By John Richardson
OIL and gas companies might very well find themselves holding on to what Izabella Kaminska of the FT has aptly called “a trove of financially toxic assets” as a result of the growing, and irreversible, consensus that climate change is man-made.
She was basing her phrase on the work of the consultancy, Carbon Tracker, which has coined another useful phrase: “Carbon Bubble”. This refers to all the fossil fuels that are still in the ground that may never be allowed to be extracted and burnt so we can avoid a devastating rise in global temperatures.
Carbon Tracker cleverly frames its work in terms of the potential impact on financial markets, which has, of course, piqued the interest of listed oil and gas companies as well as investors.
The reason is that share prices of energy companies are to large extent valued on the basis of how effectively they can replace their oil and gas reserves. But what if, in the future, the higher the oil and gas reserves a company has, the lower its share price? Or perhaps more likely – and see my comments below about natural gas that fully explain this – the higher a company’s oil reserves are as opposed to those of natural gas, the lower might be its share price.
And, in this context, as Izabella also wrote after the Climate Finance Day that took place in Paris in May:
The big takeaway was consensus is shifting, especially among asset managers and real money investors who no longer view environmental sustainability as a fringe theme. Climate is a bona fide risk for beneficiaries which professional investors must guard against to fulfil their fiduciary duties. To do nothing, essentially, is to encourage a disorderly capital transition and, potentially, a financial panic.
This helps to explain why, at the start of this month, six oil and gas companies – BP, Royal Dutch Shell, Total, Statoi, Eni and the BG Group – sent an open letter to the UN Framework Convention on Climate Change in advance of its meeting in Paris in December of this year.
In the letter, the companies accepted that claims about man-made climate change had not been exaggerated. And more remarkably, they agreed that there was a need for a global carbon tax.
Five years ago no one would have expected the move: as producers of much of the world’s dirty fuels, their industry was disinclined to join forces and advocate accelerating the switch to cleaner ones. “It is a sort of revolution,” says Patrick Pouyanné, the boss of one of the six, Total. As world leaders prepare to meet in Paris in December to produce an agreement on reducing greenhouse-gas emissions, attitudes towards climate change have altered profoundly among businesses of all kinds.
“The cost of not doing things is starting to be higher than the cost of doing them,” says Paul Polman, chief executive of Unilever, an Anglo-Dutch consumer-products maker. “Our motives are not exactly altruistic,” admits another European boss. “Our clients and stakeholders demand such initiatives.”
Along with the financial community dumping oil and gas assets, The Economist identifies two other motives behind the letter from the six energy majors:
- The price of renewable sources of energy—especially solar—has dropped dramatically, and their share in power generation is growing. I would add that if these companies can find out now what carbon taxes they are likely to be paying in the future, they can then cost their business against renewables. This predictability might also accelerate their push away from oil and towards more natural production, given that natural gas, when used in power generation, generates less CO2 emissions than fuel oil and coal. So natural gas may end up carrying a better share-market value, and a lower carbon tax, than oil.
- Consumers care more about climate change than before. Even a majority of Republicans in the US agree that climate change is man-made, according to a recent survey. And, of course, what the public things will be reflected in the actions of investors, leading to a much-higher cost of capital for energy companies if they decide to bury their heads the sand instead of dealing with this issue up front, right now.
When the news of this letter first broke, a lot was made of the fact that all six of these energy companies are European. But I strongly suspect that whilst US energy companies are in more of a difficult political position in speaking out openly on this issue, they must surely be working behind the scenes to the same effect as BP, Shell and Total etc. For the US companies, the risk is that being open about their work in this area could alienate some of their Republican backers.
For the chemicals companies they, too, might find themselves sitting on a trove of financially toxic assets – in other words their share prices will take a parallel hammering. There is no way of escaping this risk as the vast bulk of chemicals will continue to be manufactured from oil, gas, and also coal in China, for the foreseeable future.
The oil, gas and chemicals industries all need to act now if they are is to secure their long-term economic health – as I have been arguing in my special series of posts throughout this week.
Here are the links to my other four posts from this week, in date order, for your reference: