Nick Stern's Carbon Bubble Warning

Nick Stern is the latest voice to warn of the Carbon Bubble that threatens to plunge world markets into yet another financial crisis.

The former World Bank chief economist, currently I.G. Patel professor of economics at the London School of Economics, has joined with the Carbon Tracker thinktank to release a report finding that two-thirds of known fossil fuel reserves will have to be left in the ground if the world is to avoid truly dangerous climate change impacts.

Stern said that far from reducing efforts to develop fossil fuels, the top 200 companies spent $674bn (£441bn) in 2012 to find and exploit even more new resources, a sum equivalent to 1% of global GDP, which could end up as "stranded" or valueless assets. 

Stern said the investors clearly did not believe action to curb climate change was going to be taken. "They can't believe that and also believe that the markets are sensibly valued now."

"They only believe environmental regulation when they see it," said James Leaton, from Carbon Tracker  and a former PwC consultant. He said short-termism in financial markets was the other major reason for the carbon bubble. "Analysts say you should ride the train until just before it goes off the cliff. Each thinks they are smart enough to get off in time, but not everyone can get out of the door at the same time. That is why you get bubbles and crashes."

Paul Spedding, an oil and gas analyst at HSBC, said: "The scale of 'listed' unburnable carbon revealed in this report is astonishing. This report makes it clear that 'business as usual' is not a viable option for the fossil fuel industry in the long term. [The market] is assuming it will get early warning, but my worry is that things often happen suddenly in the oil and gas sector."

HSBC warned that 40-60% of the market capitalisation of oil and gas companies was at risk from the carbon bubble, with the top 200 fossil fuel companies alone having a current value of $4tn, along with $1.5tn debt.

Lord McFall, who chaired the Commons Treasury select committee for a decade, said: "Despite its devastating scale, the banking crisis was at its heart an avoidable crisis: the threat of significant carbon writedown has the unmistakable characteristics of the same endemic problems."

The report calculates that the world's currently indicated fossil fuel reserves equate to 2,860bn tonnes of carbon dioxide, but that just 31% could be burned for an 80% chance of keeping below a 2C temperature rise. For a 50% chance of 2C or less, just 38% could be burned.

Citi bank warned investors in Australia's vast coal industry that little could be done to avoid the future loss of value in the face of action on climate change. "If the unburnable carbon scenario does occur, it is difficult to see how the value of fossil fuel reserves can be maintained, so we see few options for risk mitigation."

Ratings agencies have expressed concerns, with Standard and Poor's concluding that the risk could lead to the downgrading of the credit ratings of oil companies within a few years.

Steven Oman, senior vice-president at Moody's, said: "It behoves us as investors and as a society to know the true cost of something so that intelligent and constructive policy and investment decisions can be made. Too often the true costs are treated as unquantifiable or even ignored."

Jens Peers, who manages €4bn (£3bn) for Mirova, part of €300bn asset managers Natixis, said: "It is shocking to see the report's numbers, as they are worse than people realise. The risk is massive, but a lot of asset managers think they have a lot of time. I think they are wrong." He said a key moment will come in 2015, the date when the world's governments have pledged to strike a global deal to limit carbon emissions. But he said that fund managers need to move now. If they wait till 2015, "it will be too late for them to take action."

Pension funds are also concerned. "Every pension fund manager needs to ask themselves have we incorporated climate change and carbon risk into our investment strategy? If the answer is no, they need to start to now," said Howard Pearce, head of pension fund management at the Environment Agency, which holds £2bn in assets.