One recent story that much of the media missed was that Blackrock, one of the world’s largest asset management firms, lost some $90 billion investing in fossil fuel companies. As a result its reducing its investment in this sector and putting the money into renewable energy instead.
This answers a question I asked sometime ago, how long more is the financial services industry going to continue pouring good money after bad investing in fossil fuels. Well it seems we might be reaching the point where the dam has burst. The trouble is that since the 2000’s the CAPEX required to develop new oil field has been going up at the same time that the rate of return has been going down. This is not surprising as all the easy to produce oil and gas fields have already been drilled (or those fields have been exhausted). Those that are left are more expensive to drill, often as they are in less than ideal locations (or represent smaller pockets of oil), or because they are unconventional sources (shale gas, tar sands, etc.).
Now the trouble with oil fields is its kind of like a box of chocolates, you never know what you’re going to get, how much oil will be produced and at what price you’ll be able to sell it at. And needless to say the low oil prices of recent years hasn’t helped, making it very hard to turn a profit. Hence the reduced rate of return. It also serves to make oil a much more risky investment. Which is a big deal for investors. They will typically spread their money out, putting the bulk into safe “boring” investments (blue chip stocks, mortgages, government bonds) and then different tranches of riskier investments. With a higher return expected the riskier the investment becomes.
Oil has traditionally been seen as a fairly safe bet. But since the shale gas boom under Bush, its become something of a wild west. Yes there’s money too be made, but it means you need to pump in more cash up front and be prepared to take on more risk. Which might be fine for some Texas oil men, but not for others, as they have shareholder who’ll skin them alive if they lose that much money. Certain firms, notably pension funds, are often forbidden from undertaking any form of investment above a certain level of risk. And the snake oil tactics some in the oil industry have engaged in, notably in the selling of shale gas plays, has hardly helped endear them to wall street investors.
And of course climate change makes investment in certain industries a lot more risky, most notably the oil industry. The bank of England has actually issued warnings to that effect. Not least because climate change could trigger another financial crisis (as if companies didn’t have enough reasons to shun investment in fossil fuels already!).
So Blackrock’s position here isn’t that surprising. And there are many in the same boat. Investment in oil and gas has been steadily declining for sometime now. Normally this would just be seen as part of the fossil fuel industry business cycle. A spike in oil prices, causes a massive jump in investment, they go on a drilling boom, everyone gets rich, production goes up, causing an oil glut, prices collapse, everybody loses their shirts and jokes like this become popular in Dallas “how do you address an oil geologist – can I get fries with that!”. Then the cycle repeats itself.
However, the problem for fossil fuels is that they now have competitors. Renewable energy is increasingly seen as an alternative. And electric vehicles means that we can run vehicles off something other than dino juice. Energy saving measures are reducing the need for oil and gas consumption in the first place. And more money going into renewables allows for greater economies of scale to be developed and lower installation costs. Which means they get to eat more of the fossil fuel industry’s lunch. So its possible that oil production could fall, without causing a significant increase in prices.
Yes populist governments, some of them in the pocket of the fossil fuel industry, can go on a rampage and commit acts of ecological vandalism (just look at the crimes against nature the Brazilian president is committing as he tears down large chunks of the Amazon rainforest), but all they can do is cause their country to fall behind in terms of renewable technology, so those jobs go overseas. And ironically enough there might be links to the rise in populism and climate change.
Granted if there was to be an artificial shortage, e.g. a war with Iran cutting off oil from the Gulf states for several months, that could push up prices…which could explain what Trump is up too. But it might not necessarily lead to an increased investment in the oil industry. We’ve been here before. Yes wars in the middle east led to an oil shock, shortages and high prices. But they were short lived affairs and nearly always followed by a massive price crash.
In fact one possible scenario in the event of a war could see investors, gambling on a quick American victory (and a probable drop in oil prices), dumping their oil investments as soon as the bombs start falling (doesn’t mean a war won’t happen, Trump is pretty dumb, but on the plus side it will just guarantees he loses in 2020).
Ultimately the problem here is that people tend to see the issue of peak oil through one of two lenses, geological or economic. When its actually a combination of both. Yes the amount of fossil fuels in the world (the resources) is a fixed finite value. How much of that can be turned into reserves and ultimately pumped out of the ground however, is a factor of economics and technology. You throw enough money at the problem, you can increase production. This has been the position of cornucopians.
However cornucopians fail to appreciate the practicalities of what they propose. There are engineering and geological factors that have to be accounted for. i.e. you are having to drill a lot more wells to great depths in more challenging conditions, unconventional oil has a higher carbon footprint and a lower EROI.
And its not a linear relationship between investment and oil production. Doubling your investment doesn’t double your production. Instead its more like you put ten times the amount in and get a lot less out than you’d have previously gotten from a conventional oil field….for a short time anyway (unconventional wells tend to produce for a much shorter time period than conventional wells).
And that money doesn’t rain from heaven, nor can we assume the oil price will magically stay high just because we need it too. Someone has to be willing to invest in it and if they can make more money investing in something else (e.g. wind farms, electric cars, short selling anything British in advance of brexit) then they will take their money and run.
In short, the oil industry has spent the last decade running faster to stand still. And they are about to get hit with a massive attack of cramp. Hence its entirely possible the current trends might not only continue but even accelerate. Oil production falls yet the oil price doesn’t go up much, so more investors pull out.
Which raises the question, how will it end? With a slow steady decline to obscurity? Or will the fossil fuel industry go out with a bang? While Blackrock and others might well be walking away, there’s still an awful lot of money tied up in the industry, so what happens if the bubble suddenly bursts? It could create the mother of all financial shocks.
Only time will tell. But I’ll have the popcorn ready just in case!