricky questions face managers that plan to launch the structure on the continent
The signs of tacit collusion in the dividend play trade
Game theory and real-world data point to a different understanding of how arbitrage in markets works
Decades of history says you can beat high inflation with quality
Factors such as momentum and value generally outperform the market irrespective of inflation, but new research suggests quality stocks are best when prices are rising rapidly
Esma faces tough task in implementing Emir 3.0
EU regulator must contend with tight timeframes and increasing workload without additional resources
Quants are using language models to map what causes what
GPT-4 does a surprisingly good job of separating causation from correlation
China stock sell-off will test securities firms’ risk managers
Regulatory measures to support stock market could add to risks facing securities sector
Most read
- Top 10 operational risks for 2024
- The American way: a stress-test substitute for Basel’s IRRBB?
- Filling gaps in market data with optimal transport