Asset Management

Fossil Fuel Exit: The COVID-19 Factor

Jackie Bennion Deputy Editor 8 June 2020

Fossil Fuel Exit: The COVID-19 Factor

Research from a leading think tank suggests that clean tech and climate policy could cut fossil fuel profits by two thirds. And the shock of the pandemic to supply and demand is putting the onus back on stranded assets. Mark Carney has been speaking to wealth managers on accounting progress there.

New analysis from the think tank Carbon Tracker suggests that the COVID-19 crisis is accelerating the decline of fossil fuels and demand for oil could fall by 9 per cent in 2020, according to forecasts from the International Energy Agency.

In market terms, fossil fuel-related businesses account for $18 trillion in listed equity – or a quarter in value of the global equity markets. Within that sits $8 trillion worth of corporate bonds. The research group reckons that unlisted debt related to the carbon industry may be four times that, much of which is owed to banks.

Alongside the health response, collapsing demand has become the abiding theme of the pandemic and reignited debate about how to replace a consumption driven economy with something different and better.

Even for those who want a massive reset moment, rapidly declining fossil fuel demand without a transition plan threatens global financial stability and the pandemic has become an unpredictable accelerant. Before the COVID-19 crisis, growth in fossil fuel demand was already below 1 per cent a year, and clean technology has been meeting an increasing share of world energy demand.

"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,” said Carbon Tracker's energy strategist Kingsmill Bond. “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,” Bond said.

In Decline and Fall: The Size & Vulnerability of the Fossil Fuel System, he sets out how falling demand leads to overcapacity, driving prices down, along with company share prices. Markets saw flashes of this in April when crude fell spectacularly into negative territory. The London-based non-profit that researches the impact of climate change on financial markets, and long warning about stranded assets, argues that many companies will be forced to write off assets, cancel investment or go bust, and possibly in faster fashion than previously imagined because of shock to demand. “Even those remaining profitable will make far less money than before”, the report said. Morgan Stanley recently joined Citigroup, Goldman Sachs, JPMorgan and Wells Fargo in peddling back on committing to any new oil investment.

Carbon Tracker has calculated that if demand for oil, gas and coal falls by 2 per cent a year in line with the Paris Agreement and discount rates rise in line with increased risk, future profits for the sector will drop by nearly two thirds to $14 trillion. This is based on the World Bank in 2018 forecasting future profits from oil, gas and coal at $39 trillion.

It also reports that companies worth a combined $6 trillion are at high risk by operating in sectors that are expanding fossil fuel use, from those building LNG plants and oil pipelines to those making car engines and gas turbines; and marked economies in Venezuela, Ecuador, Libya, Algeria, Nigeria and Angola as especially vulnerable.

In his new role as UN Special Envoy for Climate Change, Mark Carney has been hot on the transition trail. At a PIMFA event last week, he said the COVID-19 crisis has dropped global emissions by 6 per cent but that figure would need to be globally compounded to achieve net zero emissions by 2050, signalling the challenges ahead. "This is a whole economy adjustment, this isn’t just about niche products or renewable solutions or ex-ing out some dark brown industries or fossil fuels.”

Carney said a couple of reporting cycles under the Task Force on Climate-related Financial Disclosure (TCFD) have helped companies be more consistent about risk disclosure, but this must now become mandatory. What's encouraging is that demand for this type of disclosure is very high, he added. From the demand side, “we’re talking about companies with huge balance sheets. If you total up the assets under management it’s $130 trillion; banks want it, insurance companies want it, the ratings agencies want it."

A number of companies have already come out with transition plans, while others are planning to publish in the coming months, including BP later this year. The former central banker said it was a mistake to see climate change as a binary issue - simply about divesting from energy companies. "If we don’t come up with ways of communicating how important a company is in a portfolio the whole thing becomes quite binary and it won’t achieve that whole economy transition," he added.

But energy companies are giving mixed responses. Exxon is forecasting continued growth demand for fossil fuels, and the industry as a whole has been investing $5 trillion a year on new infrastructure, Carbon Tracker reported. It said Shell's recent dividend cuts, Spanish giant Repsol writing down €4.8 billion in assets last year, and recent bankruptcies in the US shale sector are “all symptomatic” of the industry going through structural change.

It warned investors that there are far more risks inherent in fossil fuels than financial markets are pricing. “Investors need to increase discount rates, reduce expected prices, curtail terminal values and account for the clean-up costs," the report said. It used the UK as an example of where oil and gas generated 24 per cent of dividends from the FTSE in 2019. "Markets might sell down stock in anticipation of peak demand long before assets are written down," it said.

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