Oil Majors Need To Boost Leadership On Climate Change
Earlier this month, Shell became the latest oil major to respond to an international group of investors asking the world’s largest fossil fuel companies to assess the risks they face from climate change. These investors, managing trillions of dollars in assets, are motivated by concerns that companies in their portfolios are not adequately preparing for a future of lower demand for fossil fuels as the world transitions to cleaner energy sources. Not to mention climate-related physical impacts such as rising seas, stronger storms and more severe droughts.
Like its peers ExxonMobil and Statoil, which have also responded publicly to the request, Shell says it views climate change as a serious issue, and that the company invests in carbon-reducing technologies and incorporates a carbon price in business planning. And, like Statoil, Shell calls the current international goal to limit global warming to below two degrees Celsius “desirable.”
While it is good to see these companies publicly acknowledging climate change and the need to reduce carbon pollution, Shell and its peers appear to be preparing for a world of ever rising – not declining – oil demand. Indeed, ExxonMobil, Statoil and Shell all argue that oil demand will keep growing until at least 2030. They largely ignore the grim picture painted by the Intergovernmental Panel on Climate Change of what the world will probably look like if carbon pollution continues unabated, arguing that it is impossible to turn the tide in the timeframe scientists say is necessary. As a result, the companies reject the idea that they face any substantive financial risk.
Of course, these arguments are not surprising. In fact, the companies’ approach to shareholder engagement on this issue has been a constant refrain about the essential role they play in meeting the world’s insatiable demand for fossil fuels. This perspective is short-sighted and needs to evolve.
Shell and Statoil do provide some discussion of the International Energy Agency’s scenario that shows how the two-degree goal could be achieved, which shows oil demand peaking around 2020 and then declining. But they are quick to point out that even under that scenario, the world will continue to use oil and companies will need to make new oil discoveries to meet consumer demand. Statoil comes the closest to answering investors, saying, “In Statoil we are of the opinion that we have a fairly robust project portfolio, even in the event that global or regional climate regulations were to become much stricter than what we currently expect.”
Investors know that the world is not going to stop using oil overnight, and they aren’t advocating for that either. Rather, as smart stewards of capital, investors want to know what oil projects companies are betting billions on, which may be suspect down the road. These riskier, expensive projects – like deepwater drilling and oil sands – might make sense according to the companies’ bullish oil demand growth forecasts, but would be highly questionable in a world where some of that demand growth doesn’t materialize.
This is a critical question for investors, not just because they don’t want to finance oil projects that shouldn’t go forward in a world that takes the economic threat of climate change seriously, but also because oil demand destruction is a real risk. Companies know this, but are declining to discuss it publicly.
Recent research by the Carbon Tracker Initiative (CTI) shows that, over the last decade, capital spending by the 11 largest publicly traded oil companies has increased five-fold, while their production levels have remained essentially flat. Meanwhile, despite historically high oil prices, their returns have fallen below a 30-year average of 11 percent, leading firms like Goldman Sachs to raise questions about whether companies can generate enough cash to meet their dividend and investment commitments without oil prices rising even higher. Yet, CTI shows how, in a world that tackles climate change, lower oil demand could push oil prices down to around $75 per barrel.
In its response, Shell outlines an upstream capital investment budget for 2014, including exploration expenditures of $35 billion, with the “oil” element of that being an estimated $10 billion. Indeed, over the next decade, CTI shows that the oil industry has the potential to invest an estimated $1.1 trillion for high-cost oil projects that require oil prices above $95 per barrel to be profitable. Shell accounts for more than $63 billion of that. While such projects are economically marginal even at today’s oil prices of just over $100 per barrel, they could become uneconomic if oil demand were to decline by a relatively small amount. Shell openly admits that high oil prices are needed to make such projects viable.
Despite how much certainty these companies have expressed that strong international policies on climate change are unlikely in the next few years – and we have reason to believe they’re wrong – this isn’t the only factor that could dampen oil demand. We’re already seeing increasing fuel efficiency, fuel substitution and technological advances in clean energy and electric vehicles. The oil majors themselves are already seeing flat to declining oil demand in the U.S. and other developed countries due to these factors. They see virtually all of the demand growth coming from the developing world, and argue that meeting that demand is important to improve living standards for the world’s poor. It’s a fair point.
But what is the best way to meet that energy demand, considering that climate change disproportionately affects the world’s poor? Scientists warn that hundreds of millions of people will be displaced by the end of this century due to climate impacts, increasing the risk of violent conflict and wiping trillions off the global economy. Furthermore, how much oil will the developing world actually demand if prices keep rising? Given that oil prices are high now and the industry needs them to stay that way, oil alternatives would be a safer bet as developing countries reach for the living standards of the developed world.
It’s not only fair for investors to be asking companies for more transparency around their capital spending plans – it is the fiscally responsible thing to do. We have mistakenly invested in companies and markets that were ‘too big to fail’ in the past, and we have seen the catastrophic results. The fact is that the effects of the subprime mortgage meltdown on the global economy pales in comparison to what will happen if we do not change how we invest in energy. As major players in an industry the world relies on for so much, ExxonMobil, Statoil and Shell have not yet demonstrated the kind of leadership we need from them.