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The Carbon Bubble

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Five years after the Great Recession wiped trillions of dollars off global stock markets, the world is facing another economic risk from the fossil fuel industry.

According to a recent report by Carbon Tracker, this sector is creating a dangerous bubble which is about to burst. It says that most oil, gas and coal reserves could be worthless in a few years time as nations across the globe commit to legally binding cuts in carbon emissions.

The study comes fives months after over 190 countries agreed to mandatory cuts in 2015 in a bid to limit global warming to two degrees celsius. In order to meet that target, it says that two thirds of existing fossil fuels will need to remain in the ground.

According to former World Bank economist Lord Nicholas Stern, one of the lead authors of the report, the top 200 oil and gas firms spent over 600 billion dollars in developing fossil fuel reserves last year. HSBC thus believes that the majority of these companies may face a carbon bubble in the not too distant future.

And, although carbon capture and storage may eventually help to bury some of these emissions, the most optimistic scenario would only allow for an extra 4% of these reserves to be burned. In many ways, fossil fuels can now be regarded as sub prime assets.

"We need to prevent the deep and profound harm that could be wrought by an overexposure to high-carbon assets and a rapid shift in their values," says said Ben Caldecott from Climate Change Capital.

Part of the problem is the short term view that the markets take. As James Leaton from Carbon Tracker points out:

"They only believe environmental regulation when they see it. 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."

Ratings agencies and pensions funds have added their voices to the chorus of concerns. According to Standard and Poor's, oil companies could face a ratings downgrade in the near future. And, that leaves major oil heavy stock markets in New York, London and Moscow, all vulnerable to a crash.

Activists in the US have cited this research to encourage investors to pull out of these assets in a campaign modeled on the divestment movement that forced South Africa to unwind its position on apartheid in the 1980s.

The report comes a few months after the World Bank warned that our planet may warm by up to four degrees celsius within the next 50 years. It's grim prognosis came a few weeks after super storm Sandy took centre stage in the final week of the US election as it swept across the north eastern seaboard to leave much of New York City submerged under water. The storm was a brutal reminder of what the future may look like if climate change continues to run riot.

As the US and China are the world's largest economies and polluters, any hope of reining in global carbon emissions depends on the commitment of these two powerhouses. Earlier this month, the two nations forged a new Climate Change Working Group dedicated to combating the issue.

The move comes one month after Beijing ushered in its new generation of leaders headed by Xi Jinping. The government has come under increasing fire to tackle pollution after the capital became cloaked in a thick apocalyptic smog earlier this year which led to a 30% rise in hospital admissions.

The world's most populous nation has already over taken the US to become the leader in the clean energy race. It is also in the midst of developing its first national climate change bill.

Since his reelection last November, president Barack Obama has stoked hopes that he will not only fight climate change, but make it part of his overriding legacy. But, two months after his State of the Union pledge to deploy his executive authority if necessary, he has failed to unveil any form of green policy thus far.

Members from the environmental community are now looking to the president's decision on the controversial Keystone XL pipeline which has been dubbed as "a fuse to the largest carbon bomb on the planet".

It hopes to transport dirty oil from the Canadian tar sands down to refineries in Mexico. According to a recent study, annual carbon emissions from the tar sands alone would be equivalent to that generated by over 50 coal fired power stations. In fact, if we were to use all of that oil, it would warm our planet by a further 0.4 degrees celsius.

Many see it as a litmus test for the president's true commitment to the environment. "It's not possible for him to approve the pipeline and say with a straight face that his administration is serious about stabilizing our climate," says Michael Brune, president of the Sierra Club.

Moreover, if global appetite for dirty oil falls after nations commit to curbing CO2 emission in 2015, perhaps the billions of dollars it requires to develop can be viewed as a huge waste of tax payers dollars. In the words of legendary investor Jeremy Grantham:

"If you put billions of dollars into a new tar sands project, you will not see a decent return on it. It will be underpriced by solar, wind and other alternatives which are moving at considerable speed. And, they will slap a carbon tax on coal and tar sands in the not-too-distant future - and that will be a death blow."

In an era where America is struggling to rein in its ballooning budget deficit, that money would be better spent on research and development into more efficient forms of clean energy that will eventually power our future. This would help the US to regain its crown as the top green energy producer whilst paving the way for millions of new decent jobs.

As Grantham points out, as China takes pole position in the race towards greener power, they will eventually have such cheap energy, "they will be the terror of the capitalist system. Low cost energy, that's the ball game."