Unburnable Wealth of Nations

• Author: James Cust, David Manley, and Giorgia Cecchinato

Unburnable Wealth of Nations Finance & Development, March 2017, Vol. 54, No. 1

James Cust, David Manley, and Giorgia Cecchinato

Successful action to address climate change would diminish the value of fossil fuel resources in many of the world’s poorest countries

To achieve climate change goals, the world must cut consumption of fossil fuels dramatically. But climate change success may put developing countries rich in fossil fuels in an almost no-win situation.

If there is no progress in combating climate change, poor countries are likely to be disproportionately harmed by the floods, droughts, and other weather-related problems spawned by a warming planet. But if there are successful global actions to address climate change, poorer countries that are rich in fossil fuels will likely face a precipitous fall in the value of their coal, gas, and oil deposits. If the world makes a permanent move away from using fossil fuels, the likely result will be a huge reduction in the value of their national and natural wealth.

These nations face three special challenges. First, they have a higher proportion of their national wealth at risk than do wealthier countries and on average more years of reserves than major oil and gas companies. Second, they have limited ability to diversify their economies and sources of government revenues—and it would take them longer to do so than countries less dependent on fossil fuel deposits.

Last, economic and political forces in many of these countries create pressure to invest in industries, national companies, and projects based on fossil fuels—in essence doubling down on the risk and exacerbating the ultimate consequences of a decline in demand for their natural resources (see map).

Carbon riskWhat seems clear to virtually all scientists who study the issue is that the world cannot consume all of its oil, gas, and coal reserves without catastrophic climate consequences. To limit the increase in global temperature to 2 degrees Celsius—the more conservative of the goals agreed to by governments at the 2015 climate change talks in Paris—more than two-thirds of current known reserves, let alone those yet to be discovered (see Table 1), must remain in the ground (IEA 2012). They are the indirect target of climate policies that seek to limit carbon emissions—probably through taxes and quotas on carbon and the fostering of new low-carbon technologies. At some point, therefore, it is likely that the market for fossil fuels, especially highly polluting coal, will dramatically shrink, and with it their value to exporting countries. Reserves—that is, so-called proven reserves, which are estimated to be extracted profitably at current prices—may also remain undeveloped if governments impose policies to limit the market supply of fossil fuel resources. For example, Collier and Venables propose a sequenced closing of the global coal industry (2014). Furthermore, unless there are major—and unlikely—breakthroughs in technology to capture the carbon emitted by fossil fuels, the sharply reduced demand for oil, gas, and coal will be permanent.

Such a “carbon market risk” is potentially catastrophic for the economies of low- and middle-income countries rich in fossil fuels. While many of them have enjoyed the benefits of fossil fuel extraction, including the significant excess profits sometimes associated with oil and gas exports, they have typically failed to diversify their economies. Those that discovered their fossil fuels more recently may find themselves arriving “too...