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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Will The Climate Crisis Spread Financial Chaos In Oil and Gas?


Will climate change spark a financial crisis? It may not seem like an obvious connection but that was exactly the warning from the deputy head of the Bank of England a few months ago, a warning that is all the more stark as we are set to close the books on the world’s hottest year on record.

“It is potentially a systemic risk,” Paul Fisher, the deputy head of the Bank of England, said in October. "You don’t need to believe in climate change, you don’t need to believe that it is man-made," he added. "You just need to believe that governments are going to do stuff and that is going to affect your business. And then it is a material risk." That echoes the voice of Mark Carney, Bank of England Governor, who expressed similar sentiments last year.

The Paris Climate Change agreement was a signal that the world intends to reduce greenhouse gas emissions, even if the accord was relatively unambitious. Nearly all countries signed it, and although President-elect Donald Trump could decide to pull the U.S. out of the treaty, the world is moving on. Reducing greenhouse gas emissions necessarily means burning less oil, coal, and gas. Energy companies often have very lofty valuations, at least when commodity prices are high, but action on climate policy could undercut those valuations if fossil fuels are forced to be left in the ground.

That is not in immediate danger in the U.S., where the incoming administration has promised a drilling frenzy. One could argue that as the world’s second largest emitter, the non-involvement from the U.S. could shift global action. But there are few reasons why that line of argument does not hold water. First, the U.S. is slated to reduce emissions anyway as renewable energy becomes cheaper than coal and natural gas in large parts of the U.S. The solar industry just had a record quarter, installing 1 megawatt on average every 32 minutes. Moreover, 2016 will mark the first year that utility-scale solar outpaced all forms of new electricity generation. The future has already arrived for clean energy, the only issue is how quickly it will displace fossil fuels. Donald Trump could try to throw some assistance to the coal industry, but the economics of renewables are getting stronger.

Additionally, as technologies, renewable energy costs will only decline, while as extractive resources subject to scarcity, the same cannot be said for oil, coal and gas. Clean tech is a tough nut to crack, but our knowledge of how quickly clean energy will see costs decline and adoption ramp up is limited. It is not hard to imagine the energy industry being taken by surprise. After all, the iPhone did not exist a decade ago and now it is ubiquitous.

Electric vehicles will be key to displacing oil, and to be sure, they are much further behind in transportation than solar and wind are in the electric power sector. Still, new models are coming online, and adoption of EVs could see a ‘J’-like curve upwards. The estimates vary, but there is a general consensus that EVs will cut off several million barrels of oil demand in the coming decades. Related: Musk’s Space X: Down But Not Out

Of course, that is far away, but it won’t take much to upend fossil fuel assets. Just look at the extensive damage that small increments of solar and wind are already doing to the finances of major utility companies.

(Click to enlarge)

There are a few other reasons why a Trump presidency may not rescue fossil fuels from a financial squeeze. He won’t be president forever, so a future president could kick start climate action once he leaves office. More to the point, future policy is uncertain, and a sudden natural disaster could focus minds and force an abrupt shift in taxation or regulation. Paul Fisher warned that there is a chance of a “system-wide repricing of assets happening quite suddenly."

“Climate change is a genuine investment risk,” Andrew Gray said at a Citigroup Inc. conference in Sydney in October.

One example of a shift in policy is the Obama administration’s sudden decision to ban offshore drilling in the Arctic and parts of the Atlantic Ocean. The announcement on December 20 was made in conjunction with the Canadian government, which also placed the Arctic off limits. The U.S. Arctic is thought to hold nearly 30 billion barrels of oil and it was not too long ago that Royal Dutch Shell was drilling an exploration well in the Chukchi Sea and several major oil companies were gearing up for seismic testing in the Atlantic. Now those reserves are off limits. Obama’s move apparently cannot be undone by the next administration – it is a permanent ban that could only be reversed by an act of Congress. Of course, that is possible with Republicans in control, but the point is that policy changes can occur suddenly.

The investigation by the U.S. SEC into ExxonMobil is also illustrative. Federal regulators, along with several state attorneys general, are trying to figure out if the company is misleading shareholders about the company’s value. The allegation is that Exxon understands the ramifications of climate change and the inevitable restrictions on future extraction, but is misleading shareholders into thinking that all of the oil and gas reserves on its books will be produced. If that is not the case, then Exxon is a much less valuable company than the markets currently believe. It could be a blockbuster investigation, but it could also go nowhere in the Trump administration. Rex Tillerson’s nomination to the State Department is the cherry on top for the company as it enjoys a new dawn in America. Related: Why Oil Markets Don’t Have To Worry About Libya

The threat of a financial crisis from climate policy has grown in salience and credibility in just the past few years, but it is also built on a lot of assumptions. Dismissing the theory earlier this month in the pages of the Wall Street Journal was Daniel Yergin, a notable oil historian and Vice Chairman of IHS. He points to several pieces of evidence about why the link between climate policy and a financial crisis is just “babble.” First, he notes, most of the value of an oil company comes from “proved reserves,” which are projects that will come to fruition within the next decade or so, which offers some degree of certainty about their ability to reach completion. More importantly, Yergin argues, the industry has gone through a significant “stress-test” over the past two years with the collapse of oil prices, which erased $1.4 trillion off the books of 82 global oil companies. That did not spark a financial crisis, and since climate policy will be more gradual, there is little reason to worry.

That may be true, but the effects of climate change will only grow stronger over time. It is hard to imagine governments sitting idle while that happens. Even the most bullish oil driller recognizes that cleaner technologies will eventually take over. The debate is about when, not if. A gradual shift could avoid a financial crisis, but it is hard to avoid the conclusion that there will be substantial financial turmoil in the energy industry in the years ahead.

By Nick Cunningham of Oilprice.com

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  • Dan on December 22 2016 said:
    A record year for solar is still not that much. Let's watch the SEC investigation of Exxon after Jan.21st. Some govmint people gunna need new jobs.

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