JIM KRANE, Baker Institute for Public Policy
HOUSTON -- Fossil fuels are responsible for two-thirds of the world’s emissions of greenhouse gases. These same fuels also represent the economic mainstay of resource-rich countries (e.g., Saudi Arabia, Russia) and the world’s largest firms (e.g., ExxonMobil, Chevron). Any steps humanity takes to reduce climate warming emissions will damage commercial opportunities. In other words, relief for the climate means danger for the fossil fuels business. By Citicorp’s estimate, large-scale resource abandonment translates into an eye-watering $100 trillion in foregone fossil fuel revenues by 2050.
For the industry, a new set of risks has come to the fore. These range from legal and shareholder actions pertaining to big international oil companies (IOCs), government moves to block export pipelines, and assessments that divide fossil fuel reserves into usable and “stranded” portions.
At the other end of the spectrum, the natural gas industry has benefited from climate action. Lower-carbon gas is widely accepted as a preferential replacement for coal and a “bridge” toward decarbonized electricity markets. Decarbonization risks are also higher in the mature OECD economies, where abatement actions and government regulation is more common and robust. In much of the developing world, fossil fuel demand growth remains high. Governments can be expected to insulate state-owned energy businesses from some risks.
A 2016 report from Bloomberg New Energy Finance predicts that demand for all fossil fuels used in power generation will peak by 2025 and fall thereafter, chased out by cheaper wind and solar power with improved battery storage. By the late 2020s, the report argues, it will be cheaper to build and operate a new renewable generation plant than to simply operate an existing coal or gas-fired plant. The crucial element is battery storage, which allows constant output from intermittent generators.
Prominent oil executives have estimated that the world could see total oil demand reach its zenith by 2025 or 2030. McKinsey predicts that oil demand for transportation will peak by 2025, while its use as a petrochemical feedstock will allow overall demand to increase slowly until 2050.
Other forecasts predict that global oil demand will continue to grow beyond 2040, as developing countries grow wealthier and alternatives like biofuels and electric vehicles will have either proven disappointing or unable to grow at sufficient scale.29 While oil will inevitably peak at some point, most forecasts find that demand will tail off gradually, requiring companies to continue producing for decades.
Divestment participants are among the largest institutional investors in the world, including, ironically, funds responsible for investing fossil fuel profits. The Norwegian Government Pension Fund, the world’s largest hydrocarbon-based sovereign wealth fund with some $900 billion in assets, decided in 2015 to divest from companies that received more than 30 percent of their revenues from coal. The Rockefeller Brothers Fund, based on the Standard Oil fortune, pledged in 2014 to eliminate its exposure to coal and Canadian tar sands while examining the possibility of further fossil fuel divestment in coming years.
Climate threats to gas businesses appear further afield, given the fuel’s reduced carbon content. In fact, many anti-carbon policies that would damage coal would benefit gas, whether carbon taxes, cap-and-trade schemes, or other restrictions. Oil, by contrast, is insulated by its unique and valuable role in transportation. That doesn’t mean oil firms will be unaffected. Expectations of escalating restrictions encourage increases in current production.
Environmental regulation could, through the “green paradox,” lead to lower oil prices, increased demand, and a gain in market share by low-cost producers like Saudi Arabia at the expense of higher cost ones like those in North America. Since upstream oil investments are typically based on 20- or 30-year time horizons, one must accept the possibility that financial returns will be affected by climate action.
IOCs may weather the climate storm more deftly than fossil fuel-dependent producer countries. Nimble companies can modify their business lines. Just as IBM has shifted from computer hardware to business services, IOCs are shifting their businesses. Shell’s acquisition of BG emphasizes a shift from upstream oil toward natural gas. Total has made a big bet on renewables and battery storage. Arguably, countries with ingrained political structures based on oil exports will have a harder time adapting.
It is clear that carbon-based businesses face increasing impediments to the consumption of their products. Whether through taxes, legal restrictions, moral arguments, favoritism for competitors, or hampered access to financial markets, the industry faces a future that is less accepting of its current practices. Some businesses will not survive. For others, the risks warrant changes in strategic direction.
Extracted from Krane, Jim: “Climate Risk and the Fossil Fuel Industry: Two Feet High and Rising,” working paper published by Rice University’s Baker Institute for Public Policy, August 2016.