One of the issues regarding energy that often gets missed is the financial implications of the transition away from fossil fuels. With assets worth many trillions of dollars, which a transition away from oil could well render worthless, one has to worry about the economic consequences once the penny drops.
I think the problem is that many people just don’t realise just how fossil fuels, in particular oil, is deeply embedded in the world economy. Just considering the world’s top ten oil companies, they pull in about $3 trillion in revenue each year. If just those ten companies formed their own country, they’d be the 5th largest economy in the world. So a not insignificant amount of the money sloshing around the world’s financial markets is fossil fuel money. Either the profits raked in by oil companies, which they are looking to invest (notably the oil revenue from oil rich states). Or its money that the oil companies are raising in loans (borrowed against their existing oil stocks) to go out and look for more oil.
And to make matters worse, given that fossil fuel’s have traditionally been seen as a “safe” dependable industry, some of the heaviest investors in fossil fuels are usually the very people who can least afford to take losses, pension funds for example.
Then there’s the petrodollar conundrum. American’s economic strength is in part based on the simple fact that oil is traded in dollars. Obviously, we’re doing less trade in oil in the future, suddenly we don’t need as many dollars floating around. The value of US treasury bonds falls out of bed, interest rates go up and the US can’t afford to service its debts anymore. And guess who is the biggest holder of US treasury bonds? Yep, pension funds. So any popping of the carbon bubble might easily spark a serious financial crisis, with pensioners and US pension funds finding themselves at ground zero.
Naturally, taking action on climate change will require that a significant proportion of these trillions worth of fossil fuels will have to get left in the ground. However, even if we ignore climate change, which of course we can’t (but there are some in the world who think we can!), that simply delays the problem. Fossil fuels, and oil in particular, will still be stuck with the risk of a financial bubble. There’s the small matter of peak oil.
Part of the problem with peak oil is I think many don’t fully understand it. People talk of “running out” of oil, when its more a matter of supply v’s demand and the economic consequences of trying to tie these two together. Plus the fact we can’t necessarily pump oil out of the ground at any arbitrary rate of our choosing.
Most of the oil we’ve exploited up until now has been the cheap, easy to access oil. What we’re increasingly left with is the more expensive oil. The capital expenditure needed to extract this oil is much larger than for conventional oil plays. Its a lot more expensive to drill in deep waters, frack or build the vast infrastructure needed to process tar sands oil than it does to run a traditional oil drilling operation. Higher capital expenditure makes for more financial risk.
Now if the oil price were to say go to $200 a barrel and stay there, we’d be able to pay off those debt’s easily enough, but that’s not happening. Instead oil prices have largely stagnated. And the worry for oil companies would be that if they were to fall, not only would they cease to make money on the oil play’s in operation, but they could easily be rendered insolvent. So the oil industry is becoming more risky and less profitable.
Now historically, the assumption was that oil prices would just keep going up and the suckers customers would have to just deal with that. But the growth of renewables has created a alternative to fossil fuels. While renewables are still some way off competing against fossil fuels on price, the gap is narrowing.
Consider for example this article relating to the Canadian tar sands which compares the outcome if instead of investing $200 billions in tar sands, Canada had instead invested it in renewables. Its a bit of a simplistic way of looking at things, but you get the message. It wasn’t a sensible investment, the Canadians got screwed.
There’s a bit of a debate about what would be the “breakeven” oil price (or NG price) where fossil fuels would become uncompetitive, but this ignores how the energy industry works (i.e. the differences between heating demand, electricity and transport fuels). Even so, its clear that as things stand, in some areas, notably electricity production and home heating, fossil fuels like oil and coal can’t compete any longer against renewables (although natural gas can do so….for now!).
In other areas, such as transportation, oil prices could drift upwards to some extend, but my guess is anything above $100 a barrel won’t be a good idea, as that would likely encourage more fuel efficient vehicles (hybrids) and fully electric cars. And before anyone says subsidies, recall that fossil fuels are in receipt of vast subsidies, about $5 trillion a year by one estimate (worldwide), far more than we spend on renewables.
Fossil fuels are also in competition with each other, not all fossil fuels are equal. Natural gas for example is in a battle for market share with coal, a battle that coal is losing. But even within the oil industry there’s competition, as certain producers, such as those in the middle east, can pump at a much cheaper price than say oil shale producers in America. Without a significant rise in oil demand, and thus oil price, the Saudi’s can just pump and sell at a lower profit margin. Yes, that will hurt their economy, but its not going to bankrupt them.
In fact even that last statement isn’t entirely correct. Because the truth is that US shale oil doesn’t compete with Saudi oil, it never has and it never will. Its the wrong kind of oil. Saudi light crude is the preferred oil for running things like cars and trucks. We could well see a scenario where the price of oil does climb, but only for the types used in vehicles and hence the tar sands and shale oil producers still end up losing their shirts.
What all of this indicates is that fossil fuels is going to become constrained to various narrow energy niches over time. And the danger is that those niches are going to start to implode on them, either because they just can’t pump enough of the stuff at a low enough price, or technological changes simply makes their product obsolete. The recent collapse of the coal industry in the UK is a good example of how this might play out, making them something of a canary in the coal mine (if you’ll pardon the pun).
On top of all of this, there’s disinvestment in fossil fuels. This is being pursued by many who argue its unethical to invest in fossil fuels given all we know about climate change. As a result a number of investors have started to pull their money out. However, given everything I’ve said, there’s a compelling economic argument in favour of fossil fuel disinvestment as well (particularly if you are a pension fund!). So the danger for the fossil fuel industry is that they could find it harder and harder to borrow money and invest in new oil projects, leading to eventual drops in production.
Now given all I’ve said, some might argue that it would be sensible to keep investment in fossil fuels going for the sake of financial stability. This I suspect is the line the Koch brothers will take when they put it to Trump. However, this assumes we can ignore climate change, and again we can’t do that. Renewables are part of the solution not the problem. They provide an alternative source of energy and an alternative market for investors to invest their money. The carbon bubble is going to pop anyway, because all bubbles inevitably do so. That’s economics 101.
And a correction caused by the bursting of an economic bubble doesn’t necessarily mean a financial crisis. The bursting of the dot-com bubble, while certainly bad news for anyone investing in a company with .com at the end of its name, it didn’t trigger a global financial meltdown. The coal industry, as noted, is collapsing, yet I don’t see investors leaping out of windows on Wall Street over it. That’s because the markets have known since the 1980’s that coal is a dying industry and took their money and ran along time ago. There’s economic problems (leading to social problems) in coal mining communities (soon to be ex-coal mining communities!). But this has more to do with ineffective government policy, which has focused on trying to improve efficiency in the coal industry or relaxing environmental rules (so they can dig more coal), when the fundamental problem is that nobody wants to buy their product anymore. They should instead be running down the mines and focusing on developing new industries to provide alternative jobs.
So in theory, if everyone sees it coming and everyone reacts accordingly (investors gradually pull their money out of the industry, the oil majors cancel any risky expansion plans and focus on running down the fields already operating, governments encourage investment in renewables to make sure there’s no energy shortfall) we’ll all be fine.
But there’s the problem. I’d argue that all the indicators are that while some will get out and others may even attempt some sort of big short of the carbon bubble, many in the markets and certain governments simply won’t see it coming. Egged on by special interests, they’ll try to defy the laws of economic gravity and while they will succeed for awhile, eventually they’ll fail, unleashing a heck of mess. And its a mess that could easily bankrupt entire countries and lead to another depression.