Notably, the COP28 climate negotiations in Dubai concluded with a historic commitment to transition away from all fossil fuels. The president of this year’s summit successfully brokered an agreement that garnered support from the US and the European for the world to transition away from fossil fuels. This is the first time fossil fuels are mentioned in the final COP text agreements. 

Accordingly, we will dive the ‘carbon bubble’ concept, highlighting the immense risk that fossil fuels pose to the financial market and how we can protect our economic system from such risk as we aim to meet global 1.5º climate targets. 

What is the carbon bubble?

The term 'carbon bubble' stems from an overvaluation of fossil fuel companies' oil, coal, and gas reserves. The notion of a carbon bubble is based on our knowledge that 2°C is the absolute maximum amount of temperature rise that humanity can cope with. Any temperature that exceeds 2°C will result in our planet becoming inhabitable. The “carbon bubble” started as a warning from a niche group of climate-minded financiers in the early 2010s but has since become a widely accepted term by major regulators and financial institutions. Similar to the carbon bubble, financial bubbles emerge when the value of an asset rises based on overly optimistic projections.

What risk does the carbon bubble pose?

The carbon bubble and the overvaluation of fossil fuel companies pose an immense risk to all stakeholders of climate change. It has been widely reported that Wall Street and valuation index analysts are doing their valuations based on misleading data. A RethinkX report points out that since 2010, $2 trillion has been invested in fossil fuels and nuclear power based on misleading assumptions about the value of these industries. The RethinkX report also found that Levelized cost of energy (LCOE) companies are overvalued by 400%, suggesting there is a significant risk of a potential market crash.

This carbon bubble situation is leading us to two potential outcomes:
Fossil fuel companies burn all of our reserves, clearly blowing our carbon budget and destroying the planet beyond recognition. Governments implement regulations to stop companies from extracting unburnable carbon, which would make these companies drastically overvalued overnight, causing the carbon bubble to burst.

The U.N. climate panel also estimated that fossil fuel investors could be at risk of losing between $1-4 trillion if governments act to limit global temperature rise. This so-called “carbon bubble” is recognized as a major risk to investors with a high exposure to fossil fuels and, should this bubble burst, it is thought the fallout could send shockwaves across the global economy.

As fossil fuel companies face risks of devaluation, the world must move away from these carbon-intensive energies via a switch to renewables and low-carbon technologies. Meanwhile, evidence highlights that two-thirds of solar and wind farms built globally in 2021 will provide cheaper electricity than even the most affordable coal plants – making renewables the cheapest power source today. 

In the same way that businesses implement a financial budget, organizations must implement an internal carbon budget to mitigate immense financial risks associated with sustainability and non-compliance. A carbon budget enables businesses to understand how much carbon dioxide they have left to emit to ensure they are aligned with universal climate targets. In doing so, businesses ensure the mitigation of immense sustainability risks. 

Ultimately, carbon budgets are valuable tools companies should adopt within their development of a comprehensive decarbonization strategy. A company can set a budget against its target in alignment with the 1.5 °C and, thanks to the budget, can create visibility around the “low-hanging fruit” and leave the rest of the budget to the more complex decarbonization challenges.

Regardless of whether you are an investor or shareholder in fossil fuel companies, the carbon bubble directly or indirectly impacts businesses and individuals around the globe. Divesting fossil fuels is not only the right thing to do for our planet - it is essential to the viability of the global economy. 

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