Carbon Bubbles & Fossil Fuel Divestment

Originally Posted at Behind the Numbers

Divestment from fossil fuels is an idea whose time has come. Sparked by Bill McKibben’s Rolling Stone article last summer, “Global Warming’s Terrifying New Math”, divestment campaigns are now up and running on over 300 university campuses in the US, with 4 early victories already notched. Students in Canada have declared tomorrow (March 27) Fossil Fools Day, a national day of action, with many campuses launching divestment campaigns.

Originally Posted at Behind the Numbers

Divestment from fossil fuels is an idea whose time has come. Sparked by Bill McKibben’s Rolling Stone article last summer, “Global Warming’s Terrifying New Math”, divestment campaigns are now up and running on over 300 university campuses in the US, with 4 early victories already notched. Students in Canada have declared tomorrow (March 27) Fossil Fools Day, a national day of action, with many campuses launching divestment campaigns.

This makes for great timing for us to release a new national report, Canada’s Carbon Liabilities: The Implications of Stranded Fossil Fuel Assets for Financial Markets and Pension Funds (summary below). We “do the math” on Canadian fossil fuel reserves, in the context of a global carbon budget of 500 Gt. This builds on the great work of the Carbon Tracker Initiative, who found that too much “unburnable carbon“ – known reserves of fossil fuels that are five times larger than what can “safely” be burned — made for a carbon bubble in the financial markets.


My research partner, Brock Ellis, a student just finishing up his Masters of Public Policy at Simon Fraser University, put together a database of fossil fuel companies in Canada and their fossil fuel reserves. We convert these into potential emissions and apply a price of carbon at $50 and $200 per tonne to estimate a range of their ”carbon liabilities”. Even with our conservative estimates, these carbon liabilities end up being much larger than assets or market capitalization. In a nutshell, their business model is incompatible with the need for a (relatively) stable climate, and this is compounded by having a large share of that in coal and bitumen, the dirtiest of fossil fuels that would most likely take an early hit from new global climate action.

Of particular concern is the impact Canada’s carbon bubble could have on pension funds. After housing, the right to future income through a pension is significant asset for millions of middle-class workers. It is a financial problem if fund managers are systemically ignoring climate risk by holding vast reserves of fossil fuel companies, whose value could plummet. Pension funds — as well as university endowments – need to go through a careful process of evaluating their portfolios for climate risk. We wrap up the paper with some broad recommendations to government for a “managed retreat” from fossil fuel investments.


Mounting evidence of climate change impacts worldwide will inevitably lead to a new global consensus on climate action. Based on recent research, between two-thirds and four-fifths of known fossil fuel reserves have been deemed to be unburnable carbon — that cannot safely be combusted.

This is of profound importance to Canada, a nation making fossil fuel development and expansion the centrepiece of its industrial strategy. This study looks at the implications of unburnable carbon for the Canadian fossil fuel industry and in particular for financial markets and pension funds. We argue that Canada is experiencing a carbon bubble that must be strategically deflated in the move to a clean energy economy.

Doing the Math

A carbon budget is the maximum amount of CO2 that can be emitted in the future, based on scientifically-estimated probabilities of staying below 2°C of global warming, above which would lead to catastrophic or “runaway” climate change beyond humanity’s capacity to manage. The world’s carbon budget is now approximately 500 billion tonnes (Gt) of carbon dioxide, an amount that would provide an 80% chance at staying under 2°C.

Canada’s share of that global carbon budget would be just under 9 Gt based on its share of world gdP, and 2.4 Gt based on share of world population. An internationally negotiated carbon budget for Canada could go up depending on export arrangements with other countries, or down if larger historical emissions mean disproportionate reductions
from rich countries. A plausible carbon budget for Canada would almost certainly fall between 2 and 20 Gt.

Canada’s reserves of fossil fuels are significantly larger than Canada’s fair share of a global carbon budget:

  • Canada’s proven reserves of oil, bitumen, gas and coal are equivalent to 91 Gt of CO2, or 18% of the global carbon budget.
  • Adding in probable reserves boosts this figure to 174 Gt, or 35% of the global carbon budget.
  • A final, more speculative category including all possible reserves is 1,192 Gt — more than double the world’s carbon budget.

This means that business as usual for the fossil fuel industry is incompatible with action to address climate change that keeps global temperature increase to 2°C or less. Even at the high end of a 20 Gt carbon budget, this would imply that 78% of Canada’s proven reserves, and 89% of proven-plus-probable reserves, would need to remain underground.

Carbon Liabilities, Stranded Assets

The Toronto Stock Exchange (TSX) is highly weighted towards the fossil fuel sector. At the end of 2011, the TSX had 405 listed oil and gas companies with a total market capitalization of over $379 billion. When coal producers are added this number rises further.

To assess the implications of Canada’s carbon bubble, we developed a database of 114 fossil fuel companies operating in Canada — 103 listed on the TSX (assets greater than $70M for oil and gas, and $50M for coal), and 11 foreign-owned subsidiaries. For each we compiled financial data on revenue, assets and market capitalization. Then we added data on fossil fuel reserves (proven and probable), which we converted into potential CO2 emissions. We develop an estimated range of their carbon liabilities by applying a carbon price, representing the estimated damages from emitting a tonne of carbon (known as the social cost of carbon, or SCC, based on recent literature).

For the Canadian-listed companies:

  • Our low estimate considers a $50 per tonne Scc applied only to the proven reserves category, and amounts to $844 billion in carbon liabilities — more than two and a half times the market capitalization and nearly double the assets of those companies.
  • Our high estimate of $200 per tonne Scc applied to their proved-plus-probable reserves yields a figure just under $5.7 trillion, an amount 17 times larger than market capitalization and 13 times assets.
  • For 12 companies in our database included in the S&P/TSX 60 index, total carbon liabilities are between $0.5 and $3.5 trillion. Even the low estimate of carbon liabilities exceeds both assets and market capitalization.

For foreign companies, the estimated carbon liability of their Canadian fossil fuel reserves is between $0.3 and $1.2 trillion. The latter amount, incredibly, is larger than the full market capitalization of foreign companies, and 81% of their assets, even though market capitalization and assets are based on global operations.

This situation is exacerbated by the predominance of bitumen and coal in the reserve mix because these particular fuel types are far more GHG-intensive than other fossil fuel products, and are much more likely to be regulated earlier under a global climate action framework.

  • Bitumen and coal account for more than three-fifths of both the proved and proved-plus-probable potential emissions in our database.
  • If synthetic oil is added, which is crude oil produced from oil sands bitumen, the proportions jump to more than four-fifths for both categories of reserves.

An important consideration is that Canada’s oil and gas sector has a very high degree of foreign ownership.

  • Foreign corporations owned 35% of the sector’s $518 billion in assets in 2010, and received roughly half of the sector’s revenues and profits in 2010.
  • US corporations have been the principal foreign investors, although their share has declined in recent years from 79% in 2001 to 64% in 2010. Recent takeovers of oil and gas assets by China’s cnooc and Malaysia’s Pentronas in late 2012 — deals worth $21 billion combined — have increased the foreign-owned share.

Canada has a unique role in the global economy with regard to fossil fuels. Some 80% of the world’s oil reserves are held by state-owned companies; that is, countries who have made public ownership of this strategic asset a top priority. Of the remaining global oil reserves, two-thirds are found in Canada, making the country a top destination for private investments.

As foreign capital flows in, so it may flow out. External drivers such as international, regional or national rules that shrink Canada’s export markets for fossil fuels, or successful divestment campaigns in other jurisdictions could have a spillover effect that could trigger a withdrawal of capital from Canada. This is an additional source of instability or external shock that could lead to a bursting carbon bubble.

Pension Funds and Climate Risk

The recent experience of high-tech and housing bubbles should serve as a stern warning to policy makers. In 2008, the collapse of a housing bubble (in particular, in the United States and Europe) threatened the global financial system as a whole. The fallout from the housing crash affected a broad segment of society because housing is the most important asset for middle-class households.

Next to home ownership, the right to future income through employer pension plans is the second-most important asset for a wide swath of middle-class households. Registered pension plans cover more than 6 million members in Canada, and the total market value of trusteed pension funds in 2012 was over $1.1 trillion, of which almost one-third was held in stocks.

At a system-wide level, however, it is difficult to ascertain the exposure of Canadian pension funds and other investment types to the carbon bubble.

  • More than half of Canada’s pension system is in the form of employer pension funds (55%), followed by RRSP assets holdings (35%), and the Canada Quebec Pension Plans (under 10%).
  • In the US, pension funds alone owned almost one-third of oil company stocks in 2011.
  • About one-third of the assets of the Canada Pension Plan are invested in publicly traded equities, representing $13 billion in Canadian equities and $43 billion in foreign equities, as of the end of 2012.

Addressing risk is inherent to financial market investment, which routinely must account for risks due to inflation, currency movements, regulatory changes, political turmoil and general economic conditions. However, there has been a general failure to account for climate risks, and a tendency to view any screening for environmental purposes to be detrimental to financial performance. Our analysis turns this on its head: by not accounting for climate risk, large amounts of invested capital are vulnerable to the carbon bubble.

There is an important inter-generational equity argument built into the management of pension funds. While pension funds have to generate maximum current return value for existing (and soon-to-be) pensioners, at the same time they are legally obligated to ensure the long-term sustainability of the fund. That is, funds must equally represent the interests of young workers for their eventual retirements.

Deflating the Carbon Bubble

Pension funds and other institutional investors need to be part of the solution. Other private savings vehicles, such as RRSPs, and public investments through the Canada Pension Plan, are also in need of a “managed retreat” from fossil fuel investments. We recommend the following to green Canada’s financial markets.

  • Establish a National Carbon Budget — In order to do their job properly, and contribute to achieving a zero-carbon Canada (and world), financial markets need a clear and credible long-run climate action commitment that provides investment security and certainty. In addition to credible emission targets, Canada needs to establish a national carbon budget to manage its fossil fuel resources for wind-down. A corollary to this is that the federal government must acknowledge that a large share of proven and potential reserves is indeed “unburnable carbon.” These reserves should be effectively taken out of circulation, leaving only Canada’s fair share of the remaining global carbon budget.
  • Make Market Prices Tell the Truth about Carbon — Shifting the terrain towards clean or renewable sources of energy from fossil fuels requires policies that make sure the costs of greenhouse gas emissions are reflected in market prices. Broad framework policies to level the playing field for clean energy alternatives and internalize costs include: carbon pricing; removal of subsidies to fossil fuel producers; regulations and standards; and public investments.
  • Develop Green Bonds — Pension funds and other investors divesting from fossil fuel companies need an alternative place to put their money, and one major transitional support could be the development of a national green bonds program (along with complementary provincial programs). The long-run investment horizons of pension funds align nicely with long-term bond issues, and the need to invest in public infrastructure for climate action. While carbon taxes are an ideal source for funding climate action it will take time for those revenues to ramp up with a rising carbon tax. Green bonds can bridge this gap by essentially borrowing against future carbon tax revenues.
  • Public Sector Leadership —The government of Canada should direct the Canada Pension Plan Investment Board to divest from fossil fuel companies. If pension plans on behalf of public sector retirees and employees (or their relevant investment management boards) join this effort, this would provide a powerful signal to other pension funds. Outside of pensions, divestment is broadly applicable to other related investment funds, such as university endowments or investments held by municipalities and Crown corporations. The federal government should also make changes to private savings vehicles, such as Registered Retirement Savings Plans (RRSP) and Tax Free Savings Accounts (TFSA) by restricting preferential tax treatment to funds or investments that meet certain green economy criteria.
  • Mandate Carbon Stress Tests — Canadian financial markets need a mandatory system of climate stress tests for new financing commitments and for outstanding portfolios. Disclosure of climate change information must be standardized to provide high-quality and comparable information (ideally, internationally comparable) about climate change policies and assessment of risks. The federal government could lead in developing selection criteria to be used in the screening of investment opportunities, and in requiring ratings agencies to report on climate risk and the implications of unburnable carbon in their evaluations. Securities and accounting oversight bodies should be involved in developing a harmonized Canadian approach to climate risk.

Our suggested reforms would go a long way to providing the foundation necessary for taking Canada’s economy towards a cleaner future. A coherent and credible action plan led by the federal government that includes action to better regulate financial markets will make it much easier for investors to account for climate change in their risk-return assessments. Our hope is that these actions can steadily reduce the exposure of Canadian pension funds and other investors, and the Canadian economy as a whole, by deflating the carbon bubble.

Until such time as our governments take decisive action, we should rightly see an expansion of divestment efforts by civil society groups — on campuses, within churches, by credit unions, and by other community-based organizations seeking to influence the investment choices of major institutions. Such efforts are encouraging — they signal an early understanding that a managed retreat is preferable to a financial meltdown.

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