October 30, 2013

It’s now clear that any sort of solution to the climate change crisis that requires action from Congress — where many members of one party refuse to admit the problem exists at all — is pretty much impossible. But there are plenty of ways Obama can use executive action — not to solve the problem, perhaps, but to forestall doom as long as possible.

Case in point: The United States will no longer fund foreign coal-fired power plants through international finance organizations like the World Bank. This is probably a small change in the grand scheme of power generations worldwide, but it’s a small example of the hidden financial dangers that are faced by the world’s carbon-mining companies. Oil, coal and natural gas extractors are all wretchedly profitable at the moment, riding high on expensive fuel prices and a thus-far successful lobbying campaign against climate policy. But their fat profits and high valuations are predicated upon being able to pollute the commons at will. Should they be forced to internalize those costs, they could collapse in a flash.

A financial bubble is when the price of something is higher than is justified by the “intrinsic value.” It’s a foggy concept but a useful one. Since the 2008 financial crisis talk of bubbles is everywhere, and often misapplied, but the case for a carbon bubble is sound. Carbon dioxide pollution causes a lot of damage to the world economy, estimated at about $1.2 trillion per year, or about 1.6% of global GDP. Another interesting facet of climate change’s economic damage just came up recently, when a new bill to bring flood insurance subsidies in line with skyrocketing flood-damage costs due to climate change led to huge rate increases. Inevitably, the afflicted demanded restored subsidies, which look likely to pass.

Economists call such economic damage a “negative externality,” but to normal people that is stealing. By shifting their cleanup costs onto the rest of global society, carbon-mining companies (and those that use carbon-fueled machinery) are engaged in quite possibly the most colossal theft in history. But theft on that scale — and the damage will very likely increase greatly — is inherently unstable. If carbon-mining companies were forced to pay for their cleanup costs, their valuations would plummet, and they would likely go bankrupt.

Al Gore and David Blood have a brilliant article in the WSJ today laying out the financial case for this. According to scientific estimates, to avoid what countries have agreed is the worst effects of climate change, carbon miners will have to leave something like two-thirds of their known reserves in the ground, unburned — assets are currently part of these companies’ assessed valuations. There’s a finance term for this: a “stranded” asset, one which loses value ahead of its anticipated lifespan. Here’s how:

First is regulation that could strand assets in several ways: direct regulation on carbon led by authorities at the local, national, regional, or global level; indirect regulation through increased pollution controls, constraints on water usage, or policies targeting health concerns; and mandates on renewable energy adoption and efficiency standards. Even the threat of impending regulation creates uncertainty for long-lived carbon-intensive assets.

Second, stranding may occur as a result of market forces. Renewable technologies are already economically competitive with fossil fuels in a number of countries without subsidies. This cost competitiveness, combined with the ability to secure stable long-term prices for power, and an increase in distributed electricity models, could continue to shift capital allocation way from fossil fuels.

Third, sociopolitical pressures (e.g., fossil-fuel divestment campaigns, environmental advocacy, grass-roots protests and changing public opinion) could create an environment in which carbon-intensive businesses could lose their “license to operate,” thereby stranding assets.

When climate policy reached the potential action stage, carbon miners went double-or-nothing on their current business model. They directed tsunamis of money at climate-denying think tanks and a few “skeptic” scientists, and lobbied the government furiously. But by delaying any effort at adaptation, they have made themselves extraordinarily vulnerable.

Hurricane Sandy didn’t spark any climate policy bills. But imagine if we had ten Sandy-sized events in a single year. That might convince even Republicans to come around on climate policy, making Congressional action possible. Might.

Let’s hope it doesn’t happen too late.