Climate campaigners have a new weapon in their arsenal: they say that if shareholders want value for money they had better start questioning the high-risk, high-cost projects oil companies are undertaking on a massive scale. And not just because of climate risks, but for purely economic reasons as well. The Carbon Tracker Initiative, which first put the idea of ‘stranded assets’ on the map (i.e. the notion that a large part of the fossil fuel reserves in the world can never be produced because of the climate risks), argues in a new path-breaking report that climate aside, investments in the Arctic, oil sands, deepwater, and so on, make no economic sense either, as they are increasingly based on oil prices that may not hold up in the future.
It’s a clever idea: people who care about climate change today argue that you don’t need to care about climate change to conclude that big oil companies are taking unacceptable financial risks by pursuing difficult, expensive projects – that also emit large amounts of greenhouse gases. “Many oil projects today make neither economic nor climate sense,” according to the latest report from the Carbon Tracker Initiative, a group of financial specialists who want to make carbon-related risks tangible in financial markets. “There is a clear alignment between high cost and excess carbon.”
After introducing the idea of stranded assets and wasted capital – arguing that in a carbon-constrained world most fossil fuel reserves are ultimately worthless – the Carbon Tracker team has now tried to pinpoint exactly which companies and which projects are most at risk and why this is true for economic as well as climate reasons. “Carbon supply cost curves: Evaluating financial risk to oil capital expenditures” is the first of a trio of reports which will tackle the oil, coal (due in September) and gas (due in December) industries in turn. The oil sector is responsible for about 40% of energy-related emissions.
The argument is simple: demand, and with it oil prices, may not be as high as many oil companies expect in future. This puts pressure on margins – and dividends for shareholders – especially as these companies have been spending more and finding less. Capital expenditure by the largest oil companies today is five times that in 2000, say the authors, yet production has barely increased. The productivity problem has been hidden by an oil price that has quadrupled over the same period.
Will it continue to go up in future? No one knows of course, but price is a factor of supply and demand. “We now see the possibility that future demand for fossil fuels may not be as robust as the industry is planning for – certainly for coal and possibly for oil – even in the absence of strong international policy action on climate change,” said Ryan Salmon, oil and gas manager at Ceres, a not-for-profit sustainable investment campaign group based in the US, in an interview earlier this year.
“Financial regulators are applying stress tests to the banking sector to understand the resilience of each organisation. This is not determined by how likely the banks or the regulators consider the scenario to be. In the last decade the Brent oil price has been below US$50/bbl for two periods in 2008/9 and in 2004. It does not seem unreasonable to stress test against oil prices that range from this up to the current level.”
-Carbon Tracker Initiative
Many factors shape demand for oil besides international climate policy. For one, national, regional and even local climate policies can have an impact. Two, there are air pollution concerns. These are fuelling the substitution of coal in China for example (see our interview with Chinese Professor Qi). Three, speaking of China, there is a real chance that the country’s economic growth will slow. Four, we see more and more improvements in end-use efficiency, through fuel economy standards for cars for example. Fifth, gas is an increasingly interesting substitute for oil in the chemicals industry and transport. And then we haven’t even touched on electrification and the fast growth of renewable energy!
The oil companies, in contrast, point to expanding economies and rising living standards to explain upward projections for demand. “All of ExxonMobil’s current hydrocarbon reserves will be needed, along with substantial future industry investments, to address global energy needs,” said William Colton, ExxonMobil’s vice president for corporate strategic planning in a press release on 31 March, when the company published two reports for shareholders on how it is managing climate risk.
“Exxon have come clean that they are betting on 6 degrees of warming,” responded Anthony Hobley, Carbon Tracker’s CEO. “Investors need to take action.” ExxonMobil released its reports on the same day that the Intergovernmental Panel on Climate Change (IPCC) released its latest analysis on the impacts of climate change.
On the supply side, the Carbon Tracker team points to oil companies’ increasing exposure to unconventional sources and extreme physical environments – oil sands, shale oil, the Arctic and deepwater drilling – and warns that these can impose higher technical, legal and regulatory costs on exploration and production.
However, other experts, such as Professor Samuele Furfari, author of a new book Vive les energies fossiles, point out that fossil fuels have never been as abundant as today. “After a few years on standby, upstream oil projects have multiplied, investments are ongoing and the results are about to appear one after the other,” writes Furfari. But he warns that demand will not follow, citing the reasons detailed above. “It is reasonable to expect to return towards more reasonable prices of around US$70 per barrel, or even less,” Furfari says.
And this is the crux of the problem. The Carbon Tracker team calculates that private companies are planning up-front investments of about US$21 trillion between now and 2050 in projects that require a market price of at least US$95 per barrel to break even. According to Goldman Sachs, in the last two years, no major new project came on-stream at a price below US$70 per barrel and most were in the US$80-100 per barrel range.
“This report bridges the worlds of oil project economics… and carbon, allowing investors to gauge where risk lies, given a range of demand scenarios. It makes it clear that investors have reason to engage companies on many high cost and high carbon content projects.”
-Mark Fulton, advisor to the Carbon Tracker Initiative and former Head of Research at Deutsche Bank Climate Advisors
“If oil companies are to create optimum value for shareholders they need to focus on doing lower cost, lower risk projects which give better returns,” the Carbon Tracker authors conclude. The oil majors typically have project portfolios that contain these kinds of projects (the risky stuff makes up just a quarter of their total capital expenditure). The authors urge investors to engage with private oil firms on an estimated US$1.1 trillion due to go to the “highest cost, highest risk opportunities” (i.e. requiring a price of over U$95) over the next ten years. Nearly 40% of this sum is due to go to oil sands in Alberta, Canada. Next up are shale oil and tights liquids on the US Gulf Coast and deepwater exploration in the Gulf of Mexico. There are some expensive conventional projects lined up too in Western Siberia and the Caspian Sea.
The private sector – where shareholders have a voice – has a larger role in the future of oil production than reserves data suggest. Private companies are responsible for over half of potential production from now to 2050, according to the Carbon Tracker Initiative. Less than 35% is in fully state-owned hands.
Most exposed to high-risk, high-cost projects are small, independent operators that have specialised in exactly these. Least exposed are state-owned operators and OPEC. The report provides a list of absolute and relative exposure by oil type (e.g. Arctic or shale) per company. Peruse these at your leisure. It then tallies them all up to arrive at an overall risk-list, again expressed in absolute and relative terms. In absolute terms, the names are familiar: 1) Petrobras 2) ExxonMobil 3) Rosneft 4) Shell 5) Total 6) Chevron 7) BP 8) Gazprom 9) Statoil and 10) CNRL (Canadian Natural Resources Limited).
Last autumn, Ceres orchestrated a series of letters from investors representing US$3 trillion in assets to the world’s top 45 oil, gas, coal and power companies asking them to report on their exposure to climate policies and impacts. Companies are engaging, it says.
We need a refocus on shareholder value instead of a pursuit of production volume. Practically, that could see returns to investors though buy-backs and dividends, rather than investments in high-cost oil exploration.
-Carbon Tracker Initiative
At the same time, a bottom-up divestment movement is sweeping across the world. Stanford University became the latest headline on 6 May, when it announced it would no longer invest any of its US$18.7 billion endowment in coal mining. This made it the first major university to lend support to a nationwide divestment campaign in the US, reported the New York Times. The campaign is embodied by 350.org, now international, which says it is working to create political, economic and social space for low-carbon legislation.
Money divested from carbon-intensive fossil fuels will not necessarily flow into efficiency or renewables of course. This is where policymakers have a job to do to create new, green investment opportunities. These are starting to emerge – the market for climate bonds has exploded in the past year, says Sean Kidney, CEO of the Climate Bonds Initiative for example – but it is early stages yet. Green investments can be fully competitive with mainstream investments: Green Century Capital Management in the US has a fossil fuel-free Balanced Fund which outperformed the mainstream market over five years at the end of 2013, for example. In practice, the differences that occur with the mainstream market can often be attributed to the price of oil.
For many investors, climate change is not a priority. The beauty of this new report, from the perspective of the authors, is that it doesn’t need to be to trigger investor action that will benefit climate change.
The activists at Carbon Tracker believe long-term investors will play a crucial role in redirecting the financial system towards funding long-term infrastructure investments that take us to policy goals such as a low-carbon economy. Investors may do this not in the name of climate change but because they want reasonable, reliable returns on their investment.
Oil firms meanwhile, are likely to set their sights on gas. We look forward to a future Carbon Tracker report that combines the economics of oil, gas and coal – and makes the link to carbon – to understand where the future of the fossil fuel industry really lies.