We need to shift investment from fossil fuels to other climate-friendly energy sources, but it must be done more intelligently than we’re doing it today, says Schalk Cloete. The rapid global economic development needed to uplift the 86% of the world’s population currently living below $1,000/month is inextricably linked to the continued and timely growth in an abundant supply of affordable energy. It would be unjust – and probably futile – to stand in the way. Right now, fossil fuels deliver that. But campaigning for divestment in fossil fuels is squeezing supply, raising prices on these essential commodities, and therefore doing little more than transferring wealth from importers (i.e. most countries, including the developing ones) to exporters. Far better to allow continued investment in fossil production to increase supply and get the market price down. Meanwhile, squeeze consumption with carbon taxes which governments collect and can use on their own nation’s economic uplift and energy transitions. This way, fossil prices become affordable, economic development continues and transitions get funded. In short, promote fossil supply surpluses, squeeze demand, says Cloete. He lays out the argument in depth, ranging across the whole value chain.
This article will make one simple point: Fossil fuel divestment is akin to imposing a large (and very poorly structured) global carbon tax on ourselves and paying all the proceeds to stakeholders in the fossil fuel industry.
Put another way, the inevitable energy price shocks resulting from indiscriminate fossil fuel divestment create a huge wealth transfer from developing world citizens with tiny carbon footprints to oil oligarchs with massive footprints (and sometimes ominous geopolitical aspirations). Obviously, that’s the complete opposite of what we want to be doing.
In the following sections, I’ll unpack how we got here, why fossil fuels are demonstrating such incredible staying power, how high fossil fuel prices damage economic upliftment, and what we can do to rectify this broken system. Let’s kick things off with the fundamental reason why fossil fuel divestment was always going to create more problems than it solves.
Complete and utter dependence
Take a look around you. Most likely, every man-made object you see has fossil fuels intricately woven into nearly every part of its value chain.
Let’s take the ~60 tons of concrete in your home as an example. First, limestone is mined using massive fossil-fuelled mining equipment and transported to the cement plant using fossil-fuelled heavy-duty trucks. Once there, it is calcined at extreme temperatures in an enormous rotary kiln by burning coal that was mined and transported in a similar manner. The resulting cement clinker is crushed, blended with additives, bagged, and transported to distribution centres using more fossil-powered machines. Finally, the end-user consumes even more fossil fuels in the transportation, mixing, and use of the cement to build your house. To further complicate this fossil web, every piece of equipment and every worker along this value chain features a similarly complex chain of fossil fuel dependences.
One can tell a similar story for almost anything else, whether it’s the food we eat, the cars we drive (electric or not), the clothes we wear, the mountains of cheap stuff we import from Asia, or the device you’re using right now.
In short, the lives of almost the entire 8 billion strong population of planet Earth depend entirely on fossil fuels. If the fossil fuel industry was to vanish tomorrow, most of us would probably be dead by the end of the year.
Why is this important? Well, if you divest from a certain commodity, it will become harder to produce, and supply growth would slow. However, if all our livelihoods depend on this commodity, all that will happen is a massive rise in prices (extreme price inelasticity is the technical term). And that’s exactly what we’ve experienced in the Covid recovery period.
Clean energy is no exception
In the long run, it’s certainly possible (and necessary) to reduce our fossil fuel dependence by developing, scaling up, and deploying a long list of more sustainable alternatives. But here we encounter our first great irony: to accelerate our transition away from fossil fuels, we need the fossil fuel industry to be at its very best.
Indeed, high fossil fuel prices caused by the divestment movement also make clean energy substantially more expensive. Like the example of your house given earlier, wind turbines, solar panels, and electric cars have fossil fuels interwoven all across their value chains. If just one element of that value chain gets disrupted, prices rise and progress slows.
For example, the current commodity supply crunch, caused by a lack of investment in several dirty and energy-intensive industries, is projected to add about $100 billion to the cost of wind and solar deployments over the next three years (below) and hamper the rollout of solar PV. These numbers are from November 2021 and have probably grown rapidly since.
Electric vehicles face a similar dilemma. 2022 will see large battery price inflation due to huge price gains in a broad range of battery materials. Similar to wind and solar, this cost inflation is expected to last until 2024. For some perspective, I estimated previously that the current material price spike in electric cars is equivalent to absorbing a 50 $/barrel oil price spike for 20 years in a hybrid car. Furthermore, electric cars will remain dependent on fossil fuels for many decades into the future, both for their manufacturing and to ensure a reliable electricity supply for charging.
Cheap fossil fuels are needed to prioritise the transition
As enthusiastically as green activists claim the opposite, moving away from fossil fuels is uneconomical (otherwise it would happen naturally without the need for a wide array of clean energy support policies). The appetite for uneconomical investments aimed at mitigating long-term climate damages on the opposite side of the world naturally declines when times are tough. And a global pandemic followed by a tripling in the price of the commodities our lives depend on certainly signals tough times, pushing the energy transition down the policy agenda.
Despite all the political rhetoric to the contrary, this simple truth is playing out once more. In 2020, the IEA hopefully laid out its “sustainable recovery plan” that calls for more stimulus spending to be directed toward clean energy incentives. Unfortunately, recently released emissions data for 2021 shows that CO2 emissions rebounded even above the projection with no effect from sustainable recovery plans to set a new all-time high. Only about 40% of the IEA’s recommended recovery spending was mobilised.
All in all, clean energy is just as dependent on fossil fuels as any other economic sector. Even if we ignore all the other much more serious socio-economic consequences of high fossil fuel prices, the divestment movement is hurting the energy transition more than it helps.
Slowly breaking our addiction…
The motivation behind the fossil fuel divestment movement is noble: We need to shift investment from dirty fossil fuels to cleaner and more sustainable sources, thereby breaking our addiction. Unfortunately, it’s not quite that simple, especially for the #1 fossil fuel…
The big hope for breaking our oil dependence is transport electrification. Sadly, the potential for electric vehicles to displace oil consumption is quite limited. As illustrated below, even in the unlikely Sustainable Development Scenario, transport electrification will only displace about 3% of global oil demand by 2030 (while increasing electricity demand by 3%).
BNEF’s optimistic view of electric vehicle adoption pegs the amount of oil displaced by the year 2050 to only about one-fifth of the current demand. In exchange, electricity consumption will rise by one-fifth of today’s demand. Accounting for the Jevons paradox, electricity demand will probably rise considerably more. More importantly, had BNEF accounted for all the extra embodied energy in EV manufacturing, they would have found a much larger consumption of all fossil fuels associated with their envisioned EV revolution.
I’ve recently covered the main problems of deploying battery-electric vehicles on the scale projected by BNEF, and the list is intimidating. Furthermore, as a subsequent article illustrates, all the electric SUVs incentivised by current policy frameworks cannot solve any of the environmental, supply security, or sustainability challenges of conventional vehicles.
…Natural gas and coal
Our dependence on natural gas and coal will not be much easier to break. We’re slowly and reluctantly realising that these concentrated sources of inherently stored energy will be required for power system reliability for decades to come. The EU is even classifying natural gas as green — a stance that became even more complicated with the tragedies now unfolding in Ukraine. In developing Asia, the region that will drive future energy and climate trends more than any other, coal will continue to play a similar role.
More importantly, similar to oil, coal and natural gas are used in many industrial processes that are very difficult to decarbonise. Cement is one example, with other sectors like steel and a wide range of other metals, petrochemicals, and ceramics also consuming vast quantities of fossil fuels. This is a decisive issue because over six billion world citizens remain below decent living standards, and almost all future population growth will happen within this major segment of the global population.
The developing world
A critical fact that all too few rich-world citizens appreciate is that most of the world still needs to be built. And fossil-intensive primary material industries are central to this massive global construction effort. It’s only natural for developing world citizens (half of whom consume less than 5% of what the typical rich-world citizen consumes) to keep striving for increased living standards. This trend guarantees continued growth in industrial fossil fuel demand as well as a wide array of oil-driven long-distance and heavy-duty freight associated with this massive global construction effort.
The obvious result is that fossil fuels continue to demonstrate tremendous staying power despite massive global pressures to decarbonise. When the IEA buckled under all the green pressure and released their mandatory net-zero by 2050 scenario, the Saudi energy minister famously dubbed it as the sequel to La-La Land. He wasn’t wrong.
Slow and steady wins the race
In the long run, we obviously need to get off fossil fuels, given that their supply is finite. However, there are sufficient proven reserves of fossil fuels (BP data) to consume the two-degree carbon budget four times over. We’re also continuously finding more, given that ultimately recoverable resources are multiple times larger than proven reserves. For example, proven oil and gas reserves have increased by about a third since the start of this century (BP data), although fossil fuel divestment is now slowing reserve growth.
The abundance of remaining fossil fuel resources has an important implication: the problems of climate change and fossil fuel dependence are unrelated. We have more than enough fossil energy left to uplift billions of developing world citizens to decent living standards, develop socio-techno-economically viable sustainable energy technologies, and evolve our culture beyond today’s primitive paradigm of fruitlessly chasing happiness through wasteful consumption (the hedonic treadmill).
During this vital transition period, a fair price on CO2 is all that’s needed to correctly deploy currently available technologies to balance economic development and climate change mitigation. We’ll come back to this critical point in the final section of this article. But first, some more evidence of just how valuable fossil fuels are to society.
Crazy fossil fuel profits
So, how valuable are fossil fuels, really? Well, the fossil fuel divestment movement combined with the rapid demand recovery after the pandemic is giving us a pretty good idea. Despite the vital rise of remote work during the pandemic, oil was approaching $100 a barrel even before the Ukraine invasion and now resides at even higher levels. Over here in Europe, natural gas is now far more valuable than oil. Without large Russian imports, we simply can’t keep our lights on or keep our houses warm. Even coal has seen a massive jump in price since the economy reopened. And despite all these massive price hikes, demand remains robust.
Fossil fuel “subsidies”
Green advocates often downplay the value of fossil fuels, even claiming that they require massive subsidisation to stay competitive. Well, that’s simply untrue. Unlike wind and solar electricity, fossil fuels are easy to store and trade internationally. For that reason, global prices are set by the most expensive global producer, especially for oil which is extremely cheap to distribute internationally. That means market prices are generally far above the average cost for producing a barrel of oil.
Yes, fossil fuels in developing nations are often sold below this highly inflated market price, shielding low-income consumers from the worst effects of sharp price fluctuations. However, sales prices are very rarely below the cost of production (as opposed to wind, solar, and electric cars).
Fossil fuels subsidise governments, not the other way round
The following graph shows the evolution of oil, gas, and coal rents over time. Resource rents are the difference between sales revenues at market prices and the cost at which the resource can be profitably produced. Profitable production implies an attractive annualised rate of return on capital invested, usually about 8%. Clearly, resource rents from fossil fuels far outweigh the subsidies shown in the previous graph.
Fossil resource rents will likely set large new records over the next couple of years, partly thanks to fossil fuel divestment. To illustrate the scale of these surpluses, let’s think of the oil industry as a giant company with profits equal to the resource rent. It looks like $100 oil will be with us for a while even though profitable production costs only $23 per barrel. The result is a crazy profit margin of more than 300%. Very few other industries can deliver such margins and none come anywhere close to doing it on this tremendous scale.
And oil’s generous bounty doesn’t stop there. The average OECD excise tax on gasoline is 2.24 $/gallon, which works out to almost $100 per barrel of oil. The excise tax is similar in India and about half this amount in China. About 60% of global oil goes to transport fuels, which adds about $1.1 trillion to state coffers if we assume an average global excise tax of 50 $/barrel.
Ignoring excise taxes, the graph below compares the profit from oil production to that of all clean energy companies worldwide. It’s a total mismatch: Oil profits at $100 per barrel outweigh clean energy profits by two orders of magnitude.
Even so, green policies and activist investors have ensured that annual spending on renewable power now exceeds spending on upstream oil & gas (below). While such a shift is necessary, we should be very careful not to force it too aggressively. Regardless of how inconvenient it may be, we must recognise how much more economically efficient fossil fuels are than renewables. Obviously, it’s much easier to uplift 6 billion people to decent living standards using energy that remains in high demand at a 300% profit margin than on energy that only manages a 5% profit margin with the help of generous support policies.
The resource curse
Part of the reason for nearly $3 trillion in global oil profits is that the oil industry was forced to become much more efficient by the oil price slump in 2014. This efficiency gain is great news for the global economy, but it will quickly be undone if fossil fuel prices stay at today’s levels.
If the divestment movement keeps fossil fuel prices high, the industry will once more get complacent and average production costs will rise. This benefits no one, not even fossil fuel exporters. Take Russia and several OPEC nations as an example. Over the past two decades, these nations have had the potential to rake in up to 10x their GDP in surpluses from their oil riches. Yet, the level of human development in these countries is mediocre at best (UAE is ranked best with a HDI similar to countries with half its GDP per capita).
Indeed, the “resource curse” is very real with Venezuela being the most prominent example and Norway being pretty much the only exception. Indeed, getting life handed to us on a silver platter does more harm than good, whether we’re an individual or a country.
Hence, it’s in everyone’s best interest to force the oil & gas industry to tap every last bit of its ingenuity to reduce production costs. And the only way to do that is to actively encourage the supply surpluses needed to bring prices way down. As discussed later, fossil fuel consumption should instead be controlled from the demand side, mainly via CO2 taxes.
This is diametrically opposed to the goal of the divestment movement which is all about obstructing fossil fuel supply. Given the damage done by high fossil fuel prices, it’s a good thing that this misguided movement has limited power.
The limited reach of the Divestment Movement
Activist investors mostly take aim at “Big Oil,” especially in Europe, forcing firms like BP, Shell, and Total (now TotalEnergies) to shift investment from oil & gas exploration to renewables. While this sounds like a victory for green activists, the reality is not quite that simple.
…because Big Oil is actually pretty small
The companies collectively known as Big Oil are surprisingly small when viewed in the global oil picture. As illustrated below, these companies produce only a tenth of global oil. A much larger fraction is controlled by state-owned companies in energy-exporting nations. In these countries, socio-economic welfare is inextricably coupled to oil profits, so the likelihood of aggressive fossil fuel divestment there is next to nothing. Thus, pressuring Big Oil to rapidly reduce oil & gas production will do little other than massively increase the wealth transfer from oil importers to oil exporters.
My home country, Norway, gives an illuminating example. On the one hand, we’re virtue-signalling like never before, not only via our incredibly cost-ineffective electric car revolution but also by moving the massive Norwegian oil fund out of fossil fuels. Ironically, this is tremendously profitable for Norway’s fossil fuel sector. Our divestments are helping to drive up fossil fuel prices while we continue to pump oil and gas at maximum rates, deriving extreme profits from the current situation in Europe. At the moment, oil and gas sales are producing profits in Norway to the tune of $20,000 per person per year.
Of course, Norway is a small player in the global oil and gas market, responsible for only about 2.5% of global output. As illustrated earlier, the amount of money flowing into places like the Middle East and Russia is far greater. Activist investors putting pressure on Big Oil will do little but shower these oft-questionable regimes with more money than ever before.
Private equity steps in when Big Oil divests
When there are such incredible amounts of money to be made, people will always pursue it, regardless of political pressures. The Economist and DW have recently started picking up on this with some good reporting on how less publicly scrutinised companies are making huge returns by taking over assets sold by Big Oil in their attempt to satisfy activist investors.
So yes, activist investing is making it harder for companies to drill for oil and gas, but when the inevitable price rises occur, the drilling will continue. Just as well; if the divestment movement had its way, 200 $/barrel oil would be upon us in no time (even without Putin’s help), further augmenting the already enormous societal costs.
The social cost of fossil fuel divestment
As already established, the large price gains resulting from fossil fuel divestment are causing a huge wealth transfer from importers to exporters. Sadly, highly populous developing regions stand for a large fraction of these imports, especially in Asia. Economic growth in these regions is driving tremendous gains in human welfare, and the need to pay double or triple for imported energy slows this development at a tremendous social cost.
Let’s take India as an example. As illustrated below, India currently has to pay a massive 7.7% of its GDP for the fossil fuel imports it needs to continue uplifting its citizens. Over half of that is due to unnecessarily high international prices caused by insufficient fossil fuel supply.
Put bluntly, the population of India, where the average person consumes 10x less than the average American, needs to pay an extra 4.1% of their total productive output to finance wasteful spending in oil-exporting regions. Most Indians need 100% of their output just to afford the most basic of lifestyles, so this is a huge burden, equal to well over half the economic growth rate in recent years.
This tremendous economic inefficiency has long-lasting effects. India now has to pay for things like Putin’s war and a whole herd of white elephants in Middle Eastern deserts instead of building decent housing, roads, schools, hospitals, business districts, and all the other things we in the rich world take for granted. The opportunity costs of such lost investments in life-enhancing infrastructure year after year quickly accumulate and persist for decades. As a result, the true burden of high fossil fuel prices in developing energy-importing nations can easily exceed 10x the direct cost of more expensive fuel.
The Obvious Solution
This finally brings us back to the first paragraph of this article. Yes, divestment will help to reduce fossil fuel demand by increasing prices, similar to imposing a carbon tax. But the outlandish profits generated by these high prices all end up in the pockets of fossil fuel producers at a tremendous societal cost, especially in energy-importing developing nations.
The solution? Impose a proper carbon tax and stop obstructing fossil fuel investment. Such measures will keep international market prices low by raising supply and limiting demand, thereby minimising highly inefficient wealth transfers and forcing producers to maximize efficiency.
Carbon Tax: an infinitely more beneficial wealth transfer
A carbon tax also creates a wealth transfer, but an infinitely more economically beneficial one than fossil fuel divestment. Whereas divestment transfers wealth from poor world citizens with tiny carbon footprints to oil oligarchs with massive footprints, high carbon taxes transfer wealth from people with excessive carbon footprints to people with smaller footprints within each country.
It’s important to note that the net cost of a carbon tax is close to zero until a substantial amount of more costly clean energy is built. Up to that point, its only effect is the abovementioned wealth transfer that leverages the full capacity of the free market to reduce CO2 emissions.
Far better market stability and efficiency
Furthermore, a carbon tax on top of a well-supplied fossil fuel market will increase prices in a much more predictable, efficient, and controllable manner.
In contrast, excessive market prices from a self-imposed undersupply can cause serious and long-lasting instability. For example, we could see an economic contraction due to energy scarcity just when new supply finally comes online, leading to a subsequent price slump causing another phase of underinvestment and disrepair, starting the cycle all over again.
Another key difference is that a CO2 tax will raise end-user prices in proportion to carbon intensity instead of the random price jumps in different fuels caused by the divestment movement, making it more effective at reducing CO2 emissions.
Getting off the train to La-La Land
A carbon tax may be politically challenging to implement, but the measures we’re implementing today (largely green technology-forcing policies and fossil fuel divestment) are so expensive and inefficient at reducing CO2 emissions that we really need to do something else.
Surely, if all sustainability activists stop fighting over their pet decarbonisation solutions/pathways and instead unanimously call for a carbon tax, it will happen. Until that glorious day comes, net-zero by 2050 (or 2100 for that matter) will remain in La-La Land, and fossil fuel producers will continue laughing all the way to the bank.
Reducing fossil fuel investment the right way
In conclusion, it’s undeniable that we need to shift investment from fossil fuels to other energy sources, but we need to do it much more intelligently than we’re doing today. The correct reason for fossil fuel investments to fall should be because current and expected market prices are so low that most investments are unattractive, not because developers are forced to struggle to secure capital even when prices are sky-high.
The rapid global economic development required to uplift the 86% of world citizens currently living below 1,000 $/month is inextricably linked to continued growth in an abundant supply of affordable energy. If the energy transition is going to make energy scarce and expensive, it will be a great humanitarian failure. We cannot let that happen.
Schalk Cloete is a research scientist studying different pathways for decoupling economic development from emissions and environmental degradation
This article is published with permission