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March 2021

The World's Carbon Budget and What it Means for Investors

The cyclical upswing we are currently in is creating additional demand for commodities and is also pushing up oil prices and oil stocks. But the securities of companies with exposure to fossil fuels carry long-term risks. These arise not so much from a possible scarcity of fossil resources, but rather from a shortage of the earth's atmosphere's capacity to absorb carbon dioxide emissions. As the world's governments set out to create policies to combat global warming and reduce CO2 emissions, there are important implications for investors.

We are unlikely to run out of fossil fuels very soon…

In the 1970s, the “Club of Rome”, a group of natural scientists, predicted the imminent limits to growth. Its argumentation: fossil fuels are finite and so is the growth of an economy based on these energies. Once burnt up, growth ends because these fuels are non-renewable.
Since this warning, however, the exploration of new oil and gas deposits has pushed the scenario of a possible shortage of resources about 400 years further into the future. With the structural shift towards the service economy, the CO2 intensity of economic growth has decreased considerably, so that fossil reserves could last even longer. Does this mean that it was all just scaremongering? The answer is no, because the limiting element for fossil energies is not their finiteness, but the absorption capacity of the earth's atmosphere.

…but the budget of the still burnable carbon reserves will be depleted

“If we continue like this, we only have seven years left until global warming reaches 1.5°C.” This is the sober, albeit abridged, conclusion of the scientific studies of the World Climate Council, the Intergovernmental Panel on Climate Change (IPCC). We know that there is a direct link between the greenhouse gases (GHG) emitted by humans and the rise in the global temperature compared to the pre-industrial era. If emissions rise, temperatures rise as well. So for each amount of greenhouse gas emitted, the IPCC calculates a temperature with a certain probability. We are now already facing one degree of global warming. In order to limit the expected temperature increase to 1.5°C, the IPCC estimates that we will only be able to emit a total of 300 gigatons (Gt) of carbon dioxide equivalent (CO2e). This is the so-called carbon budget we have left. At current rates, it will last for only seven more years. The less we emit today, the longer the budget will last.
CO2 emissions and the way to net-zero
Source:, Glen Peters, 01.2020

What are the implications of the carbon budget?

The budget implies that CO2 emissions must be radically reduced. There are many possible pathways. But it is generally accepted that by 2050, humanity should aim for net-zero carbon emissions. This means that by then, the same amount of carbon that is emitted, should be absorbed - a very ambitious plan! The good news is that more and more countries are committing themselves to the Paris Accord with concrete targets. A large number of countries has announced over the last year that they would reduce greenhouse gas emissions to net-zero by 2050, including Japan, the UK and also Switzerland. Even China, one of the largest GHG emitters, is aiming to reach net-zero by 2060. The new Biden administration in the US has announced to step up their efforts for a green new deal. The European Union is increasing its already ambitious target from a 40% reduction to 55% by 2030.
Share of renewable energies in total energy production in %
Source: Refinitiv, J. Safra Sarasin, 15.02.2021

What does the carbon budget imply for investors?

These announcements will be followed by increased regulations, taxes, penalties and incentives. This is bad news for fossil fuel companies. All known existing fossil gas, oil and coal reserves far exceed the carbon budget. If we also add to this the presumed but as yet untapped reserves, we arrive at an amount of almost 3000 Gt of CO2e of potential emissions. But if only around 300 Gt can be emitted in line with the climate targets, the rest of the fossil reserves will become worthless in the very near future. They will become stranded! And along with them, the power stations, ships, planes and trucks that burn them as well as the companies that manufacture them.

What is at risk for investors?

The risk of “stranded assets” is a problem not only for companies but also for investors. Over the next few years, the securities of fossil-fuel-exposed companies could be drastically devalued. CarbonTracker estimates that a total of USD 26 trillion in market capitalization could be at risk. They have long argued that the stranded assets are a carbon bubble waiting to burst. Worried by this prospect, the Global Financial Stability Board under Mark Carney, the former governor of the Bank of England, has done everything to increase the level of available information on climate-related exposures by encouraging companies to report them. Looking at the performance of energy stocks in the last ten years, it seems that the bubble has already deflated slowly but surely. The mostly fossil-dependent energy sector has underperformed the MSCI World Index by around 75% percent over the last ten years. And more underperformance is yet to come.
The energy sector has underperformed the broad market over the last 10 years
Source: Refinitiv, J. Safra Sarasin, 15.02.2021

How should investors position themselves?

While the carbon bubble is deflating and fossil-fuel-assets are stranding, there will also be huge opportunities for investors. The introduction of carbon taxes and cap-and-trade-systems will spur a structural shift to a net-zero carbon emitting world economy by 2050. Entire new industries of carbon-positive activities such as carbon capturing and storage, forestry and soil-preservation will have emerged in order to compensate the remaining carbon emissions. Other industries will employ technologies to substitute or store carbohydrates. For example, more and more buildings will be built with wood to store CO2. Companies will have diversified their businesses to become carbon-neutral or positive themselves. Investors can benefit by picking these champions of tomorrow. At the same time, they should avoid stranded assets while reducing the carbon footprint in order to protect their portfolios against the unavoidable climate transition.

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