The divestment campaign being waged by environmental groups – and an increasing number of well -credentialed financial analysts – is clearly getting under the skin of Big Oil.
In the past month, two of the biggest listed oil majors, Shell and ExxonMobil, have protested to shareholders that the carbon bubble scenarios and the concept of stranded assets is overdone. There is, they insist, nothing to fear except binding and ambitious climate agreements. And they don’t see much chance of that.
They have reason to want to downplay the concept of a carbon bubble. Recent analysis suggests that $30 trillion of fossil-fuel revenues might be at risk in a world that takes climate action seriously and seeks to limit greenhouse levels at 450 parts per million, much of this in the oil industry.
Mark Fulton last week, in his piece “Trillion dollar question, is Big Oil over investing in high-cost projects” questioned the rationale behind investing one trillion dollars in new oil reserves, many of which may never be economic. Not only are costs of extraction rising, but the cost of competing renewable energy technologies is falling.
Investment bank Alliance Bernstein suggested last month that the falling cost of renewables, in particular solar, could lead to energy price deflation within a decade. Even a hint of that eventuating could cause a massive rethink from investors that would impact capital flows.
In their letters to shareholders, and in response to pressure from certain investors, Shell and ExxonMobil have made it clear that they are staking their economic future on the idea that that global climate policy might never be tightened in a way that may cause their assets to be stranded.
They are doing this in much the same way that the Abbott government in Australia is committing its economic future to the assumption of everlasting demand for its fossil fuels. All these parties are assuming that the current pattern of fossil fuel energy demand will not be threatened for several decades.
An important new analysis from Mark Lewis, from Paris-based Kepler Chevereux, highlights the paucity of these arguments.
“Shell’s approach to stranded-asset risk looks naïvely binary, complacent, and defensive,” he writes.
“Shell is starting from the premise that the sheer weight of the incumbent global energy system, the need to meet growing energy demand in the developing world, and the political difficulty of reaching a deal mean that such a deal simply cannot and will not happen within a timeframe that would pose a risk of asset stranding either to Shell’s broader resource portfolio or its ongoing exploration capex.”
That is wrong, Lewis says. It’s not just the prospect of falling oil prices induced by a structural fall in demand resulting from tighter climate policy. Lewis argues that the stranded-asset risk also exists under a scenario of elevated and even rising oil prices, because the costs of new developments are likely to rise even further.
The cost curves of renewables, on the other hand, has been falling sharply, and can be expected to continue falling over coming decades.
“This means that if oil prices continue to rise in future – and like Shell, we think this is the most likely scenario – then such a divergent cost dynamic will in our view only accelerate the move away from oil and towards renewables in the global energy mix,” Lewis writes.
“In turn, this will create the risk of stranded assets for those oil companies that are in denial about the ongoing transformation of the global energy system.”
Lewis also points to the experience of utilities in Germany and other EU countries , who have been “disintermediated” by renewables over the last decade. RWE, for instance, has now admitted it should have invested more in renewables, rather than fighting them. “This should be seen as a cautionary tale for the oil majors,” Lewis suggests.
Lewis further takes both Shell and ExxonMobil to task for being reluctant to acknowledge that there is even a debate to be had on the subject of carbon risk, when “they could be taking the opportunity to engage with investors on this topic and to start recalibrating their business model away from high-cost oil projects towards the renewable energies of the future.”
He continues: “Indeed, Shell’s letter looks to us to be designed more in order to close debate down rather than open it up, and as far as we can see offers no prospect of an ongoing dialogue with investors on stranded-asset risk.
“On the contrary from the tone of this letter Shell gives the impression that it has now said all that it thinks needs to be said and that it will now clam up on this subject.”
