Are oil company valuations as ephemeral as the smoke rising from this oil refinery? Photo: Horia Varlan via Flickr.
Oil companies' $1.1 trillion gamble
16th May 2014
Financial experts warn investors that their money is being used by oil companies for high-risk projects, reports Paul Brown, on the assumption that oil prices will go on rising, with little or no regard for climate change. $1.1 trillion could be at risk.
Ignoring climate risk and hoping it will go away is no longer an acceptable risk management strategy for investment institutions.
Financial experts warn investors that their money is being used by oil companies for high-risk extraction projects.
The projects are based on the dubious assumption that oil prices will go on rising, and with little or no regard for climate change factors
Investors are being urged to warn oil companies that they are risking trillions of dollars in exploiting oil fields that will probably never be profitable - and to consider selling their shares if the companies fail to listen to them.
A new report from the Carbon Tracker Initiative, a not-for-profit organisation of specialists who assess climate risk in today's financial markets, says it was surprised to find that many of the investments by oil companies were financially dubious - even without taking into account climate change factors.
The assumption - prices will remain high
To justify the high capital costs of extracting oil from shale deposits, oil sands, ultra-deep sea sites and Arctic regions, the companies are making assumptions that the price of oil of will rise and stay high.
The dozens of company investment portfolios analysed in the report include global names such as ExxonMobil, Shell, BP, Chevron, Total, Statoil and Gazprom.
Many of these companies have large reserves where the cost of exploitation is well below the market price, but they are also still investing in high-cost, risky fields.
Smaller companies, on the other hand, often have even greater exposure to risk, believing that the high price of oil will eventually rise high enough make their investment profitable. The report also names these companies, and the size of the investments that authors of the report believe are at risk.
No account of climate change commitments
The report says that oil companies are generally assuming that oil demand will continue to increase, and are taking little or no account of the fact that governments may act to keep their pledge to prevent the world warming by 2 degrees Centigrade.
Many projects cost far too much to fit with the low-demand, low-price scenarios that would result if governments take action to limit oil-related emissions and save the planet from undue warming.
To test their theory, the experts took a figure of $95 a barrel for oil as a level above which shareholders would be unwise to invest in new fields. Although the price of oil is above this at the moment, the report says it has twice been below $40 a barrel in the last 10 years.
$1.1 trillion at risk
The research identified $1.1 trillion dollars of potential capital expenditure by 2025 on oil fields where the oil would cost more than this to produce, and so expose shareholders to a loss on all the production from the new fields.
The report says that the companies were "betting on a high demand and price scenario", and that investors might want to consider whether this capital was being wasted.
Those conclusions would apply even if governments took no action on climate change. The oil companies' gamble is that the world's economies - particularly China and other developing countries - will go on expanding at the current rate.
However, if climate change is taken into account, and action is taken to reduce carbon emissions, the outlook for investors in high-cost oil projects looks even bleaker.
Where's the risk management strategy?
Anthony Hobley, chief executive of the Carbon Tracker Initiative, said: "Our analysis also shows that if demand for oil is not substantially reduced, we are clearly heading for a level of warming far in excess of 2C, which reveals that there is no free lunch here for investors.
"Either policy and technological tipping points (like electric cars) will reduce demand in line with our analysis, or we will face levels of warming described as catastrophic by man.
"There is a realisation that ignoring climate risk and hoping it will go away is no longer an acceptable risk management strategy for investment institutions."
Hobley said that pensions funds and other big investors were under increasing pressure to explain how they were adapting to climate and market investments.
ExxonMobil - renewables wil provide only 5% of world energy by 2040
Previous investor concerns that the increased costs of hard-to-recover reserves could not be justified led to a dismissive response from ExxonMobil, one of the key companies named in this report as planning to exploit marginal fields.
The company's assessment is: "We believe producing these assets is essential to meeting growing energy demand worldwide, and in preventing consumers, especially those in the least developed and most vulnerable economies, from themselves becoming stranded in the global pursuit of higher living standards."
The company added that it did not believe that renewables could expand fast enough to meet increasing energy demand, and would comprise only about 5% of the total energy mix by 2040.
Paul Brown writes for Climate News Network.
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