Petroleum enemy No. 1
Move over, shale: climate change will supplant the U.S. oil revolution as the energy industry’s No. 1 disruptor in 2016. The world’s politicians may be about to get serious on cutting greenhouse gases at the United Nations climate summit in Paris over the next two weeks. The consequences for the industry will be longer lasting than the recent revolution in oil production.
The growth of shale, largely thanks to hydraulic fracturing technology, shook up the sector over the past few years. It allowed the United States to flirt with becoming energy self-sufficient and thus reduce the political sway of OPEC. Increasing supplies also led to a drop in prices that accelerated last year as China’s economic growth began to slow.
The price of crude is now mired around $45 a barrel, 60 percent off its 2014 high. That hit shares: the S&P Global Oil Index, which tracks the stock prices of 120 petroleum producers, had fallen 30 percent between mid-2014 and September this year. It has since rallied nearly 12 percent as hopes grow that the oil price will stabilize as both shale and OPEC producers finally adjust production properly to reflect recent turmoil.
Out of the frying pan…
The Paris talks could upend this relief. Skeptics may find it easy to dismiss the event. Little has ever been established at these jaw-jaws in the past. The Paris U.N. summit, though – officially known as the 21st session of the Conference of the Parties already has a good deal of momentum. The idea is to reach an accord that will reduce emissions by a large enough amount that the temperature of the earth’s atmosphere will not be more than 2 degrees Celsius higher by 2100 than before the Industrial Revolution.
The United States and China, which between them account for some two-fifths of all CO2 emissions, in September detailed a series of accords to start limiting these pollutants over the next 10 to 15 years. In all, nearly 180 countries responsible for some 90 percent of global greenhouse gas emissions have announced reduction targets ahead of the summit. Almost 140 heads of state are to attend – including Barack Obama of the United States, China’s Xi Jinping, India’s Narendra Modi and Vladimir Putin from Russia.
If all their various proposals are fully implemented, it may still not be enough to meet the 2 degree goal. That’s the threshold that many scientists regard as the starting point for dangerous climate change – though a growing number are putting the tipping point at 1.5 degrees Celsius. At that stage, yields from crops as currently grown may fall by roughly 15 percent, water flow in some river basins may drop as much as 10 percent while elsewhere rain falling during heaviest precipitation may jump by the same amount, causing floods.
Hitting a weaker target would still represent progress, though, especially if countries agreed to revisit it periodically with an eye to introducing more ambitious policies later.
Either way, the talks increase the focus on how exposed the energy industry is to changing environmental policy. The main concern among investors is how many so-called stranded assets companies may end up with – in other words, how much of their oil, gas and other energy reserves would no longer be viable – and what impact these will have on performance.
In 2011, researchers at the Carbon Tracker think tank calculated that companies and governments around the world own five times as much coal, oil and gas than be safely burned without an unacceptable risk of exceeding the 2 degree limit.
In a report published this week, the group calculates that fuel companies risk squandering over $2 trillion of capital expenditure over the next decade – around a quarter of oil majors’ potential investment – pursuing projects that may ultimately end up uneconomic due to tighter carbon policy and advances in renewable technologies. Exxon Mobil and Royal Dutch Shell would be most at risk in dollar terms.
Both companies largely dismiss talk of a carbon bubble. They argue that fossil fuels, especially oil and gas, will still be needed if policymakers want to supply a growing, more affluent global population with reliable energy. The industry appears willing to bet that the high cost of keeping global temperatures below 2 degrees Celsius will make the target untenable. Better, in that case, to keep pumping, invest in technologies to make fossil fuels burn cleaner, and invest to offset the worst effects of climate change.
For the first time, though, the industry is facing a combination of both political and financial pressure. So they are unlikely to be let off the hook even if the Paris summit fails to deliver a meaningful agreement.
Bank of England Governor Mark Carney, for example, revealed in September that as chair of the Financial Stability Board he is considering recommending to the G20 that “more be done to develop consistent, comparable, reliable and clear disclosure around the carbon intensity of different assets.” Such information could make “climate policy a bit more like monetary policy.”
The International Energy Agency and several Wall Street firms have published studies supporting the carbon bubble logic. Earlier this month, New York Attorney General Eric Schneiderman issued a subpoena demanding documents related to Exxon Mobil’s communication about climate risks.
Shareholders are taking a more active role, too. At times, that’s simply a case of publicly committing to sell fossil fuel holdings. Big institutions and individuals responsible for $2.6 trillion in assets have done so, according to a September report by philanthropy consultants Arabella Advisors. That’s a 50-fold increase in assets under management over last year.
Others have used companies’ annual proxy voting process to push for more disclosure on climate risks at Exxon and Shell, for example. And research and lobby groups are corralling investors to take action, too. CDP, for example, gathers data from at least 4,500 firms – not just energy companies – on behalf of more than 800 investors responsible for some $95 trillion of assets.
All in, it puts energy companies in a bind. Those that ignore climate risk – and the willingness of politicians and financial markets to deal with it – could eventually see billions of dollars of investment go up in smoke. Those that forgo investing in fossil fuel altogether, though, may struggle to grow as the rising global population demands a better lifestyle that, currently, only more traditional energy methods can help provide. Whatever happens in Paris, climate will prove more vexing than shale in 2016.
This view is a Breakingviews prediction for 2016. Click here to see more predictions.