So what’s The Big Thing about the Carbon Bubble?

What is the big thing in the upcoming report from Exxon? It is the shift from thinking of carbon in terms of price or tonnes – which has not dramatically affected the bottom line of really anyone – to thinking about carbon in terms of reserves.  Different numbers used in different ways that as another oil giant (Shell) pointed out in their recent annual report could impact (to paraphrase) everything.

So this is new territory for many and here is a little Reserves 101 that should help in understanding the upcoming stranded asset report being issued by Exxon.

First, what is a stranded asset? This is something you, a company, or government owns but for various reasons cannot use or sell either temporarily or permanently. Those various reasons can be a change in consumer preferences (e.g. your forests are not certified ‘sustainable’ and you are left with timber or pulp you cannot sell) or your power generating plant bid to sell electricity is too high and so for that day your plant is sitting idle. For oil companies an important asset is the amount of reserves that they own. The challenge they face is that using those reserves will release a lot of carbon, more than scientists tell us we can afford to release. Thus some of the world’s reserves are or will be stranded.

Second, unburnable carbon and carbon bubble.  Starting with the last term, our previous Premier introduced the term bitumen bubble – the phrase carbon bubble is used differently. What the group Carbon Tracker is saying is that the value of oil reserves is inflated. This inflated value or bubble is caused by carbon. In other words, if carbon risk is taken into account then the bubble will burst and only a portion of the reserves is of value – the rest of the oil must become a stranded asset because you will not be able to burn it in your vehicles, trains, ships and planes (and thus the second term, unburnable carbon – yes, you have the hydrocarbon in the ground but you won’t be able to produce, refine, transport and sell it for burning).

Third, carbon budget refers to a study by Mannheim et al where they calculate that if we are to keep our planet below a carbon level that is dangerous (e.g. fry the planet) than between 2000 and 2050 we can only emit 886 Giga Tonnes of CO2. Considering we have used about 1/3 of that in 11 years (321 GtCO2) this means with increasing global emissions we won’t get to 2030 before we use up the entire carbon budget. Another way to get a handle on this – if we flatline the amount of oil we consume globally (about 90 million barrels every day) between 2000 and 2050 then that alone accounts for 80 per cent of our carbon budget – leaving only a small amount for coal, natural gas and other carbon emissions.

The next step in preparing for the upcoming report from Exxon is an understanding of how the term “oil reserves” is understood and used.

Oil reserves are an estimate of the amount of oil that can technically and economically be recovered from a formation. This is not the total amount of oil actually in the ground (i.e. called “oil-in-place”) but reserves are the amount of barrels, based on given technology and economics (e.g. price of oil, cost of extraction, etc.), that can feasibly be recovered.  So for example, currently about 10 per cent of the oil sands can be recovered or only 2 per cent of North Dakota’s Bakken shale oil can be produced.

Also in Exxon’s report another accounting term we are likely to see is P90 (or a proved reserve) which means that the oil reserve has a 90 per cent chance of being produced over the life of that field.

This number is used in a number of accounting and business practices. For example, in Canada, under what is called National Instrument 51-101, oil reserves must be reported. National Instruments are in the realm of security regulators as opposed to accounting regulators. These numbers show up in a number of calculations including investment appraisals, depreciation and triggers but not in a company’s balance sheet until the oil is actually produced.

For example,two important uses for reserve numbers are in the calculation of depletion and, for Alberta’s oil sands mines, in the Mine Financial Security Program (MFSP). The former is a deduction calculation where the reserves number is a denominator that gives a percentage of how much the reserve has been depleted.  The smaller the reserves number the greater the depletion deduction.

In MFSP there are some serious cash implications. MFSP is a program to ensure there are resources necessary to carry out the remediation and reclamation of a mine, processing facilities and upgrading plants in the oil sands (also applies to coal) as a mine is nearing its end of life. A critical trigger is that when there are 15 years of reserves left then either the requirements of a reclamation plan are being met or financial security must be posted.

You can access Canadian securities data through here. So for example, entering in Imperial Oil and Forms 51-101 ends up with a report for Imperial’s disclosure of reserves data which says that they have a working interest in total proved reserves of bitumen of about 3.2 billion barrels. Pricing calculations that are also found there do not explicitly attach a carbon value or restriction.

So what is the punchline? Think of the housing bubble when the value of homes in the US deflated overnight.  Yes, there is a carbon bubble and yes it will deflate reserves but there is a catch before selling off oil stocks.  Given the high prices for crude, oil companies are in a good position to pay any carbon tax that may come along. This is called expensive emissions.  Not so for other industries that may be impacted by some form of price restraint on carbon. But this is a next step in a trend to a more carbon constrained world.