Download The carbon bubble and systemic risk Philip R. Lane, Trinity College

Too Late, Too Sudden:
Transition to a Low-Carbon Economy and
Systemic Risk
Daniel Gros
Director, Center for European Policy Studies
ESRB General Board
Frankfurt, 17 December 2015
Outline
1. The adverse scenario
2. Systemic risk in the adverse scenario
2.1 Macroeconomic impact of energy supply shocks
2.2 Financial system exposure
2.2a To fossil fuel firms and stranded assets
2.2b To other carbon-intensive assets
2.2c Global risk dimensions
3. Macroprudential policy implications
3.1 Short-term policy response
3.2 Medium-term macroprudential policy response
4. Next steps and discussion points
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1. Adverse scenario: disorderly transition
Physical
and transition
risks
40
30
20
Amplified by lack of technical progress
10
2050
2045
2040
2035
2030
2025
0
1985
A later transition may also pose larger
physical risks from climate change.
1980
•
2020
–
Mostly
transition risks
Projected path
Projected path if emissions are fixed at 2014 level
Transition path for 2C target if starts in 2020
Transition path for 2C target if starts in 2025
Transition path for 2C target if starts in 2030
2015
Large emissions cuts implemented over a
short horizon
50
2010
–
60
2005
The adverse scenario is a “hard landing:”
Physical
risks
2000
•
An early and gradual shift can facilitate a “soft
landing” in a low carbon economy
(b)
GtCO2 per year
70
1995
•
The shift to a low-carbon economy will
require significant reductions in greenhouse
gas emissions
1990
•
Source: Bank of England, Prudential Regulation Authority (2015)
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2. Link to systemic risk
Adverse scenario could affect systemic risk via two channels:
1. Macro-economic effect due to reduction in energy supply and/or increase in
energy costs as external effects are suddenly priced.
2. Sudden negative revaluation of carbon-intensive assets, (i.e. real and
financial assets whose value depends on the extraction and/or usage of fossil
fuels and other high carbon resources).
These two channels could interact with other financial frictions and stimulate
negative feedback loops. They might further interact with a third channel: the
impact of physical shocks (e.g. natural catastrophes) associated with climate
change, which are likely to increase along with temperature.
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2.2a Macroeconomic impact of energy supply and price shocks
•
•
•
•
Substituting low-carbon for fossil fuel
energy quickly will be expensive at the
margin.
Adaptation of infrastructure may also imply
energy shortages and abnormally high
energy costs in a transitional period.
Increased energy costs has tended to
impair economic growth (see e.g. Kilian,
2014).
Carbon restrictions affect both energyintensive industries and industries that
depend heavily on other carbon-intensive
inputs.
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Greenhouse gas emissions by sector, EU-28
Industrial
processes
7%
Waste
3%
Solvent and
other
product use
2%
Agriculture
10%
Transport
including
international
aviation
21.9%
Source: Eurostat
Energy
excluding
transport
57%
2.2b Financial system exposure to stranded assets
•
•
Elkins and McGlade (2015) estimate that
approximately 35% of current oil reserves,
50% of gas reserves and nearly 90% of coal
reserves are ‘unburnable.’
Oil and gas producers: total debt to assets(a)
The market values may not currently reflect
this risk
–
HSBC estimated a 50% decrease in
market capitalization for oil and gas
companies, including both the risk of
stranded assets and reduced demand
(HSBC, 2013).
•
Energy production based on very long term
assets, often finance mainly by debt
•
Potential for financial instability.
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Sources: Domanski et al, 2015. BIS calculations based on data
from Bloomberg and Thomson Reuters Worldwide, showing me
dian and 25-75th percentile.
(a) Integrated oil, gas and exploration/production companies. Lar
ge US and EMEs include companies with total assets in 2013 e
xceeding $25 billion.
2.2b Financial system exposure to stranded assets
•
The EU financial system may have significant direct exposure to fossil fuel firms.
–
•
Weyzig (2014) estimated this exposure at more than €1 trillion, with potential losses
of €350-400 billion even under a “soft landing” scenario.
Assets dependent on cheap fossil fuels will also be affected, including carbon- and
energy-intensive sectors such as transportation, manufacturing, agriculture, and real
estate
•
Recent macroeconomic modelling estimated that, under a scenario in which markets
revalued assets in accordance with policy limiting warming to 2°C, major stock
market indexes could fall up to 15-20% (CISL, 2015).
•
The initial shock could trigger substantial second-round effects, compounded by
contagion effects and financial system frictions.
•
The systemic risk implications depend on the level of exposure to carbonintensive assets and the degree of debt financing, both of are difficult to
quantify given available data
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2.2c Global risk dimensions
•
The potential systemic implications are
compounded by the global nature of
transitional risk, particularly for oil and gas
exporting countries
– State-owned oil firms in emerging
market economies contribute a large
part of the government budget and are
increasing their debt financing
(Domanski, 2015)
•
Emerging markets are also more exposed
to physical risk, a ‘global megatrend for
sovereign risk’ (Kraemer, 2014)
•
The EU is comparatively less vulnerable
but exposed to vulnerable third countries
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Section 3: Macroprudential policy implications
•
The systemic risk implications depend on the level of exposure of individual
agents, and highly levered financial institutions in particular, to carbonintensive assets and the specific form of emission abatement policies,
both of which are highly uncertain and will vary widely across member
countries.
•
In response to the potential systemic risk involved, macroprudential
policymakers could encourage identification and disclosure of carbonintensive assets, and use this information to run dedicated stress tests of
financial institutions.
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3.1: Short-term policy implications
•
In the short-term, the ESRB could:
– Develop a view of the economic/financial implications of a ‘hard landing’.
– Support the call for greater information collection and disclosure.
•
Ensures a timely assessment of the associated potential threats to
financial stability
– Develop stress testing tools for future use.
•
A) incorporate risks associated with a “hard landing” into the ESRB’s
macroeconomic scenarios used by the ESAs in their regular stress
testing of regulated financial institutions.
•
B) run dedicated “carbon stress tests” to define the most pertinent
systemic risks and that could be adapted to the specificities of “hard
landing” stress scenarios (such as the long time horizon)
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3.1: Short-term policy implications
•
•
Topic of climate change and
financial stability is currently
under consideration by
several institutions (see right)
Opportunities for
collaboration within the ESRB
on both of these options.
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Institution
Initiative
Bank of England, PRA
Ongoing research, e.g. “The
Impact of Climate Change
on the UK Insurance
Sector.”
Financial Stability Board
Climate Disclosure Task
Force (upcoming)
French Treasury
Department
Stress testing and
disclosure requirements
People’s Bank of China
Green Finance Task Force
UNEP
Inquiry: Design of a
Sustainable Financial
System
3.2: Medium-term macroprudential policy response
• If research suggests significant exposure to carbon risk under a hard landing
scenario, regulators could consider further policy actions:
–
building systemic buffers so as to protect against the macroeconomic and
macrofinancial implications of a "hard landing";
–
regulatory loss absorbency requirements, e.g. in the form of the issuance
of "carbon risk bonds," the payoff on which would be contingent on a
contractually-defined critical event (e.g. the imposition of a high carbon tax
or a rise in the price of carbon);
–
specific capital surcharges based on the carbon-intensity of individual
exposures; and
–
large exposure limits applied to the overall investment in assets deemed
highly vulnerable to an abrupt transition to the no-carbon economy.
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4. Discussion points
• Thoughts on the short and medium-term policy options
• To agree to publication of the note as ASC paper
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References
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Appendix 1: climate and emissions scenarios
•
Past and current state of emissions suggest a highly
uncertain environment regarding the speed and
timing of the low-carbon transition
–
•
•
Carbon budget and CO2 emissions
Extrapolating from existing emissions pledges
and the targets consistent with limiting global
warming to 2°C suggests a late, hard transition.
Under a soft landing, the low-carbon transition could
have an overall positive effect on the economy, given
timely investment in alternative energy and
infrastructure. (See e.g. Acemoglu et al (2012), Stern
(2008), Wei (2010), Fankhaeser (2010))
This soft landing would require a significant but
feasible increase in investment and infrastructure
(Kaminker, 2012).
•
The implementation of emissions regulation has
shown considerable variability and volatility in
establishing a price for carbon emissions, dampening
investment in clean energy sources (Masini and
Menichetti, 2011; IEA, 2014).
•
Absent stable price signals and decisive global
political commitment against climate change, a hard
landing becomes more likely.
Source: IEA (2015). Global energy-related CO2 emissions extrapolating from current national
emissions pledges under the UNFCC, compared to remaining carbon budget.
Carbon futures price under the EU Emissions Trading System
Source: Investing.com. Euros per ton of CO2 equivalent, 2008-2014 .
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