Fossil fuel companies hold vast oil, gas and coal riches that they frequently tout to the investing universe to help elevate their market values. However, not a single energy company has ever told investors about the potential effects on the environment if all their hydrocarbon reserves were burned.
And certainly few, if any, have ever told investors that a large chunk of these assets could be doomed to forever remain buried in the ground - and essentially worth nothing - should environmental regulations tighten.
Yet, the specter that these assets might one day end up stranded and theoretically worthless as the clamor for clean energy heats up looms large.
According to estimates in the Financial Times’ Lex column, nearly $900 billion worth of reserves - or about one-third of the value of big oil and gas companies - is at risk of one day becoming worthless as market and policy forces continue to undercut hydrocarbon economics due to the threat of climate change.
In effect, these companies could see a third of their value evaporate if governments aggressively attempt to restrict the rise in temperatures to 1.5C above pre-industrial levels for the rest of this century and avert catastrophic climate change as per Intergovernmental Panel on Climate Change (IPCC) estimates.
Consequently, investors are likely to increasingly price in the risk of asset writedowns by the world’s leading oil and gas companies unless a solution to the ongoing climate change is found within the next decade.
High Risk Investments
The effects of such a huge scale in writing off frozen assets - gradually at first and then at an accelerated rate - is likely to be keenly felt across the business world.
We could argue that notoriously secretive national oil companies (NOCs) and not independent oil companies (IOCs) are the biggest financial risk since they control ~$3 trillion in oil and gas assets and an estimated 90 percent of all known reserves. Nevertheless, considering that publicly traded energy companies have collectively lost $400 billion in their fundamental value over the past five years, losing anything in that ballpark over the next five could be disastrous for the sector. Related: Oil Traders Could Lose Big On Coronavirus Panic
A good case in point is Chevron Corp. (NYSE:CVX), which recently reported a large $10.4B shale asset writedown. ExxonMobil (NYSE:XOM) also recently found itself in the hot-seat over its failure to make disclosure about climate risk even as shareholder pressure for risk disclosure mounts. It was later absolved.
Here’s a rundown of the financial risk burden that fossil fuel companies carry:
- Stranded Assets - the assets currently contributing to the market value of many fossil fuel companies that cannot actually be developed and sold will lower their overall valuations
- Loss of market capitalization - downward pressure on energy stocks from divestiture efforts especially by institutional investors could hurt your mutual funds and stocks
- Cost of capital - in December, we reported that Goldman Sachs had ruled out financing drilling in the Arctic as well as new thermal coal mines anywhere in the world and that other large banks were likely to follow suit. Fewer banks willing to finance fossil fuel projects will make it progressively more expensive to bring these buried assets to market
- Scarcity of insurance - by the same token, fewer insurance companies will be willing to back such projects, thus increasing both the cost and time to get the necessary insurance to build them
- Insufficient renewables investment - faced with this critical disruption in the well-established fossil fuel model, it would be smart to develop substantial lines of business that do not carry these risks. Yet, current investment in low carbon energy sources by fossil fuel companies is less than 1 percent, way too little to move the revenue needle for the vast majority
- Market risk - there might be seismic changes in how the market begins to value fossil fuel reserves
The Dirtier, The Riskier
Although the Lex report sounds decidedly bearish, let’s not forget that even a more benign case where governments target a 2C rise in temperature - which is what they targeted at the 2015 Paris Agreement on climate change meeting - energy companies would still have to write off more than 50 percent of their reserves as stranded assets.
Meeting the 1.5C threshold would mean leaving over 80 per cent of hydrocarbon assets worthless.
In a recent piece on climate change, we reported that global energy emissions are showing serious signs of slowing down due to a more aggressive clean energy push.
Global CO2 emissions climbed just 0.6 percent in 2019 compared to 3.4 percent in 2018 thanks to China’s green energy push. Better still, the IEA sees CO2 levels in 2050 clocking in at 4 percent below 2019 levels despite an otherwise healthy economy, thanks in large part due to coal power retirements while natural gas consumption - with a lower carbon footprint - is expected to increase quite dramatically. Related: Peak Shale Will Send Oil Prices Sky High
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Ultimately, we could be at the cusp of one of the biggest ever shifts in the allocation of capital in the energy sector. Investors need to be wary of the risks that could come with this shift.
By Alex Kimani for Oilprice.com
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I think the basic misconceptualization here is the view that climate change response will only work by government fiat, that unless the government outright bans it, it will be produced profitably. But government mandate is not the only risk here and it is not the only policy option on the table. For example renewables, EVs and other clean technology are following their own learning curve to lower cost and higher volume. This is already undermining the prices of all fossil fuels. Furthermore, governments can continue to accelerate this onslaught by subsidization and other policies that need not directly bar fossil fuel production. Such policies accelerate cost declines and volume ramp up.
The point here is that fossil fuels are increasingly under massive price pressures, and that will make many resource unprofitable to develop. And developed resources will lose value. So it is asset impairment that investors should fear.
The CEO of the global oil giant ‘Shell’ rebuked these groups by saying that while Big Oil will continue to invest heavily in clean energy solutions, neither the global economy nor Big Oil will change course on oil and natural gas until it makes financial sense meaning until renewables become as a lucrative business as oil and gas. Until this happens, it is not oil and gas assets that could be stranded during the 21st century and beyond, it is renewables. The legendary Bill Gates also recently echoed Shell's CEO by rebuking divestment campaigners for talking big without offering solutions.
Furthermore, the global economy will always provide capital and insurance to Big Oil. Therefore, there will neither be a loss of market capitalization nor risk to shareholders and investors.
For instance, divestment campaigners tell Big Oil, companies and sovereign funds to divest of their oil and gas stocks but they don’t tell them or provide them with a similar lucrative alternative as Norway’s Sovereign Fund, the world’s biggest found to its chagrin and was forced to drop the bulk of its divestment plans otherwise the whole fund would have been undermined financially affecting the future and prosperity of Norway’s people and economy.
They tell people of the world to drop internal combustion engines (ICEs) and move to electric vehicles (EVs) but they neither tell them about the trillions of dollars needed for global capacity expansion of electricity generation to recharge the millions of the EV’s batteries nor the fact the overwhelming electricity expansion will still come from natural gas, oil and nuclear energy.
Divestment and global climate change campaigners should first learn about the facts of life that underpin the global economy and therefore its prosperity and livelihood.
They should learn that there will be no post-oil era and no peak oil demand either and also no imminent global energy transition throughout the 21st century and far beyond and that the oil and gas business will continue to be the core business of the global economy and Big Oil well into the foreseeable future. They should also know that we’re now in an era of energy diversification where alternative sources to fossil fuels, notably renewables, are growing alongside—not at the expense of—the incumbents.
For energy transition to accelerate, it should have three realistic objectives: benefit to users, practicability and lucrative financial returns from renewables to match those from oil and gas. Mandatory transition will only achieve limited success.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
World elites have been advocating global depopulation for around two generations now. Their insistence upon "climate change" austerity will most certainly help them help the rich get richer, while the poor simply "disappear!"
However, that won't matter to the get-rich-quick people who want to just pump and dump.
How well we embrace innovation and new directions in our economy will determine how quickly we transition.
Today, we have huge differences among nations in how far along we are in transitioning away from burning fossil fuel. Great Britain (mostly Scotland), Denmark (and several other European countries), Norway, Sweden and Costa Rica are progressing well. Leadership in Russia and the U.S. is happy to be fossil-fuel dependent. China is a mixed bag -- a standout leader in renewable energy (they want to breathe), but China is still terribly dependent on fossil fuel due to their rate of growth and level of manufacturing.
Where's it all leading? -Away from burning fossil fuel, just a soon as we can get there -- without unduly affecting quality of life. Secondary benefits of transitioning, like clean air and water, contribute to maintaining life and life quality.