As the price of oil falls below $50 a barrel, wiping billions of dollars off global inventories, will these investments continue to support fossil-fuel industries, or will they seek out value and growth in the renewables and clean-technology sectors?
There are 12,000 gigatonnes of hydrocarbons locked up in the earth’s crust. The cheap stuff, such as the oil from the Ghawar field in Saudi Arabia, has been found, and most of these fields have passed the peak of their output, although they will go on producing, at reducing levels, for many years. Selling this oil cheaply is not in the interests of the Gulf states, which need the income to fund elaborate social programmes designed to keep their restless populations occupied, and to dampen the appeal of religious extremism.
Outside the Gulf, further oil extraction is from inherently more expensive areas: tar sands in Alberta, Canada; US shale deposits; seabed extraction from increasingly deeper waters.
The fall in oil prices has brought a jolt of reality to energy investors. If production costs are higher than $70 per barrel, then their investment is wasted.
Oil exploration and production is what it always has been: speculative, with very volatile outcomes. The UK’s Financial Times reported that of the $2trn invested last year across the sector, $930bn may never see a return. It is no wonder that international regulators have commissioned reviews of the implications of this investment bubble in fossil fuels.
About $70trn is available for energy investment, mainly accrued in pension funds and insurance companies. Are oil and gas still a safe harbour for these funds? Returns on equity have fallen from more than 20% in 2008 to a forecast 5% this year, with further contraction ahead. A low oil price wipes huge value off future inventories, while a high price drives exploration into environmentally and politically challenging areas. Coupled with a price on carbon, the historic attraction of oil as an investment fit for widows and orphans looks decidedly risky.
The owners of, and investors in, companies with large fossil-fuel inventories face another barrier to delivering value. Scientists calculate that a 2°C rise in global temperatures by 2050 would be consistent with a concentration of 450 parts per million of CO2 in the atmosphere. This would mean that of the 12,000 gigatonnes of fossil-fuel reserves, only 936 gigatonnes can be used. A report published in the journal Nature say this commitment by the world’s governments renders substantial expenditure on fossil-fuel exploration unnecessary, “because any new discoveries could not lead to increased aggregate production”.
So whether at $40 a barrel or $120, the essential proposition is this: the reserves must remain in the ground. That alone should persuade sensible investors that fossil fuels present an unattractive long-term bet.
Investors must also add to their due diligence this question: “What price will be put on carbon in every country in future?” For there will be a price on carbon. It may even be sufficient on its own to incentivise changes in investment strategies that keep the global temperature rise to 2°C.
So if fossil fuels are too risky, how are the pension funds going to deploy their money, and where will they find value?
Renewable energy is providing a compelling case for replacing oil and gas as the long-term shelter for the world’s retirement funds. Wind and solar are already low-risk investments, and battery storage and smart-grid technologies are moving swiftly from medium- to low-risk categories.
Wind technology is now immensely reliable, with modern turbines available for 98% of their operational lifetime. The price of generation has fallen by 30% in the past seven years.
The fundamentals of wind energy make it extremely attractive for pension-fund investors. Almost all the cost of wind is accounted for in the capital cost. The fuel is free. It is always local. It will always be there. It makes electricity without pollution and without water.
Less obvious, perhaps, are the inherent engineering properties of wind turbines. No high temperatures or pressures are needed to make the electricity. The only failure mechanism is fatigue. Parts are simple to manufacture and simple to replace. Essentially, a wind turbine can last indefinitely.
The same fundamentals apply to solar, which enjoys the added benefit of scale, allowing for rooftop deployment as well as utility-scale plant. Decentralised solar is seriously undermining utilities’ business model in many parts of the world, putting them into the high-risk bracket along with oil and gas companies.
A wind or solar farm with a power off-take agreement is the lowest-risk investment a pension fund could make. It doesn’t matter how oil, coal and natural-gas prices fluctuate; the price of renewable power remains constant, delivering consistent cash flows over the lifetime of an investment — a perfect vehicle to deliver the returns sought by the world’s pensioners.
Today, alternative energy is no longer alternative, but mainstream. It is oil that is the outlier, and our investments must recognise that fact.
Adam Bruce is global head of corporate affairs at Mainstream Renewable Power and co-chairman of the UK’s Offshore Wind Programme Board
This piece was published as part of the Thought Leaders series. Recharge’s Thought Leaders Club brings together leading thinkers and participants from the renewable-energy sector to examine the key challenges facing our industry
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