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Whether you think climate change is real or not, global insurers, investment funds, many corporations and most governments believe in it. While global policy consensus remains elusive, from a long-term investment standpoint significant risk now attaches itself to fossil fuel assets. The risk has a name: stranded assets.
Coal is the poster child – and Rohitesh Dhawan, Eurasia Group’s director of strategy and alliances, says it’s also a harbinger. The U.S. Energy Information Agency (EIA) data shows that over 40% of coal-generating power plants shut down in the decade since 2008, many of them long before their expected lifespan. The main cause is not regulatory policy, but cost. EIA also finds that a kilowatt generated by onshore solar or wind farms is significantly less expensive than coal, and natural gas – newly plentiful thanks to fracking – is cheaper still.
Dhawan believes the fossil fuel operations of the oil majors – primarily conventional oil drilling – exposes investors in such firms to stranded asset risk. “There is a fundamental divide between the pro-energy industry investors and investors who take climate change seriously,” Dhawan says. “It’s primarily about the pace of change. That’s really interesting to unpack.”
Dhawan spoke to Karma Network’s Contributing Editor Michael Moran.
Michael Moran: How do investment funds, corporations, nonprofits, PE and VC players come down on climate change? Do they buy into the United Nations Paris Climate Summit warning that anything above a two-degree centigrade rise in temperatures is an existential risk to the planet? And how is this affecting their investments?
Rohitesh Dhawan: There are many investors taking the two-degree scenario literally and seriously. It’s showing up in how they’re deploying their capital. Whereas the fossil fuel industry is thinking this change is light years away and that it’s super slow so (it) has no real bearing on how the large oil companies are going to be investing, that is not necessarily true. So what does that mean for the way the main asset managers, who hold stocks in those larger oil companies, are going to react? That is a super interesting question. Everyone is talking about the march of renewable energy, how it’s cheaper and better and makes a ton of sense, especially in the developing world. But I don’t think that has really lit the path from a fossil fuel-dominated energy industry to one that promotes a balanced energy mix. That’s going to be disruptive, and it is going to create stranded assets – very big stranded assets.
Michael Moran: What are the practical effects you’re seeing in the marketplace?
Dhawan: On the one hand people are like, “I don’t want to invest in Big Oil,” because they don’t want to be stuck with a stranded asset. These people are challenging the idea that they should invest in something predicted in 10 years to be economically valuable, like oil reserves under specific geological formations. The problem is by the time you get to it in 10 years and actually begin to extract the fossil fuel, the world could be under severe carbon budget. So long cycle upstream oil projects are taking the hit. One statistic that drives that point home is investment in upstream oil through the big supermajors and others is now lower than it was in 2016. It’s amongst the lowest we’ve seen in a long time. Global upstream spending is about $500 billion annually, which is about $300 billion lower than in 2016. And this at a time when oil prices have been relatively stable.
Investment in upstream long cycle oil projects is down because of new attitudes like ESG investment (Environment, Social, Governance), but also because people realize that short cycle projects like US shale and production are a much better position to fill demand than long cycle. . So you’ve seen record investment in US and Canadian shale production, which indicates the market is demanding flexibility (as) a way to avoid the risk from long cycle oil.
Michael Moran: So this suggests a real possibility that coal isn’t the only segment of the US energy mix where there is a risk of owning stranded assets?
Dhawan: Yes – this leads us to a pretty striking conclusion: There are bigger risks than ever in investing in oil, which of course is what most people in the ESG/sustainable/transition movement had been predicting. Now that trend creates another big risk: What if the transition from fossil fuels to renewables takes longer than the ESG types think? That’s not impossible. In that case, at least economically, the bigger risk is actually under-investment. In that slow transition scenario, if we’re under-invested in oil and gas, we might be setting up for an oil price shock of the type we saw in the 1970s. I don’t think people are prepared for this, but because (of) the chronic under-investment in oil and gas capacity, the risk is there.
Michael Moran: When you’re talking about the publicly traded majors and big state owned SOEs, where do equity investments fit into this picture? What new technologies or models stand out as alternatives to owning, say, 10,000 shares of Exxon-Mobil?
Dhawan: You’re totally right that some of the most interesting innovations are happening outside of supermajors and public equity markets. Let me give you a couple of concrete case studies. My bias is with the African continent because I think it’s generally underreported, and because I know a bit more about that than I do about other places. So I think there are (a) couple of examples in the energy world where alternative investors are starting to play a pivotal role.
One is called LADOL, which is Lagos Deepwater Offshore Logistics Base, a privately funded initiative to build an ecosystem around oil and gas that is not linear but rather circular. The idea is to ensure that the output from one oil and gas major process flows into the next so that there’s minimal wastage, lower costs, lower environmental footprint. LADOL probably will be copied in Ethiopia and Tanzania on the continent, but also in Pakistan and in Saudi Arabia. LADOL for me is a great example of how some of the alternative investors are seizing the opportunity.
Michael Moran: Where else in sub-Saharan Africa do you see this trend playing out?
Dhawan: A second example is in South Africa, where there is something called the Western Cape Industrial Symbiosis Program or WISP. What WISP is doing is giving individual investors access to opportunities that rely on multiple kinds of processes in the same geographic location. [WISP describes itself as “a free service that connects companies so that they can identify and realise the business opportunities enabled by utilizing unused or residual resources (materials, energy, water, assets, logistics, expertise), enhancing business profitability and sustainability.”]
They’ve identified about $80 million worth of commercial revenue that’s been unlocked by linking different parts of the oil and gas industry but also other supply chains together. What they have managed to do is open up new investment routes (for) people who have a stated commitment to sustainability goals, however you may define them. So SEGs [Solar Energy Generators] or something narrow like that have the opportunity to invest in a way that provides superior return in preferential opportunities in a way that public markets just can’t access.