Could the Carbon Bubble Ruin Your Retirement?

If the world is going to avoid more than 2 degrees of warming, the vast majority of existing fossil fuel reserves will be unburnable — and hence worthless. By Roschetzky Photography/Shutterstock

When the United Church of Christ voted to divest from fossil fuels, the decision was mostly couched in terms of ethics and "creation care." For a religious institution, that line of reasoning makes sense. But with organizations ranging from the Rockefeller Brothers Foundation to the British Medical Association voting to move their money from fossil fuels, the conversation is now increasingly shifting from the ethical to the financial argument for divestment.

And the reason for that shift is the carbon bubble.

What is the carbon bubble?

Despite how it may sound, the term does not refer to a bubble of carbon dioxide gas. Instead, it refers to the idea that as the world gets serious about moving to a low carbon economy then we are going to have to leave a large quantity of fossil fuels in the ground. And leaving a large quantity of fossil fuels in the ground leaves companies that are invested in the extraction, processing, transport or use of those fuels — not to mention the individuals, banks and pension funds who are invested in those companies — vulnerable to the risk of "stranded assets."

In much the same way as the financial crisis of 2008 rendered huge quantities of home loans largely worthless, a new energy landscape could render investments considered prudent under one set of assumptions substantially less lucrative and/or not worth the paper they are written on if those assumptions prove wrong.

offshore wind turbines photo
Offshore wind farms have grown rapidly in recent years. Because wind speeds are higher and more predictable out at sea, they are increasingly able to compete with baseload coal-fired power plants. Global Marine Photos[CC by 2.0]/flickr

How big is it?

How you accurately size the carbon bubble will depend, of course, on how widely you define it (see below). But at least one report from Carbon Tracker, a group that boasts current and former financial experts from companies like J.P. Morgan and Citigroup among its ranks, has valued the stranded asset risk from a carbon bubble as being as big as $6 trillion — a staggering figure that could put the entire global economy in significant danger.

What types of investment are vulnerable?

Typically, when we talk about a carbon bubble, the first point of discussion is fossil fuel companies' significant investments in new exploration and production. In a world where we can't burn the fuels we've already found, for example, the decision to greenlight Shell's oil drilling in the arctic begins to look highly questionable, not just from an environmental standpoint but a fiscal one too.

But the risk of a carbon bubble isn't just confined to investments in exploration, but rather many of our established fossil fuel reserves are at risk of becoming stranded assets too. Indeed, no less an expert than the Governor of the Bank of England recently described the "vast majority" of existing coal, oil and gas reserves as being essentially unburnable. And that means a whole host of related assets ranging from coal-fired power plants to car factories that are tooled to churn out gasoline-powered cars will all be valued very differently in a low-carbon economy too.

Are all fossil fuels created equal?

One important point to note is that not all fossil fuels, and not all fossil fuel-dependent assets, are equally vulnerable to the carbon bubble threat. Even within a specific category of investment, there will be substantial differences in the exposure to risk. Returning to the example of the car factory above, for example, an investor might view the degree of risk for a factory producing fuel efficient hybrids differently to one that is focused exclusively on large, inefficient SUVs.

Similarly, the fact that nobody expects an immediate transition to a fossil fuel-free future means that some fossil fuel producers will fare better than others. Carbon intensive fuels like tar sands oils or thermal coal, for example, will be the first to hit the rocks. This fact was illustrated recently by the announcement that Bank of America — an institution still heavily invested in fossil fuel production and consumption — would systematically reduce its exposure to coal mining investments, which it views as too risky given the declining prospects of the coal industry.

Conversely relatively lower carbon fuel sources like natural gas, or Saudi Arabian oil, for example, may actually see increased market share in the short term as they are used as a "transition fuel" for a truly low carbon economy.

What do low oil prices mean for the carbon bubble?

Do a Google search for "low oil prices and clean energy," or anything similar, and you'll find plenty of commentators loudly declaring the death knell for a low carbon future. The reality, however, is much more complex than that. While low oil prices may have created a slight uptick for sales of SUVs in some markets, economists have generally been surprised that oil consumption hasn't risen anywhere near as much as expected since prices fell off the cliff.

In fact, because lower prices mean smaller returns for investors, the oil price crash itself has actually undermined investments in many unconventional sources of fuel, kicking off a flurry of cost cutting and job losses in industries like tar sands extraction which will not only slow production in the short term, but will make scaling back up if oil prices recover considerably more difficult. And because alternatives ranging from electric vehicles to solar power are becoming increasingly commonplace, the oil industry is in a tough predicament at low or at high prices. Low prices mean poor returns on investment. High prices give a huge boost to the clean tech competition.

Adding to that complicated picture, there is much speculation that Saudi Arabia's role in keeping oil prices low is a direct attempt to throw a spanner in the works of tar sands oil production and fracking, thus preserving its market share in a limited-carbon future and maintaining the medium-term value of its less carbon intensive oil reserves. This school of thought gains added credence when you consider that the Saudis are investing heavily in solar power, and a Saudi Arabian solar company recently shattered records for the lowest-cost solar anywhere in the world. Could it be that the desert kingdom is crafting its exist strategy?

Surely, the fossil fuel industries are aware of this threat?

Whenever I talk about the carbon bubble, somebody usually pipes up that fossil fuel industries, not to mention the banks that finance them, employ some of the smartest minds in the world. Wouldn't they be aware of, and planning for, such an existential threat as this?

The answer, oddly enough, is both "yes: and "no." On the one hand, Big Energy has spent a lot of time and money on responding to the "threat" of clean energy. Whether it's the Edison Institute's warnings about a utility "death spiral," attempts by lobby groups to slow down clean energy progress, or commitment from some gigantic utilities to completely decarbonize, responses have ranged from concern to hostility to adaptation and transition. Yet many people who follow the carbon bubble debate closely are convinced that too many energy and finance executives are sleepwalking into a nightmare scenario, where new players and technologies are disrupting the competitive landscape to a point where business-as-usual becomes impossible.

In his new book, "The Winning of the Carbon War" (available for free online, downloadable in installments), former oil man-turned climate campaigner-turned solar entrepreneur Jeremy Leggett described how he recently asked oil industry executives on a panel to address the threat of a Carbon Bubble. Their response, he argues, was both telling and profoundly disturbing for anyone invested in fossil fuels:

My question is on the Bank of England announcement that they are holding an enquiry into whether or not carbon-fuel companies pose a threat to the stability of the global financial system, citing the possibility of stranded assets. On a scale of 0-10, how confident are you that the arguments we have heard this morning will persuade the Bank that they have zero need to worry? Chevron’s man, Arthur Lee, responds first. I haven’t heard of that statement by the Bank of England. I hope the journalists clock that one. A week has passed since the announcement. Could it be that the oil industry, or Chevron at least, is that badly informed? Or perhaps that it doesn’t even take the Bank of England seriously?

Leggett's point, as he expands on later in his book, is not that there are no scenarios where oil and coal use does not continue for the foreseeable future — but rather that many fossil fuel executives, at least publicly, appear to be 100 percent discounting the possibility of any other future. From telecoms giants to bat guano magnates (yes,

!), the financial history books are littered with seemingly invulnerable incumbents who found themselves undermined by a rapidly changing competitive environment.

Given the astounding cost declines in solar power, the explosive growth in electric car sales in many parts of the world, the announcement of Tesla's potentially world-changing home battery offering, the collapse in Chinese coal consumption and the historic deal between China and the U.S. on climate, the possibility that Big Energy is not even entertaining (let alone planning for) the notion of a low carbon future should give any sensible investor considerable pause for thought.

What can I do to protect myself?

Whether the carbon bubble deflates slowly or blows up with a bang will depend very much on how the world manages the transition to a low carbon economy, assuming we make that transition at all. (If we don't make the transition, the idea of a functioning economy becomes pretty much moot anyway.) Luckily, the same things that investors need to do to protect themselves are the same things that will help to encourage a managed (and manageable) transition. They look something like this:

  1. Divest from fossil fuels: Whether it's an individual meeting with his or her financial advisor to reduce fossil fuel exposure, or a gigantic corporation like The Guardian Media Group divesting its £800,000,000 investment fund, the sooner we move our money out of the bubble, the smaller that bubble will be.
  2. Invest in alternatives: It is not, of course, enough to simply take our money out of fossil fuels. The world needs energy. So we need to invest in the alternatives. That's why divesting from fossil fuels must be combined with investing in renewables, efficiency and other clean tech.
  3. Walk the walk: Investment is just one piece of the puzzle. How we use (and don't use!) energy in our daily lives sends an important message to the markets about where our future is headed. So install solar panels if you can, buy green energy if it's available, turn off those (LED!) lights, ride a bike (when you're not driving your electric car), and support businesses who are committed to clean energy too.
  4. Demand change: From voting for politicians who support a stable, low carbon policy environment to pressuring polluting businesses (and their backers) to mend their ways, what you do with your time and voice is as important as what you do with your money. Advocacy groups like have been at the forefront of building a global climate movement, providing a myriad of ways that you can engage on the local, regional, national and international level. Heck, even corporate CEOs are making their voices heard — demanding substantial climate action and severing ties with organizations who are standing in the way.

Ultimately, none of us can completely isolate ourselves from the fallout of the carbon bubble, any more than we can completely protect ourselves individually from climate change—but each of us can do our part. As we reduce our own exposure, and pressure and support those around us in doing the same, we are gradually building an alternative future. From clean air to a stable climate to lucrative new industries to a distributed, more democratic energy landscape, the potential upsides of this transition are enormous.

Avoiding what could be one of the biggest economic threats the world has ever known will just be the prudent icing on the low carbon cake.