Are the gyrations in the oil price the first sign of the climate change “Minsky moment” foreseen by Mark Carney and others? Vibeka Mair takes a look.
When the oil price shock hit on Monday, the Centre for Climate Finance and Investment at Imperial College London analysed the performance of renewables versus fossil fuels in listed equity markets and found some interesting results.
Charles Donovan, Executive Director at the Centre, explains: “We’ve been doing work to look at the underlying risk factors that are driving returns in renewables versus fossil fuels in listed markets.
"There was a defensive property around renewables relative to the rest of the energy sector"
“On Monday, we saw how a portfolio of renewable energy shares performed relative to fossil fuel stocks under high stress. When you have a big sell-off, that should be very bad for high beta stocks. In particular, small cap stocks usually get hammered.”
The analysis in fact found that the renewable energy portfolio – which excluded utilities – dropped by only half as much as the basket of fossil fuel stocks.
“No-one was spared from financial contagion,” says Donovan, “but there was a defensive property around renewables relative to the rest of the energy sector.”
Donovan says a decoupling of oil prices and renewable power is long overdue. “Investors are starting to discern the differences between which commodity prices drive the performance of what types of companies. The next challenge is for markets to take up more efficient pricing of relevant changes in commodities, technological developments, and government policies.”
According to another analysis by MSCI’s Remy Briand, “green stocks”, since last April have been already outperforming “brown stocks” with a noticeable uptick since Monday.
And yesterday, Reuters reported that the oil price crash has led to Danish offshore wind developer Orsted overtaking Norwegian oil giant Equinor as the most valuable energy company in the Nordics.
Of course these are short term and underdeveloped indicators, but it could suggest renewable energy is becoming less correlated with oil, coal and gas energy – which wasn’t the case for the 2014 oil drop says Seb Beloe, Partner at sustainable and impact manager WHEB – which does not invest in fossil fuels.
“There was clearly an impact on energy-efficiency type stocks suffered at the time. Renewable energy stocks as well were highly correlated with the oil price back then.
“Anecdotally it sounds like now that relationship’s broken down. That would be our experience as well. It’s been a tailwind for the fund for the last three to five years, not owning oil and gas companies. And it has been a significant boost indeed over the last few days.”
Beloe says the risk profile of energy, oil and gas investments has changed significantly in the last five years, “part of that is due to investor pressure, the work of ClimateAction 100+ and the clear recognition of the risk of stranded assets”.
He also says while before a low oil price has driven demand, the renewable sector is much more mature to weather it, “the cheapest form of new power generation in many parts of the world is now wind and solar, it is not coal and it is not even gas.”
Beloe also points to policy commitments on climate change, such as the Paris agreement and the UK’s recent net zero pledge.
But despite these country pledges, other investors feel the drop in oil price will harm the renewable sector over the long-term, coupled with fears of an economic crisis and the coronavirus pandemic.
“It’s stressing the balance sheet of governments,” says Nick Stansbury, Head of Commodity Research at Legal & General Investment Management “We’ve already seen overnight news that China was dialling back on its subsidy programme to the solar industry.”
Stansbury does say that the energy transition is starting to bite into oil growth demand, but only at the margins.
And he adds: “The oversupply that exists in the market now is unambiguously really bad news for the low carbon energy transition.
“It is bad news because a lot of these forces that seen to be at work might be quite structural. A very big oversupply of oil is going to result in very big inventory bills. It’s going to take a long time to work its way out. A low oil price may well be with us for quite some time.”
Coupled with coronavirus, and its effect on oil demand, Stansbury says that, in terms of the energy transition, it will make substituting green cleantech more expensive relative to the carbon intensive equivalents.
He says that carbon taxes will be less effective, and adds: “We are supportive of oil and gas companies moving to renewables. But many of their balance sheets and cash flows are now deeply distressed. The ability of the industry to play a constructive role in the energy transition is contingent upon a healthy oil price.”
Stansbury also notes that the falling oil price flows through to electricity markets as so many LNG cargoes are linked to oil prices, driving down fossil fuel-based power prices relative to renewable based power prices.
Michel Salden, Senior Portfolio Manager, Vontobel Asset Management, is also pessimistic about the fortunes of renewable energy in a persistent low oil price environment. He said on Monday: “A lower oil price will stall the green revolution in the world. Energy-consuming economies like China, EU, Japan and other emerging markets will rush to exploit a period of cheap oil and gas and likely shift to cheap fuel consumption instead of renewables.”
But others say lower oil prices could have advantages if people think creatively.
Nick Spencer, a consultant with Gordian Advice, thinks governments could take advantage of lower oil prices to bring in higher carbon taxes: “It would come in at no higher price than oil used to be. And you would also retain the benefit of the economic incentive to reduce consumption.”
And Mike Clark at Ario Advisors, says the oil price war could be used as a trigger for interesting conversations about real world risks and strategic asset allocation for asset owners – an emerging field in development.