At the same time, the call to divest in certain - mainly fossil - parts of the energy sector becomes stronger. Several large investors ask for more action from the International Oil Companies (IOCs). They are asked to identify the financial risks of climate change and align their investments with the Paris Climate Agreement goals.
The fear over financial risks due to climate change – for instance due to stranded assets – and the link with the need for an energy transition is not new. We have already seen reports from the ECB, the Bank of England and the Dutch central bank (DNB) warning of possible financial risks should the energy transition progress too abrupt.
The real economy is still strongly dependent on fossil fuels, especially oil and gas, and large investments and financing are still needed for further exploration. Here, too, we see a rise in risks. Not only financial risks, but also risks to the security of supply of these commodities and the risk of negative economic impact.
We also see that in large parts of the world people are still confronted with immense energy poverty. Indeed, even today there are still hundreds of millions of people who have no access to the electricity grid. Due to the expected rise in welfare and population, global energy demand will continue to increase fast. To some extent, this demand will be met by renewable energy, but also by fossil fuels. As a result, global demand for fossil fuels will also continue to rise, especially in emerging markets.
But since investments in fossil fuels are under pressure, it will become more and more difficult to meet the global need for oil and gas demand in the coming years. Shifts in the demand for energy do not necessarily move in tandem with changes in investments on the supply side. As a result, investments in oil- and gas-production may decline too abruptly. This could not only lead to shortages, but also to a loss of expertise in geology and drilling. Both are not only important for oil and gas exploration, but also for other energy sources such as geothermal, which will be part of our future energy mix.
Meanwhile, major O&G companies have all started their transition towards a more sustainable business model. These companies are actually able to shift their portfolios significantly in a period of just 6 to 8 years. This is possible because they have reduced a large part of their reserves in recent years. If we see stranded assets in due course, the financial risks for investors will therefore not be as big as some may fear today. Nevertheless, that does not mean that this transition is free from (financial) risks. Small shortages can - in current market circumstances - lead to strong oil price gains. And the price gains of these so-called marginal barrels will have an economic impact. A common rule of thumb is that a $10/bbl increase of oil prices leads to a reduction in economic growth of roughly 0.2pp, and a rise of inflation by 0.1-0.2pp.
A higher oil price - on the other hand - should increase the economic feasibility of sustainable solutions. However, this also comes with economic side-effects. Reduced financial capability on the back of high oil prices could also hurt the investments in renewable energy. This is why I am calling for appropriate and controlled adjustments to investments in the energy sector. This applies to both renewable energy (increase) and a decrease on the fossil side of the mix.
This column has been previously published on Energieplatform.nl