6th June 2016
Lord Nicholas Stern has warned the Bank of England’s climate task force that oil and gas businesses may be pinning their business strategies on governments not being serious about the Paris climate treaty.
The warning was made in a submission from the Grantham Research Institute on Climate Change and the Environment and the ESRC Centre for Climate Change Economics and Policy at the London School of Economics.
The submission calls for companies to ‘stress test’ the risks associated with climate change, including business risks from new policies to reduce greenhouse gas emissions, and to disclose to investors their findings, as well as their strategies for dealing with those risks.
It warns that financial markets could struggle to cope if there is a sudden revaluation of companies exposed to the risks of climate change itself and to risks from efforts to reduce greenhouse gas emissions.
It suggests that if the status quo were to shift dramatically and these firms lost significant value, investors would want to know why they did not have effective contingency plans.
The submission states that “it is becoming increasingly risky for companies to pin all business strategies on the assumption that extensive decarbonisation will not happen. Business models reliant on the assumption that governments were not serious in Paris are looking increasingly vulnerable.”
Under the Paris accord, countries have agreed to say at regular intervals how they will tackle greenhouse gases so that net annual emissions eventually fall to zero.
Lord Stern, author of a 2006 UK study on the economics of climate change, said that, unless this shift is handled carefully, fossil fuel assets could be hit by “mass scrapping and stranding”.
“If an oil company does not believe global policy makers will adopt the measures necessary to attain the decarbonisation outlined in the Paris Agreement, then they need to be explicit about this,” he says.
The report was co-authored by Lord Stern and Dimitri Zenghelis, co-head of policy at the Grantham Research Institute on Climate Change at the London School of Economics.
“From an investor point of view, it is one thing for a business to assume that governments were not serious in Paris, but it is quite another to pin their entire strategy on this being so,” the submission says.
Discussing the process by which valuations could shift, the submission adds: “Tipping dynamics further result from the fact that the perceived payoff to action to decarbonise by any single agent will be a function of what others are expected to do.
“Once enough players shift, for example in markets such as China, the US and the EU, the rest will quickly follow. Technology and finance costs are expected to fall while markets are expected to grow. This is why such risks are often termed ‘transition risks’, which is intended to portray a sense of the dynamic process in which paths become reinforcing.
“The point here is not that such tipping dynamics are about to happen, they might or might not. But if they do, change could be rapid. Investors will rightly demand that firms have made appropriate contingency plans for such potential rapid changes, even if such changes remain one scenario among many. Put another way, it is becoming increasingly risky for companies to pin all business strategies on the assumption that extensive decarbonisation will not happen, for example, on the basis because of (mostly backward – looking) lack of political will.”