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Welcome home. I think this will be a huge time for investors in US oil and gas companies as the Trump administration is committed to unleashing a new era of fossil fuel expansion. However, these stocks have been performing poorly in the broader market these days. The Dow Jones US Oil and Gas Index has declined 1.2% over the past year, compared to an 11.3% increase in the S&P 500.
As highlighted below, investors’ attention on this sector is justified. And new research suggests that over time we should be prepared for a much larger decline.
Have a great weekend.
Green transition
Who will keep holding oil assets when music stops?
The latest long-term forecast from OPEC, the club of oil exporters predicts that the world will use 10 million barrels of oil per day in 2050. Oil companies from Exxonmobil to BP and Equinor are stepping up their fossil fuel investments in anticipation of strong demand for the coming decades.
But what if they’re wrong? By the mid-century, the US president was amortizing the world’s chances of weaning from fossil fuels to a considerable extent, as they were crying “drills, babies, drills.” However, for oil companies and their investors, including governments and savers around the world, the risks of peak oil demand remain real.
A new attempt to quantify risk yesterday in a study conducted by the UK Sustainable Investment and Finance Association with analytical company transition risk exeter. They looked at the outlook for valuation of fossil fuel assets under the published commitment scenario developed by the International Energy Agency.
Count the cost
Researchers found that this would lead to 2.3 tons of $2.3TN in assets fees and other financial losses by 2040, as resources were left on the ground due to insufficient demand. They also modelled how these losses are distributed. This is an exercise that has produced some interesting results.
Absolutely, the US, Russian and Chinese governments and investors will win the biggest hits, with losses of $546 billion, $400 billion and $184 billion, respectively. The fourth position was in the UK, with a potential loss of $141 billion.
The UK accounts for only 2% of global GDP, with only 1% of physical fossil fuel assets being vulnerable to “overview,” but accounting for 6% of global potential financial losses from common assets. Researchers say these losses amount to over £2,000 per UK citizen, reflecting the domestic financial exposure to the global fossil fuel industry. They said the majority of the hit will be taken by the UK pension fund sector.
Of course, all of this assumes that the government meets its emissions reduction commitment. This is questionable even before Trump collapses US climate policy. Still, it is worth noting that the IEA published pledge scenario used in this study is significantly less motivated than the net zero emissions scenario, which assumes that net carbon emissions can be eliminated by 2050.
And even under the less ambitious IEA policy scenario, it barely goes to meet climate targets than the policies already announced by the government – it found that globally marginalized assets amount to $8720 billion and UK stocks totalling $490 billion.
Who are the optimists?
The hope of fully meeting the goals of the Paris Agreement now appears to be extremely optimistic. But in its own way, so does OPEC forecasts for continued strong growth in oil demand. The transition to electric vehicles is a disastrous threat to this biggest source of demand. Sales of EVs in China are set to overtake sales of combustion engine cars this year. As costs drop and charging infrastructure improves, other countries are moving in the same direction at almost slower paces.
Marine and air transport in particular are difficult to decarbonize, but it only accounts for 15% of crude oil demand. While oil purchases for petrochemical production continue to increase, the sector accounts for less than a sixth of total crude oil demand. In other words, even rapid expansion will not outweigh the decline in demand from road transport.
This is supported by the IEA’s latest annual oil report. This is predicted that demand growth will be negative in 2030. Perhaps the IEA is crazy and does OPEC analysts have a more reliable perspective? Perhaps – it is worth noting that the IEA must repeatedly revise upwards, but conservative predictions about clean energy growth had to be repeated.
For investors managing their financial exposure to fossil fuels, this is primarily a matter of timing. Despite poor performance over the past few months, people who have been overweight in the sector have been rewarded over the past five years. The DowJonesUS Oil and Gas Index rose 105% compared to a 94% increase in the S&P 500 index. However, as soon as it becomes clear that oil demand is falling into a structural decline, a reassessment of asset values may be painful.
“Even if no additional policies are in place, the energy transition is already underway,” said Willemijn Verdegaal, co-Chief Executive Officer of Transition Risk Exeter. Investors at fossil fuel companies should ask themselves. She added: “Is this a risk we are taking? Do you want to keep this when the music stops?”
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