Inclement weather ahead?

A group of investors and environmental groups recently wrote a letter in which they posed an interesting question to the Bank of England and the European Central Bank.

It concerned the possible systemic risks that arise from UK investors’ heavy exposure to carbon-intensive oil, gas and mining companies.

The letter pointed out that, were the hydrocarbon reserves owned by the world’s largest mining, oil and gas companies to be burnt, the resulting carbon emissions would cause a rise in global temperatures well above the two degrees centigrade increase that the world’s governments agreed to target at the UN conference on climate change in Copenhagen two years ago.

The question that inevitably follows this: if the oil companies can’t burn these reserves, what will happen to their share prices? And, given that these companies represent a big slice of the value of the FTSE 100 index, might this create systemic risks for the UK investment community?

At this stage, the question is largely theoretical. Few governments have implemented the carbon taxes and other regulations needed if emissions are to be restricted to the levels necessary to keep global temperature rises below two degrees centigrade. But eventually, perhaps after another Hurricane Katrina, a severe drought or some other weird weather event in the US, politicians may summon the political will to act. What would this do to the share prices of extractive companies?

By far the most carbon-intensive activities are associated with coal. Closing coal-fired power stations would likely be the first stage of a more aggressive climate policy.

What would this do to the UK’s big mining companies? Given that they are among the world’s biggest coal producers, closing down coal would not be good news. But it wouldn’t necessarily be disastrous. The big UK-listed miners are well diversified, with interests in a range of commodities.

Coal only accounts for a small part of total revenues for most of the big players. If climate policy restricts demand for coal, these miners should have little trouble switching to other commodities.

A more aggressive climate policy would actually be good news for some miners. Copper is a key component for wind-turbines and electric vehicles, so demand should rise. But while the major UK mining companies may survive without too much pain, the same is not true of the small number of companies that only mine coal. These companies would be seriously affected should governments step up action on climate change.

The oil giants’ Kodak moment

The big oil and gas companies are rather less diversified than the miners. Nearly all of their future earnings depend on their hydrocarbon reserves. They have some small investments in low-carbon energy – BP and Shell are both now big players in the sugar-cane ethanol industry – but this is a tiny fraction of their overall revenues.