Guest post by Tilak Doshi, originally published at Forbes.
Climate change activists have long lobbied for divestment from fossil fuel-producing companies. They have largely failed in this quest. This year, the steep falls in the value of the large oil and gas companies, however, occurred with a rapidity that astonished market watchers. Within weeks, the coronavirus pandemic and the oil market-share battle between Saudi Arabia and Russia launched after the collapse of the OPEC+ talks in early March led to unprecedented falls in Big Oil equity.
The S&P Global Oil Index, measuring the performance of 120 of the largest, publicly-traded companies engaged in oil & gas fell by 45% in the month to March 18th when Brent crude was trading at $25/barrel. ExxonMobil, the bluest of blue chips fell 54% in that period while Shell, another Big Oil bellwether, fell 45%.
In mid-June, BP was among the first of the oil majors to announce its intention to write down the value of its assets by up to $17.5 billion after cutting its long term oil forecast (to 2050) from $70/barrel to $55. This was followed a couple of weeks later by another European oil major, Royal Dutch Shell, which reported its plans to write-down its asset base by $22 billion after a similar lowering of its long term oil price forecast.
Stranded Resources and Climate Change Concerns
The campaign to scare fossil fuel investors about “stranded resources” has followed two tracks. This first argues as to what should be done. Citing “consensus science” (an oxymoron), climate change models purportedly linking carbon dioxide emissions with “climate risk” are used to calculate the necessary cuts in oil, gas and coal production. Hence BlackRock, the world’s largest asset manager warned in 2015 that “the majority of fossil fuel reserves will need to be left in the ground” if global warming is not to exceed 2 degrees C. Along the same lines, consultants for the OECD asserted that “vast quantities of resource reserves will need to remain underground in order to stabilize the climate”.
The second track poses the question of what would likely happen under current trends. In this view, technological progress in energy efficiency and renewable energy combined with climate policies pursued by governments around the world will lead to substantial falls in demand for fossil fuels. A Financial Times column, for instance, pointed out that the pursuit of climate change policies would “evaporate” a third of the current value of the big oil and gas companies. If countries met their Paris Agreement commitments and kept to the “no more than 2o C above pre-industrial levels” target, 50% of all coal, oil and gas resources would be “stranded” and, by definition, have zero value. If the stricter 1.5o C maximum is aimed for, then 80% of the world’s fossil fuels would be stranded.
Why are model-based climate risk “assessments” not reflected in the value of fossil fuel companies? Are those countless investors, big and small and of varying levels of sophistication, who put up risk capital for fossil fuel companies myopic, unaware of the losses they face? One does not need to be a particularly savvy investor to be wary of betting against the large liquid oil, gas and coal markets on the basis of academic climate modellers and the research departments of multilateral agencies such as the OECD or the World Bank prognosticating on long run scenarios.
The events of the past few months show that decades of “consensus science” and anti-fossil fuel campaigning in the boardrooms and shareholder meetings of publicly-listed companies in the US and Europe could not achieve what a ‘black swan’ turn of events has wrought. On 6th March, Russia’s refused to agree with OPEC’s (essentially Saudi-led) proposal to further cut oil production in response to the demand destruction that Covid-19 was expected to cause. Riyadh’s response – steep discounts to their selling prices and intentions to massively increase exports — caused a rout in oil prices. Brent crude fell from around $60/barrel in mid-February to below $20 several weeks later. After the OPEC+ agreement in April that led to unprecedented cutbacks in oil production, prices have stabilized to around $40 – $45/barrel since June.
Fossil fuel divestment campaigners might be elated by the drastic drop in the share prices of the big oil and gas companies. But it was the Wuhan virus rather than the Paris Agreement that caused this. The value of “stranded resources” was defined by the simultaneous demand (the Covid-19 lockdowns) and supply (the Saudi-Russia market-share battle) shocks, not by expert long run climate change forecasters. And it wasn’t divestment but a rapid destruction of value, along with global assets across the board, as the world economy faces a recession this year which is likely to be far worse than the one experienced during the global financial crisis.
Oil and Gas Will Remain Important for Developing Countries
Low oil and gas prices will now be an established feature of global capital markets for some time to come. While the economic impact of the twin shocks in the oil universe have been severe, much depends on how fast the global pandemic is contained. The faster economies re-emerge from the pandemic lockdowns, the quicker and stronger the recovery in oil and gas demand. But whatever the rate of demand recovery for fossil fuels, it won’t change the fact that we live in an age of ample oil (and gas and coal).
In the 5 year period to 2019, developing countries accounted for three quarters of global oil demand growth and the Asian developing countries accounted for over 70%. As the developing world, especially the rapidly-growing populous economies of Asia, emerge out of the coronavirus pandemic lockdowns, access to cheap fossil fuels will be critical over the next few decades. Coal, oil and gas have powered urbanization, industrialization and agricultural productivity, and have led to improvements in the standards of living for the vast majority of the global population.
For the hundreds of millions of people that have newly emerged from poverty in recent decades and are beginning to enjoy the fruits of economic growth and technological progress across Asia, Africa and Latin America – among the greatest achievements in human history – demanding that the global use of fossil fuels be curtailed would be unacceptable. Wishing for a premature end to the Age of Oil (and gas and coal) will do humanity irreparable harm.