Two thirds of the value of the world’s oil and gas reserves — totalling $25trn — could be wiped out as the energy transition disrupts the entire fossil-fuel system, with profound ramifications for financial markets and geopolitics, according to a report.
Cheaper renewable technologies, more aggressive government climate policies and reduced demand due to the coronavirus pandemic are leading to lower prices, reduced profit and rising investment risk, said London-based financial think-tank Carbon Tracker.
These forces are “likely to slash the value of oil, gas and coal reserves by nearly two-thirds, increasing the risk and likelihood of stranded assets”.
Carbon Tracker argues that a 2% decline in demand for fossil fuels every year — which is needed for the world to meet the Paris Agreement goals — could cause the future profits from oil, gas and coal reserves to fall from an estimated $39tn to just $14tn, a loss of $25trn.
“The size of the gap in expected wealth between the desires of the petrostates and the aspirations of the Paris Agreement is in the order of $100trn,” the think-tank stated.
“The gap is a threat to the stability of some petrostates. The petrostates hope for growth in demand and for a return to the high level of rents [the difference between the value of crude oil production at world prices and total costs of production] of the period before 2014. The Paris Agreement requires an annual decline in demand of 2%,” it said.
The report’s author, Kingsmill Bond, said: “We are witnessing the decline and fall of the fossil fuel economy. Technological innovation and policy support is driving peak fossil fuel demand in sector after sector and country after country, and the Covid-19 pandemic has accelerated this. We may now have seen peak fossil fuel demand as a whole.
“This is a huge opportunity for countries that import fossil fuels which can save trillions of dollars by switching to a clean energy economy in line with the Paris Agreement. Now is the time to plan an orderly wind-down of fossil-fuel assets and manage the impact on the global economy rather than try to sustain the unsustainable.
“Investors need to increase discount rates, reduce expected prices, curtail terminal values and account for the clean-up costs.”
He added that there needs to be a change in mindset among the fossil-fuel industry.
“The bizarre thing is that the fossil fuel incumbents have been so resistant to the idea of change for so long, and put out so much bogus PR, that they risk falling victim to their own rhetoric,” he said.
Threat to global stability
The decline of the fossil-fuel economy also poses a significant threat to global financial stability, said the report, warning investors that there is far more risk in the fossil-fuel system than is conventionally priced into financial markets.
“$32trn in fixed assets, a quarter of the global equity market and half of the global corporate bond markets are in sectors linked to the fossil-fuel system, and the banking sector is exposed to the very large amounts of unlisted debt,” Carbon Tracker said.
The Covid-19 pandemic and consequent oil price crash have increased the number of assets offered for sale worldwide, according to Norwegian consultancy Rystad Energy, with as much as 12.5 billion barrels of oil equivalent in recoverable reserves now up for grabs.
“The pandemic is creating a number of distressed sellers and reducing acquisition costs for assets and companies, thereby creating opportunities for Big Oil to accelerate its energy transition through acquisitions,” said Gero Farrugio, Rystad’s product manager for renewables.
“And with [oil and gas exploration and production] companies announcing deep spending cuts, we may yet see a ramp-up in renewable investments as recent headlines suggest, facilitated by new mergers and acquisitions,” Farrugio said.
The falling costs of clean-energy technologies have made renewables a cost-effective investment, more so as the coronavirus outbreak is expected to be a catalyst for oil majors to pump more money into renewables as governments are basing their post-pandemic economic stimulus plans around a green recovery.
“Renewable energy costs continue to fall and renewable power generation is increasingly becoming the default source of least cost new power generation,” said the International Renewable Energy Agency (Irena) in a recent report.
“Renewable power generation technologies are not just competing head-to-head with fossil fuel options without financial support, but increasingly undercutting them, in many cases by a substantial margin," it said.
The agency said that, in the past ten years, costs in the sector have dropped by more than 80% for solar projects, and by 39% and 29%, respectively, for onshore and offshore wind projects.
As costs continue to fall, Irena said renewable power is increasingly cheaper than new and existing fossil fuel-fired plants, with potential savings of more than $23bn per year “if the costliest 500 gigawatts of existing coal were replaced by solar and wind”.