For some time now we’ve been pointing out that the worries over stranded carbon assets are overblown. This idea that all those oil rigs and fields and pumps and so on will become worthless and so the globe will face some enormous financial shock as we go green. The reason it’s overblown is that the idea fails to take note of the base climate change problem itself - discount rates.
As the Stern Review went to great pains (hundreds of pages in fact) to point out, the base problem is that we humans value the far future through the lens of market interest rates. As these are up in the 5 to 7% range this means that things which happen 50 years out are of near no net present value. That’s why Stern insists that claimte change must be evaluated using a much lower discount rate.
Assuming that all of this is true then that means that the net present value of those fossil fuel assets out in that future must be somewhere near spit. Therefore even if the value does collapse it will be from not very much to that near nothing. It’s not a problem.
The Guardian reports on a paper which makes exactly the right calculation on this. It being The Guardian of course it gets the conclusion of the paper wrong but there we are, that’s The G for us.
People in US and UK face huge financial hit if fossil fuels lose value, study shows
Strong climate action could wipe $756bn from individuals’ pension funds and other investments in rich countries
It’s the word “huge” there which is wrong.
It’s possible to quibble a bit about the assumptions made in the paper.
Our focus is on the medium realignment, in which the baseline scenario follows IEA’s WEO 2019 current policies scenario, consistent with 3.5 °C median warming in the 21st century.
That’s too high as a baseline, current policy is already well below that. But that’s the assumption they make and the paper still proves that this just isn’t a problem. The reason is this:
We discount differences in expected profits by 6% y−1
OK, we’ve introduced something akin to, close to, market interest rates. We are discounting those future values by the right number that is. The result is:
Overall, the study calculated that individuals own 54% of the $1.4tn oil and gas assets at risk – $756bn.
Global wealth is around the $500 trillion mark. Thereabouts, right sort of order of magnitude at least. The losses therefore look like 0.15% of asset value. That’s the sort of thing the global economy can take in its stride.
The countries hit hardest by losses in the financial sector would be the US, with $283bn at risk, and the UK ($98bn),
American wealth is around $140 trillion at present. UK household wealth some £14 trillion or so. Even if we take off property values the pensions and financial wealth (the paper worries that some substantial part of such losses will be to pension funds) we’re still at about £6 trillion. So, even if doom were to come to pass we’re talking about 1.6% or so of the financial wealth of the UK as a result of the entire collapse of the value of those fossil fuel assets.
Financial markets can vary by such percentages over the course of a week - heck, on exciting days, in mere hours.
That is, by taking the argument seriously, we can see that it’s not in fact a problem. Stranded fossil fuel assets, even if it does in fact all work out like they say it could, are trivial compared to the wealth of the world, or individual nations, or even the British people.
Great, so that’s another thing we don’t have to worry about then. As we’ve been pointing out for some time now.