Covid-19 is the current global crisis taking center stage and we will prevail. However there is another global crisis that has been decades in the making and that is climate change. Climate change is one of the world’s biggest, if not the biggest problem that we are facing. And it’s coming real soon to a theater near you. Climate change is hard to quantify and with so many variables it’s quasi impossible to predict any events. However we don’t need another study to remind us the “once in a century fire” is now the “once a multiple times a year fire”. The “fire season” is now a permanent part of the calendar. Climate change impacts everything. From the food we have on our plate every day, the air we breathe, our quality of life, and our national security. It’s a generational challenge with no quick fix.
On a more positive note we are closer to responding effectively to it. This post is about the notion that the oil era is winding down and that renewable energy would soak up the bulk of the entire energy industry’s investment dollars. The trend to move away from fossil fuels is real. And it’s renewable energy that’s taking shares of the pie. The global shift to renewable energy is a big step in the fight against climate change. Renewables are a form of “disruption” and I apologized for using a word that has been so overused.
Producing clean energy is not a novel topic. Thanks to innovation we are at a turning point. The technology has improved and cost has fallen. Innovation solves problems. Economics is central. Great innovations see their cost decline over time, creating real demand. The cost to produce renewable energy has fallen dramatically in recent years, to the point where it has become attractive next to fossil-fuel generating assets, particularly coal and oil. According to Lazard, the costs of solar panels and batteries have dropped by more than 89% in the past decade. Solar is substantially cheaper than it was even five years ago. The wind and solar power in Arizona that Fortis generates now costs less than 3 U.S. cents per kilowatt hour.
Peak oil theory, accredited to geologist King Hubbert in 1956, stated that the world would run out of oil. It has since been debunked. We now know that we have more than plenty of oil to meet our needs for decades. But removing all these hydrocarbons from the ground is not ideal from an environment standpoint. We might not need to. Peak oil theory was partly wrong. It was wrong on the supply side of the equation. It seems that we will have peak demand in this decade. In their latest “World Energy Outlook 2020” the IEA forecast as oil demand set to hit a plateau in 2030. In other words, demand for energy will only increase over time and the supply will be diversified.
We can’t just brush oil aside. Whether we like it or not, oil is still the most important commodity in the world. The demand for oil and gas is here to stay and is the dominant source of energy for the near-term. Oil is the lifeblood of the industrialised nations. Oil has become the world’s most important source of energy since the mid-1950s. Its products underpin modern society, mainly supplying energy to power industries, heat homes and provide fuel for vehicles and aeroplanes to carry goods and people all over the world. Oil is too ingrained in our everyday lives that we can’t change it overnight.
Oil is affordable and is very efficient to convert into energy. That’s the appeal of oil. But along with coal it’s dirty. If it wasn’t for Covid-19 we would be consuming around 100 million barrels a day. Oil demand is at 90% of pre-virus levels. The economic downturn has temporarily suppressed emissions, but low economic growth is not a low-emissions strategy – it is a strategy that would only serve to further impoverish the world’s most vulnerable populations. There are still approximately 600 million people in Africa without access to electricity. One day they will get power and transportation. The main question is what wil be the energy source supplying their economy? Only faster structural changes to the way we produce and consume energy can break the emissions trend for good.
The word “green” and anything related to it has a public relation problem. It’s mostly a feel good term. Being “green” is not a regulated term. Just like the word “natural” you can attribute whatever meaning you want it. The misusing of words has led to “greenwashing” which is the process of conveying a false impression. Greenwashing is misleading.
These days everybody is jumping on the “green” bandwagon. Most announcements were mostly for PR purposes. Businesses want to be seen as “green”. It’s something nice they can add in the glossy pages on their annual reports. Every political party sounds greener than the next one. There are slogans and announcements. The Democrats in the U.S. have the “Green New Deal”. In Canada, Prime Minister Trudeau’s Liberals promised to plant 2 billion trees over ten years. That was two years ago and not a single tree was planted yet (and yet they bought a pipeline…).
The green fad didn’t start yesterday. In 2001 oil giant BP rebranded from “British Petroleum” to “Beyond Petroleum”. Twenty years ago BP sought to ditch its image as an old-fashioned oil group and rebrand itself as an environmentally-aware energy. Not much came out of that. It was “More Petroleum”. BP still spent over $10 billion a year on oil exploration. Why? Because oil was a money minting machine. It was too good of a business to give up. Oil prices were good and there was a growing demand for the product.
Here are some recent clean energy headlines:
And it’s not just from governments. Big multinational corporations recognized the need to change.
This includes major oil producers also:
It’s normal to be skeptical when reading about another giant green promise. Track records suggest it is more “greenwashing”, a deceitful tactic of spending more time and money on marketing themselves as environmentally friendly than on minimizing their environmental impact. After all, all the buzz and hype from the past didn’t amount to much. But there are reasons to believe the recent hype is real. The main reason for the change is economical, not ecological. Renewables means more money in your pocket.
There’s also a shift in the mood and attitude towards climate change. The sense of urgency has elevated. We all feel climate change. We all have seen the pictures of California burning every year. I don’t need me to remind you of everything that’s wrong with the planet. You get it. We have Greta Thunberg, a fifteen year old environmental star that speaks at international conferences.
There’s also alignment of interest from government, humans, the business community, and the capital market. I firmly believe with these multiple party interests aligning we are on the edge of a fundamental reshaping of how the world will look like in the future.
Governments recognized the threat of climate change and the urgency for action. Citizens are demanding from their government greater “green” initiatives. Don’t respond to the people’s will and you might lose power. Oil prices are highly volatile. How many politicians lost their elections because of a spike in oil price? There’s also a geopolitical risk at play? Being reliant on hostile foreign suppliers is coming to an end. The ability to detach from Middle East oil will allow Westerns government to take a stand on human rights. It’s hard to criticize human rights abuse in the Middle East when you are financing their governments. In the U.S. the surge in domestic supply of oil & gas in the 2010s both boosted the economy and opened up new geopolitical opportunities. America can apply sanctions to petrostates such as Iran, Venezuela and Russia with relative impunity. Governments have the capacity and the responsibility to take decisive actions to accelerate clean energy transitions and put the world on a path to reaching our climate goals, including net-zero emissions.
The inhabitants of planet earth want clean air and water. That’s simple. But it gets more complex. Humans have also expressed desire beyond basic needs. They want clean cars, eco-friendly homes, solar power panels, organic food, sustainable X (agriculture, supply chain, X=everything), unbloody diamonds, guilt free cobalt, almonds that produce milk, and free range organic grain fed antibiotic chicken that has been killed ethically. Meeting certain needs can bring conflicted choices. Electric vehicles are supposed to be green, but the truth is a bit murkier. How “green” is a Tesla if your power source is coal? For those who think that Tesla’s carbon footprint is zero you might not want to look into how lithium is mined. There have been mass fish kills related to lithium mining in Tibet. Freshwater supplies in South America have been contaminated because of mining lithium. Mining and processing the minerals, plus the battery manufacturing process, involve substantial emissions of carbon. Despite the drawbacks, adopting electric vehicles that are sourced with clean power is a step in the right direction.
Businesses also realize they have to do their part too. Consumer behavior and awareness is rapidly changing. The businesses with the better Environmental, Social, and Governance (ESG) practice will attract more consumers and money. It’s also about survival. Will an automaker be around if they keep selling internal combustion engines in fifteen years? Companies have a responsibility – and an economic imperative – to give shareholders a clear picture of their preparedness. Goldman Sachs said the cost of capital for oil and gas projects is 10% to 20%; for renewable projects, it’s only 3% per cent to 5%.
Capital providers too are now looking for companies with better ESG practice. Capital providers want to invest in companies that are committed to sustainability. And not just for filling the glossy pages of their annual report. Environmental disaster is a real risk to investments. Climate change has become a defining factor in companies’ long-term prospects. Asset managers are fiduciary to their clients. Many of them emphasized the significant and lasting impact that it will have on economic growth and prosperity. We approach a period of significant capital reallocation. Greater transparency on questions of sustainability will be a persistently important component of every company’s ability to attract capital. It will help investors assess which companies are serving their stakeholders effectively, reshaping the flow of capital accordingly.
Climate uncertainty brings up questions that need to be answered. What will happen to the 30-year mortgage if lenders can’t estimate the impact of climate risk over such a long timeline? What if there’s no viable market for flood or fire insurance in impacted areas? What will happen to all that debt behind oceanfront property in Miami? How does climate risk reshape the market for Miami municipal bonds?
Climate risk is an investment risk that investors are increasingly reckoning with. What is happening is that capital markets are pulling future risk forward which leads to changes in capital allocation. What we are seeing is a reshaping of the flow of capital towards sustainable investments. For example, capital providers are throwing money at renewable energy projects, not a new coal power plant. JPMorgan Chase is bending its lending power to help the environment.
The shift to a carbon free future will need commitment, a plan, concrete milestones and lots of capital. Also one of the most challenging parts of the shift is not the investment or magnitude of renewable capacity additions but the social transition that comes with it. Coal-fired power capacity has to decline. Reduced coal capacity will result in loss of coal mining jobs, affecting provinces that depend on its revenues and employment generation. “Clean jobs” is a nice slogan but how many jobs are associated with a solar panel once it’s installed? How many people does it take to look at a wind turbine spin?
Oil is out. Royal Dutch Shell, one of the world’s biggest oil and gas companies, hit a 25-year low. Wind and solar producer NextEra tops Exxon as the most valuable U.S. energy company. God is also dumping Exxon because the Church of England sold all their Exxon stock after it failed to meet certain emission targets cut. Exxon was also dumped from the Dow Jones Industrial index. It wasn’t too long ago that ExxonMobil was the largest company in the U.S.
Renewable energy is in. According to a report by Goldman Sachs renewable power will emerge as the No. 1 area of energy spending in 2021, usurping oil and gas spending for the first time, and that the green transition will drive US$1-trillion to US$2-trillion per year in infrastructure investments, while generating as many as 20 million new jobs worldwide.
Oil will not disappear in the near term. It will remain the most important part of the energy system and is still critical to energy security. IEA estimates that trillions of dollars of new oil and gas investments are needed by 2040 to offset depletion from existing operations, even under a range of climate scenarios. Oil companies might be hurting, but they have no intention of going in the grave. Both BP and Shell are reducing their oil ambitions. Shell is investing into renewables and low carbon fuel.
BP published last month a bearish long-term forecast for oil demand that said peak demand is either here now or will arrive in the next few years. BP is active. BP owns a 50% stake in global solar developer Lightsource. BP and earlier this month announced it will push into China’s commercial and industrial solar market in partnership with JinkoSolar, the world’s largest PV module maker. BP plans to significantly ramp up their investments in renewables to $5 billion annually by 2030. The goal is to raise its solar and biopower capacity from 2.5 gw last year to 20gw by 2025 and 50gw by 2030. Along with several of its European peers, BP aspires to “net-zero” carbon emissions by 2050 and plans to shift investment away from its core oil and gas operations to low-carbon and renewable energy projects in the coming years.
Decarbonization is a global objective. The green revolution is directionally right. Renewable energy momentum is building and it’s not stopping. U.S. President Donald Trump has supported coal and denigrated wind and solar power. Nonetheless, the growth of renewable power has accelerated. Despite his stand for coal, electricity generated from coal fell 22% during his term. There are also less coal related jobs. Renewables made up for the loss share. Years ago, renewable energy needed government support. Now, following technological advances that have driven efficiency and reliability (including breakthroughs in storage), along with the declining cost of wind and solar components, renewables are clearly here to stay.
Thank you for reading,