Unburnable Carbon: Australia's carbon bubble

1

2

“Australian and overseas investments in Australian coal rest on a speculative bubble of climate denial, indifference or dreaming. Investors, governments and even some coal companies say they take climate change seriously, but this report shows they do not or are taking risky gambles. Taxpayers’ funds, retirement nest eggs and shareholder value is being gambled on investments in a world that may not, and should not, exist.”

John ConnorCEO, The Climate Institute

Unburnable CarbonAustralia’s Carbon Budget

This presentation summarises a report looking at the implications of the carbon bubble on Australia's fossil fuel assets. The report was produced in partnership with Carbon Tracker, a non-profit organisation working to align the capital markets with the climate change policy agenda. They seek to apply their thinking on carbon budgets and stranded assets across geographies and assets classes to inform investor thinking and the regulation of capital markets.

Image: Michael Hall, Creative Fellow of The Climate Institute

April 2013

3

Key Findings

+ The International Energy Agency has said that in the absence of carbon capture and storage technology, more than two thirds of coal, oil and gas reserves cannot be burnt before 2050 if we are to have a 50 per cent chance of limiting global warming to 2°C.

+ Australian coal reserves owned by listed companies have emissions potential of 51GtCO2, equivalent to 25 per cent of the global carbon budget for coal to 2050. A conservative estimate of all the potential Australian coal resources has 150 GtCO2, as much as 75 per cent of that global budget.

+ Australian coal is becoming less competitive, given its high cost operations in a highly competitive market. Expansion beyond the 11 per cent market share is highly unlikely.

4

Key Findings

+ An increasing number of countries that import Australian coal, such as China, are tightening their belt on coal use. This means that investments into Australian coal that may seem sound at the moment could easy turn into stranded assets that cannot be sold in a world acting on climate change.

+ The significance of Australian coal for investors goes beyond its own shores, with more Australian coal reserves owned by companies listed outside Australia - especially in London and Tokyo – than by those listed domestically.

5

The ‘carbon bubble’ relates to the build-up of risk in carbon-intensive assets and investments that are exposed to rapid devaluation if social, political, regulatory and technological developments enable achievement of this warming goal.

Just as sub-prime investments were based on assumptions of permanently rising house prices, carbon bubble or ‘sub-clime’, investments assume relentless demand for fossil fuels.

Growing constraints on coal use in China and accelerating investments in Asian clean energy represent threats to this assumption. Step changes in these developments and/or effective carbon prices in Australia or in export markets could render many of these investments relatively worthless and stranded.

What is the carbon bubble?

6

What is the carbon bubble?

Australia is facing a carbon bubble. A conservative estimate of all the potential Australian coal resources is 150 GtCO2, as much as 75 per cent of the global carbon budget for coal.

Australian coal represents 11 per cent of global coal markets in a competitive marketplace. Expansion beyond that market share is highly unlikely.

Investments in Australian coal that may seem sound at the moment could easily turn into stranded assets that cannot be sold in a world acting on climate change.

Australian coal against the global coal budget

7

On the radarThe International Energy Agency, investment houses and miners are aware of the problem of potentially unburnable carbon, and interest is accelerating.

“According to scientists … humanity now has a strictly limited ’carbon budget’ that may be emitted in future. To emit more than this would seriously jeopardise our chances of keeping below the 2°C threshold … It seems to us that the idea of a global carbon budget makes simple, logical sense and gives us all a clear target to work with.”

Mark CutifaniCEO of AngloAmerican

20 October 2011

“Resilience will become a watchword in the boardroom – to policy responses as well as to the climate … More radical and disruptive policy reactions in the medium term could lead to high-carbon assets being stranded.”

"The new reality is a much more challenging future in terms of planning, financing and predictability.”

Jonathan GrantDirector of Sustainability and Climate Change at PwC

5 November 2012

8

On the radarThe International Energy Agency, investment houses and miners are aware of the problem of potentially unburnable carbon, and interest is accelerating.

“Capitalism does millions of things better than the alternatives. It balances supply and demand in an elegant way that central planning has never come close to. However, it is totally ill-equipped to deal with a small handful of issues. Unfortunately, they are the issues that are absolutely central to our long-term wellbeing and even survival. ” “…if we mean to burn all the coal and any appreciable percentage of the tar sands, or even third-derivative, energy-intensive oil and gas, with 'fracking' for shale gas on the boundary, then we're cooked, we're done for. ”

Jeremy GranthamCo-founder and Chief Investment Strategist of

Grantham Mayo van Otterloo (GMO)12 April 2013

“Civilization is facing our $20 trillion big choice - our investments or our planet.  Recall the direct financial losses of the subprime crisis in the US were a mere $2.7 trillion, and we know what that did.”

John FullertonFounder and President of Capital Institute

23 July 2012

“To remain competitive in a future carbon-constrained world, Australia will need turn into a lower carbon economy … our relative competitive advantages have given us an economy that has traditionally and increasingly produced products for the export market that are materially carbon intensive.”

Marius Kloppers CEO of BHP

15 September 2010

9

Is Australia at risk?

Australia’s risk exposure to the carbon bubble is significant. A key reason for this is the fact that more than half of coal in Australia is owned by foreign companies listed on overseas exchanges. These companies are, and/or may be, exposed to different directives, regulations and disclosure rules than Australian listed companies.  Of the 51 GtCO2 equivalent of coal held on the books of listed companies in Australia, 27.76 GtCO2 are owned by companies listed overseas, compared to 23.18 GtCO2 owned by Australian listed companies.

10

What are the implications?

The vast majority of Australia’s coal, oil and gas resources (and therefore potential emissions) are exported. Yet an increasing number of countries that import Australian coal, such as China, are tightening their belt on coal use.

This means that investments into Australian coal that may seem sound at the moment could easily turn into stranded assets that cannot be sold in a world acting on climate change.

Investors and governments can pretend that the world will not act on climate. But the reality is that carbon prices and/or clean energy incentives are being put in place in all major export destinations and progress is being made on global climate negotiations.

The OECD published research in January 2013 showing that - whether through a tax, market mechanism, or other policy - carbon is priced in every OECD country. Countries like China and South Africa are also introducing carbon pricing measures.

11

Global shipments of thermal coal could be 18 per cent lower than

forecasted by 2015 should China, the biggest importer,toughen measures to curb

air pollution to safe levels

Deutsche Bank AGMarch 2013

12

Climate policy measures in Australia’s coal export markets

13

Recommendations

The carbon bubble will have negative economic consequences for the entire global economy. Below are recommendations the Unburnable Carbon report makes for how investors, companies, accountants and regulators can address the carbon bubble:

Investors

• Factor the carbon budget into their investment strategy to reduce exposure to carbon intensive activities.

• Further research commissioned to integrate carbon constraints into valuation methodologies. This analysis should be used to reallocate funds into low-carbon investments.

• Some AU$22 billion is spent annually on reserves development in Australia. But capital would be better deployed in to other sectors of the economy to limit the assets becoming uneconomic or stranded.

Companies

• Disclose the forward-looking numbers on their emissions. Traditionally, reporting has only covered disclosure of historical annual emissions rather than the emissions potential of fossil fuel reserves (in the case of extractive companies) or other forward-looking indicators.

• Factor in the many risks associated with climate change.

14

Recommendations

Accountants and auditors

• It is critical to understand how broadly-recognised carbon budget estimations are being factored into Australian companies’ valuations of their assets.

• More work needs to be undertaken on the valuation of fossil fuel reserves and resources as well as the development of guidance accompanying impairment valuations.            

Regulators

• The financial markets have proven they are not currently set up to respond adequately to systemic risks, with the current structures too focused on short-term returns.

• Other regulators have already started to issue guidance on the disclosure of climate-related risk (for example, the Securities and Exchange Commission in the United States) and monitor the level of market exposure (for example, the Bank of England). Australia needs to introduce similar measures to monitor and manage this risk.

• The regulator can only understand the level of risk if disclosure of relevant data is made mandatory.

15

Additional ResourcesFor more information on the carbon bubble and why carbon matters, download The Climate Institute’s Carbon 101 explainer:

Visit http://www.climateinstitute.org.au/carbon-101.html

16

For more information

Visitwww.climateinstitute.org.au/unburnable-carbon.html

Or connect with us on Facebook or Twitter for the latest news…

www.facebook.com/theclimateinstitutewww.twitter.com/climateinstitut