Stranded Assets and Reserve Accounting

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Sustainability

Stranded Assets and Reserve Accounting

by Stathis Gould, Head of Professional Accountants in Business, IFAC | December 2, 2013 |

The Carbon Tracker Initiative report, Unburnable Carbon, calculates that only 31% of the world's currently indicated fossil fuel reserves, which equate to 2,860 billion tonnes of carbon dioxide, could be burned for an 80% chance of keeping below a 2°C global temperature rise—commonly regarded as the threshold to avoid dangerous climate change. For a 50% chance of 2°C or less, only 38% could be burned.  At least two-thirds of fossil fuel reserves cannot be monetized if we are to stay below 2°C of warming—creating "stranded carbon assets” (see the recent Wall Street Journal article by Al Gore, former US vice president, and David Blood, senior partner, Generation Investment Management, “The Coming Carbon Asset Bubble” for additional information).

This information has potentially significant implication for loss of value to investors given how far reaching carbon is for financial markets—the top 100 coal and top 100 oil and gas companies have a combined value of US$7.42 trillion as of February 2011. Additionally, the countries with the largest greenhouse gas potential in reserves on their stock exchanges are Russia, the United States, and the United Kingdom and the stock exchanges of London, São Paulo, Moscow, Australia, and Toronto all have an estimated 20-30% of their market capitalization connected to fossil fuels. Carbon and fossil fuels, and decisions regarding their use and value, can have significant impacts on financial markets and futures around the world.

This so called “carbon bubble” leads to a reporting challenge, particularly for fossil fuel companies. For these companies, it is not necessarily the scale of operational emissions that is the strategic challenge but the emissions associated with their products, which are currently locked into their reserves. The danger is that financial reporting of extractive companies does not present the full picture needed by investors. The report, Carbon Avoidance? Accounting for the Emissions in Hidden Reserves, from the Association of Chartered Certified Accountants (ACCA) and the Carbon Tracker Initiative highlights that current financial reporting standards, stock market listing requirements, industry reporting frameworks, and non-financial reporting guidelines do not adequately alert investors to the risks of reserves associated with climate change.

Focusing on the fossil fuel and extractive industries, the report challenges the way in which fossil fuel reserves are accounted for and explores global reporting practices on fossil fuel reserves and the nature of information gaps. The report also considers the necessary steps to integrate emerging and future climate risks into disclosure.

The work of Carbon Tracker and ACCA, in which IFAC has been significantly involved, is leading to action by some investors to better understand the economic viability of reserves in a low carbon global economy.

Ceres, a US-based sustainability advocacy group, is leading a coordinated effort to get the world’s top fossil fuel companies to confront the likelihood of not being able to burn all of their reserves. A US$3 trillion investor coalition wrote to 40 energy companies specifically on stranded asset risk. Major asset owners supporting the initiative include the California pension giants CalPERS and CalSTRS; the New York State Common Retirement Fund; the UK’s Railpen Investments, Universities Superannuation Scheme, and Merseyside Pension Fund; and Christian Super and Local Government Super of Australia.

An increasing number of investors are becoming more “climate literate,” and demanding more complete, forward looking and integrated information on greenhouse gas emissions and related sustainability issues.

The Carbon Tracker and ACCA report recommends disclosure could be improved if companies were required to:

  • convert reserves into potential carbon dioxide emissions;
  • produce a sensitivity analysis of reserves levels in different price/demand scenarios;
  • publish valuations of reserves using a range of disclosed price/demand scenarios; and
  • discuss the implications of this data when explaining their capital expenditure strategy and risks to the business model.

To further support the case for more and better disclosure, KPMG’s Carbon Footprint Stomps on Firm Value, which considers the link between the value of a firm and its carbon footprint, shows how the median market value of firms that do not disclose their carbon emissions is lower than those that do. Although markets punish companies for their emissions regardless of disclosure, the research highlights that non-disclosure is penalized with an additional reduction in market value. It is clear from the study that in the absence of federal regulation in the US, capital markets are already anticipating the effects of the costs of carbon emissions on company value.

Role of the global accountancy profession

The accountancy profession is playing a crucial role in helping achieve sound and useful business reporting that is comparable across borders. Higher-quality business reporting and disclosure are needed to better reflect the climate change uncertainties facing companies. This information is required by both companies and their investors in order to take appropriate action.

The accountancy profession is also centrally involved in the broader initiative by the International Integrated Reporting Council to issue an integrated reporting framework in late 2013 to facilitate concise communication about how an organization’s strategy, governance, performance, and prospects, in the context of its external environment, lead to the creation of sustainable value. The accountancy profession is also involved in the work of the Climate Disclosure Standards Board, which issued a Climate Change Reporting Framework (CCRF), and accompanying guidance, to support organizations in disclosing decision-useful information in relation to how climate change affects financial performance. The CCRF can also be used to ensure compliance with the UK’s regulation on greenhouse gas emissions reporting.

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