In a move that underscores Wall Street's growing unease over the business-as-usual strategy of the world's fossil fuel companies, Bloomberg L.P. unveiled a tool last week that helps investors quantify for the first time how climate policies and related risks might batter the earnings and stock prices of individual oil, coal and natural gas companies.
The company's new Carbon Risk Valuation Tool is available to more than 300,000 high-end traders, analysts and others who regularly pore over the stream of information that's available through Bloomberg's financial data and analysis service. The move significantly broadens and elevates the discussion of "stranded" or "unburnable" carbon reserves—expanding it beyond climate groups and sustainability investors to the desks of the world's most active and influential investors and traders.
"It demonstrates that there's demand for the information—more and more investors are interested in these issues," said Ryan Salmon, senior manager of the oil and gas program at Ceres, a nonprofit that organizes businesses, investors and public interest groups interested in climate change and other issues.
Investors and Bloomberg are responding to a growing body of work suggesting that a variety of factors—including carbon emission limits, falling demand and the spiraling costs of new oil production—could force fossil fuel companies to abandon reserves that underpin share prices and future earnings.
While energy companies and most financial analysts see those issues as merely new risks for an industry that has thrived despite periodic financial, technological and political setbacks, others see long-term peril—especially when it comes to threats related to climate change.
To keep warming within the predicted safe range of 2 degrees Celsius, governments could, for example, establish limits on the carbon emissions that come from burning oil, coal and natural gas. Without some kind of technological fix, such restrictions could force fossil fuel companies to leave large oil and coal deposits in the ground, because burning them would exceed the limits. That's one of several potential developments that could strand those assets and permanently erase their value.
Having to forsake prized reserves or suffer big losses on them would be a potentially stunning reversal of fortune for an industry whose primary asset—crude oil—has been among the world's most coveted commodities for the better part of a century.
It could be equally devastating for investors with stock in the affected companies.
"People are getting the idea that one of the main risks—perhaps the main risk—from climate change for investors and pension funds relates to hydrocarbon investment," said Craig Mackenzie, head of sustainability at the Scottish Widows Investment Partnership, which manages $234 billion in assets and is a part of Lloyds Banking Group. "The fact that 20 percent of [investment] portfolios are invested in oil, gas and mining companies, and that those companies could be a lot less valuable in the future, has sort of brought it all home."
Using Bloomberg's carbon risk analysis tool, investors can measure the vulnerability of a single company or groups of companies using assumptions about future oil, coal and natural gas prices, as well as already compiled information about each company's financial performance, the quantity and type of their retrievable reserves, and how much it costs each company to extract those reserves.
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The information gives investors a general sense of which companies could still make money if fossil fuel prices fell to specified levels. But since companies typically provide only their average cost of extracting reserves—and not how much oil they could sell profitably if oil prices fell to $70 a barrel, for example—the tool lacks the kind of precision investors crave.
Because of that and other limitations, Curtis Ravenel, Bloomberg's global head of sustainability projects, likened the current version of the assessment tool to a beta test or an "opening serve" to get investors thinking about the potential implications for fossil fuel companies and the best way to measure possible damage.
At this point, "this is not something that I would use to make investment decisions," Ravenel said. "It's something to start the conversation among the mainstream [financial] community."
He expects the carbon risk analysis to improve as Bloomberg refines the calculations, companies release more information, and more investors and analysts focus on measuring the impact of a host of hard-to-quantify risks.
"For us, this moves the conversation from uncertainty to risk," Ravenel said. "Uncertainty is something where people kind of throw their hands up and say, 'it's uncertainty—we can't measure that.' But the point about stranded assets is that actually, it might be measurable to some degree."
Ravenel, who leads corporate-wide internal sustainability efforts and directs related new product initiatives, said the carbon risk valuation tool was a joint effort of Bloomberg New Energy Finance and primary developer Greg Elders, Bloomberg's senior analyst of environmental, social and corporate governance (ESG) data.
Adding the analysis tool to Bloomberg's customer network doesn't guarantee that Wall Street analysts and large-scale investors will embrace it. But Bloomberg's financial data, news and analysis is widely used throughout the financial community to help guide investment strategies, making it an influential platform from which to launch new valuation concepts. Subscribers pay about $20,000 a year for the service.
"As a company, we recognize that we have this distributive power," Ravenel said. "So when we introduce things like this, we do have a unique ability to elevate the conversation a bit."
Fadel Gheit, managing director and senior analyst for the oil and gas industries at Oppenheimer & Co., called Bloomberg's tool a good first step.
"It's a tall order and an ambitious kind of product because companies don't disclose all the information that you need," Gheit said. But, he added, "People are beginning now to say, 'You know what, there's something there—maybe we should pay more attention to this.'"
Seeds of Doubt
Bloomberg's Ravenel said the inspiration for the new tool started with a report by the Carbon Tracker Initiative that concluded that the fossil fuel reserves already claimed by companies contain enough carbon to warm the world's atmosphere well beyond the 2 degree Celsius limit over the next 40 years—and that those reserves may therefore become "unburnable."
Bloomberg was further motivated by a pair of reports by the foundation affiliated with Generation Investment Management, a London-based partnership devoted to sustainable capitalism and long-term investment that was founded by former Vice President Al Gore and David Blood, former chief executive of Goldman Sachs Asset Management. The reports described how a range of forces could devalue the carbon assets of many oil, natural gas and coal companies, and stressed that global limits on carbon emissions was merely the most obvious risk, not the only one.
"We believe that investors are mistaken in assuming that there is only one pathway to stranding carbon assets, and in believing that continued uncertainty about the likelihood and timing of coordinated action by governments can justify a strategy of ignoring their carbon exposure," the Generation Foundation said in its most recent report. "We believe that any such strategy is not only unwise, but increasingly reckless."
Some of the other threats include regional, national or local carbon policies; regulations to cut pollution, limit water use or reduce health risks; mandates for saving energy or using alternative sources; advances that make rival power sources more attractive; and sociopolitical pressure from movements such as the fast-growing campaign to get universities, foundations and others to purge fossil fuel stocks from their investment portfolios.
Despite those risks, fossil fuel companies have plowed ahead with expensive new oil, gas and coal projects that will require funding in the billions of dollars. There are, for instance, about 1,200 coal plants on the books right now worldwide.
"I've talked to quite a few oil and mining companies about stranded assets, and the most consistent message that the companies give is 'we're not worried about stranded assets, because if you look at the [International Energy Agency] forecast, the Wood Mackenzie forecast and the BP Energy Outlook, demand is going to keep growing for coal and for oil up to 2030 or 2040. So this is not an issue,'" said Mackenzie of the Scottish Widows investment fund.
However, given climate-related regulatory threats and signs that energy demand in China might fall short of expectations, "it's quite possible that the world will be radically different from the energy sector view," Mackenzie said. "So it's really important that the investment community doesn't get sucked into one view of the world—and that's where the Bloomberg [tool] comes in. It provides us with a different view of the world."
How the Tool Works
At its core, quantifying the impact of climate-related developments and policies on the value of fossil fuel companies is an exercise in evaluating the effects of falling prices. That's because reining in carbon consumption—whether through improved vehicle fuel efficiency, carbon emission limits or some sort of carbon tax—inevitably lowers demand for fossil fuels. All things being equal, reducing demand for something in a market causes the price to fall. Other developments, such as sharply lower demand from China, would also substantially lower future energy prices.
Investors interested in weighing the impact of climate change on fossil fuel companies will therefore want to know which companies could still make money on their reserves if the selling price for oil, coal and natural gas fell substantially—and permanently.
"If you've got mostly reserves that are very cheap to get out of the ground, then you're still going to be producing if the oil price falls," said Mackenzie of the Scottish Widows fund. "For a company that sees Canadian tar sands as its future and is increasing the share of production it gets from the tar sands, which is quite an expensive resource, its cost of production is going to go up and up, and it will be at a higher risk for stranded assets."
Bloomberg's carbon assessment tool measures the relative financial strength of the top oil, coal and natural gas companies using pre-built price scenarios as well as a series of assumptions that can be adjusted for a more tailored analysis. It took about six months to develop and was launched without fanfare on Nov. 26.
A white paper that accompanied the tool's release describes how it could be used to evaluate the effect on oil companies under five scenarios: A five percent annual decline in oil prices from 2020; oil selling for $50 a barrel starting in 2020; oil selling for $25 a barrel starting in 2030; loss of earnings because of "prompt decarbonization"; and loss of earnings because of "last-ditch decarbonization."
To illustrate how the tool works, Bloomberg used it to assess how nine of the world's largest oil companies would fare under each of the five scenarios. It found that the $50 oil price scenario had the most damaging effect on the companies' stock prices, causing them to fall an average of 58 percent.
While the Bloomberg tool will raise the visibility of the stranded carbon assets issue within the influential financial community, it is just the latest in a string of recent initiatives that have given substantial momentum to the debate. The issue grew out of a landmark 2009 scientific paper that concluded that at the current rate of fossil fuel use, dangerous warming could hit the globe in as few as 11 years.
Since then, several Wall Street analysts have broached the subject in reports, and the University of Oxford's Smith School of Enterprise and the Environment launched a Stranded Asset Programme that delved into stranded fossil fuel assets and the related divestment campaign.
In October, a group of 70 institutional investors representing about $3 trillion in assets sent letters to 45 energy companies asking them to examine and disclose what the financial fallout would be if climate policies or market factors prevented them from selling all of their fossil fuel reserves.
The concept of stranded and unburnable carbon resources recently gained a key endorsement from the United Nations Intergovernmental Panel on Climate Change, or IPCC, the world's largest scientific body on global warming. The latest IPCC report embraced the view that existing reserves of fossil fuels contain more carbon than what can be burned without exceeding 2 degrees of warming. And last month, the head of the UN Climate Secretariat told the global coal industry that it would have to leave most of the world's coal reserves in the ground if we are to avoid dangerous global warming.
"At a high level, there's a growing recognition that there are real financial risks there," said Salmon, the Ceres senior manager. "We're beginning to see what you might call a patchwork of policies, technologies and market conditions that are raising questions about the future of the fossil fuel industries."