A potential threat that looms for big international oil companies – and maybe even national oil companies – comes from an unexpected source: the world’s central banks.
So argues Daniel Yergin, the vice chairman of IHS Markit and one of the oil industry’s most respected authorities as author of its definitive history, The Prize. He will speak at this year’s Abu Dhabi International Petroleum Exhibition and Conference on why he sees efforts to force publicly listed oil companies to produce information about their exposure to the so-called carbon bubble as misguided.
For more than a year now, the oil world has voiced growing concern about an effort led by the Bank of England governor Mark Carney that would highlight the risk that climate change – and particularly policies to address it – could have on the value of oil companies’ assets, which in turn could pose a risk to the stability of the financial system similar to the housing bubble that crashed the world economy at the end of the past decade.
The underlying concept, which dates back more than a decade, holds that fully taxing carbon emissions and other policies to deal with climate change would mean having to leave a considerable amount of discovered oil and gas unexploited, or in other words leaving much of those reserves as “stranded assets”, overtaken by the world’s transition to alternative, non-hydrocarbon forms of energy.
It has also been known as the “carbon bubble” theory.
“The carbon bubble is an argument made to investors in public companies that their investments will be worthless because companies will not be able to produce their reserves at some point in the future,” Mr Yergin explained. “This is a deeply flawed theory.”
Still, since Mr Carney started advocating for it in a speech last year, it has gained currency, especially given his influential position as the chairman of the Financial Stability Board, a G20 group of regulators charged with improving risk management in the world’s richest economies.
Mr Carney and the former New York mayor Michael Bloomberg, whom Mr Carney tapped to oversee a task force to look at the financial risk of climate change, will report in December on whether or not to recommend the adoption of a code for climate reporting by oil companies.
Mr Yergin argues that the Bank of England governor adopted the “carbon bubble” theory and vernacular wholesale from the advocacy group Carbon Tracker Initiative, which popularised it a couple of years ago.
Adopting a new reporting code could in turn lead to difficulty for oil and gas companies in raising capital from investors who would perceive the risks as too high, or because of the growing trend of “ethical” and “sustainable” investment criteria, which has steered capital away from other industries, such as gambling, alcohol, arms manufacturing and especially tobacco.
“The Bank of England seems to have adopted this somewhat discredited theory as part of its argument that investing in oil and gas poses a systemic risk to the global financial system, which is a huge, huge stretch,” Mr Yergin said.
In a new paper, he argues that publicly listed oil and gas companies are valued by the market based on only about a decade or so of production rather than on the basis of the value of exploiting their entire reserves, which for the largest of the oil majors would stretch well beyond that.
Furthermore, he argues, the market value of all the oil and gas companies makes up only a little more than 6 per cent of the capitalisation of the world publicly traded stock market value, and therefore would not pose a serious systemic risk even if there was a sudden, sharp loss of value.
“To compare investing in oil and gas companies with what happened with Lehman Brothers in 2008, it just confuses rather than clarifies,” said Mr Yergin.
“Is this a side-door effort to turn central banks into environmental regulators? That’s risky for central banks because in many countries there is already a good deal of questioning and scrutiny about the role that central banks have taken on since 2008,” he added.
Mr Yergin also argues that the oil and gas industry has proved its resilience over the past two years, when it has undergone a severe stress test that didn’t pose a “systemic” risk to the world’s financial markets.
According to IHS Herold research, 82 global oil and gas companies lost 42 per cent of their market value from June 2014 to December 2015 – equal to US$1.4 trillion in market capitalisation. But over that period the broad Dow Jones Index in the US rose about 6 per cent.
The landscape certainly will change for oil and gas companies, but the transition is likely to be a slow and manageable one.
“Clearly technology won’t stand still,” said Mr Yergin. “There will be an energy transition that will unfold over decades. It’s very hard to know what the world will look like in 2050 or 2060, but we’ll probably have a much more mixed energy system. But investors will have plenty of time to make their decisions and move their capital around.”
Meanwhile, though, another aspect of the regulatory move could be to add a doubt to the potential for a public listing of shares by Saudi Aramco, which holds the world’s largest reserves. While, as Mr Yergin points out, previous state oil company listings – Statoil, PetroChina – have adopted the same valuation methods as for international oil companies, the value usually talked about for Aramco – in the trillions of dollars – is based on its vast reserves.
The possibility that valuation would only be based on a decade or so of its production would put a very different market value on a listing.