Electricity from renewable sources
- has a short run marginal cost (SRMC) of zero
- is much cleaner environmentally
- is much easier to transport
- could readily replace up to 40% of global oil demand if it had the necessary scale.
What is your main message for investors?
For the first time in history, the oil industry has to cope with competition and change will come much more quickly than most people think. The reason I say that is that we have already lived through it in the European power sector. It is significant in what this tells us about the disruptive power of renewable energy. The energy transition is here. What this report  says is that renewable energy is coming to the oil and gas industry as a serious competitor.
What risks does climate change to investors?
There is transition risk. When you set targets for renewable energy, reducing emission and improving energy efficiency, you are sending a signal to the private sector – industrial companies, the financial sector – that there is an opportunity to invest in these areas. Early on, high subsidies for wind and solar energy attracted a lot of capital. Once that capital starts to flow in, you get economies of scale. As the cost comes down, governments will set targets that are more ambitious and the cycle repeats itself. In the last two years, two factors have really been raising the speed of the feedback loop between policy and technology.
First, there is investor preference. Investors are becoming much more engaged on the topic of transition. One of the many initiative is the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures, which aims to empower investors to ask the right questions around reporting and disclosure about the financial risks of climate change, including transition risk.
Society as a whole is showing an increasing engagement on climate change, from activism by school children to Extinction Rebellion – the ‘Greta Thunberg effect’. This has a meaningful impact on government policy towards that ambitious target for carbon neutrality in 2050. All of these factors are accelerating.
Are there other climate-change related risks that matter for investors?
Physical risk and liability risk are becoming more and more important. Think of hurricane Dorian, increasing droughts and floods. People’s awareness of these is growing. Liability risk is least visible, but it is definitely there. A Peruvian farmer has sued RWE, the German energy company, and if the court rules in favour of the farmer, this will set a precedent. It will change the legal risks that (oil) companies are facing.
What barriers need to be overcome?
‘There are many. It still costs more on average to buy an electric car than it does to buy a diesel or petrol car. The cost of batteries has to fall to make it a like-for-like comparison. That is the most important barrier.
Another one is charging infrastructure. People talk about ‘range anxiety’ – the range of most batteries is 250-400km. That is fine for most people, but governments need to boost the rollout of charging infrastructure. The potential savings are enormous.
What can investors do to help the energy transition and what are the challenges?
Be careful about sector allocation. The Redburn report published in early September said that the oil sector is going to underperform in the long term. On climate change, you can reasonably assume that policy action will only tighten in the future. Investors should identify the sectors that are most vulnerable, in other words: the energy sector, and start thinking about supply chain and other sectors.
The energy transition is not going to be a linear trend. There is going to be volatility. There will be opportunities to make money from the old energy paradigm, but those opportunities will be the exception. As always, the challenge is to balance long-term structural trends and short-term volatility.
There are two things to ask yourself. Are we going to decarbonise the world energy system quickly enough to meet the goals of the Paris Agreement? At the moment, we know the system is not decarbonising quickly enough and we need to accelerate the energy transition. As investors, we have to ask: is the energy transition moving fast enough to cause severe disruption to share prices? The answer is yes, definitely.
 The ‘Wells, Wires, and Wheels – EROCI and the Tough Road Ahead for Oil’ report by Mark Lewis shows that for a USD 100 billion outlay on oil and renewables, new wind and solar energy projects in tandem with battery electric vehicles will produce 6x-7x more useful energy at the wheels than oil at USD 60 a barrel for petrol-powered LDVs, and 3x-4x more than oil at that price for diesel LDVs. Accordingly, for petrol to stay competitive as a source of mobility, the long-term break-even oil price should be USD 9-10 a barrel. For diesel, this is USD 17-19.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
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