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When the United States Oil Fund began offloading its short-term contracts earlier this week, it sent another shock to an already devastated market. Having just recovered from a tumble into negative prices the week before, US oil benchmark the West Texas Intermediate plunged 27.7% to $12.25 on Monday. Brent Crude fell below $20 a barrel. Records were broken, share prices nosedived and yet more oil companies filed for bankruptcy.
Things have rebounded slightly in recent days, but – in a sign of just how profound the damage is – Shell yesterday stunned the stock markets by slashing its dividend payments for the first time since the Second World War.
So what does all this mean for green investing? Is this a “we told you so” moment for the net-zero brigade? Or does it spell disaster for new technologies, climate stewardship and carbon prices?
This summer will mark the halfway point of Climate Action 100+, the flagship investor initiative which has spent the past two-and-a-half years coordinating shareholder engagement on decarbonisation. Many of its biggest victories over that time have involved the oil majors – a number of which have made commitments to be more transparent or ambitious on aligning with 2°C-or-lower as a result of combined pressure from its members.
But does the current situation stop those conversations in their tracks, as lock-down puts the kibosh on in-person AGMs and oil companies scramble to deal with more urgent matters than Paris alignment?
"This shouldn’t be seen as a blip. In fact, it’s just a glimpse of what the future holds" – Matt Crossman, Rathbone Brothers
“Whether it’s easier or harder, it’s certainly an opportunity,” says Matt Crossman, Stewardship Director at UK investment house Rathbone Brothers. “Business as usual is suspended, capex is being cut, staff furloughed and projects on hold,” he tells RI, pointing to climate campaigner Leo Murray, who recently argued that change is often effected best when patterns are already disturbed. “That applies to our personal lives, but also the oil majors,” says Crossman. “Investors can take advantage of this ‘habit discontinuity’ to keep talking about the longer-term necessity of a just, low-carbon transition.”
And, indeed, with lockdown already well underway, and just two weeks before it slashed its dividend, Shell made another historic announcement: it pledged to become a net-zero company by 2050. So there is some evidence already that oil companies have not shelved all their green promises.
The current oil slump is the result of a drop in demand, and Crossman says it’s a wake-up call. “Emissions are expected to drop by about 2,000m tonnes of CO2 (MtCO2) this year, or about 5% less than 2019” because of the reduction in industrial output, he explains. “To put that in context, to meet the goal of limiting warming to 1.5 degrees, we’d need to achieve a cut of that magnitude and more each year of this decade.”
“This shouldn’t be seen as a blip. In fact, it’s just a glimpse of what the future holds.”
On renewable energy in particular, Crossman points out that, before the oil slump, the sector was “riding a wave of lowering costs and increasing demand, and may well have sufficient momentum to ride through the crisis”. Plus, he proffers, “renewables projects offer a price and earnings stability which may be welcome in the recovery environment. It’s not just the historic low price which puts investors off traditional fossil fuels – it’s their volatility.”
And there is another, more unexpected, source of price stability in the current market. Europe’s carbon price. After the last financial crash, the bottom fell out of the EU Emissions Trading System (ETS) and many dismissed it as toothless and ineffective. But it may be proving critics wrong this time around.
At the end of last year, the price of a tonne of carbon under the system was nearly €27, and it is now down to just below €20. It is a decrease, but, as Mark Lewis, Head of Sustainability Research at BNP Paribas Asset Management and an expert in European utilities and carbon pricing, points out: “Compared to this extraordinary collapse in the oil price, the carbon market has held up remarkably”.
“Energy markets generally move in some kind of sync, and yet the carbon market is currently so out of sync with other commodities in terms of volatility that even its harshest critics would have to be impressed.”
It is all the more amazing because of its track record. In 2007, a glut in carbon credits on the back of the financial downturn resulted in prices hitting close to €0. After much political negotiation, a “Market Stability Reserve” was introduced last year, providing a mechanism to withdraw excess allowances from the market to ensure pricing levels didn’t plummet again.
“That’s providing a lot of support to the market, because it knows that a lot of the excess supply created by the current crisis will simply be removed,” says Lewis, although he warns that some of the buoyancy may be because emitters needed to have their allowances sorted for their 2019 emissions by the end of April. “There may have been some companies scrambling to buy their remaining allowances to meet those requirements, which could have kept the prices up a little,” he explains. “So I would expect a drop in price this month, although nothing overly dramatic.”
And if prices do continue to sit around €20, the EU ETS may offer more than just a safe haven against broader commodity volatility.
“At €20 a tonne, even the least efficient modern gas plants are currently cheaper to run than the most efficient coal plant,” says Lewis, adding that lignite has also been more expensive than gas this week. “That means that, at the moment, the carbon price is enough to make gas cheaper than coal and lignite in every country in Europe that has gas as an energy option. That really is astounding.”
Even Fatih Birol, Head of the International Energy Agency (IEA), has changed his mind on the impact of the low oil price on clean energy. Speaking to the Financial Times last week, he said the oil slump would “definitely put downward pressure on the appetite for a cleaner energy transition” but, in an IEA report released yesterday, he expressed a notably different position.
“Amid today’s unparalleled health and economic crises, the plunge in demand for nearly all major fuels is staggering, especially for coal, oil and gas,” he said in a statement that accompanied the report. “Only renewables are holding up during the previously unheard-of slump in electricity use.”
“It is still too early to determine the longer-term impacts, but the energy industry that emerges from this crisis will be significantly different from the one that came before.”
The report goes on to predict that renewables will be the only energy source to grow this year, although it will still fall short of previous years.
And then there is transport – another key investment theme for decarbonisation and impact strategies that could suffer brutally at the hands of a low oil price.
“There has been a lot of talk about whether these recent developments will pose a risk to the green transition in the transport sector,” says Kristina Church, Senior Investment Strategist for sustainable investment at Lombard Odier and a specialist in the automobile industry.
“Historically, a low oil price would have meant that we would see a lot of consumers switching to bigger, gas guzzling cars and driving more frequently; and you can see why people still expect that to be the case. But we don’t see that happening this time around, because there are such powerful market forces driving these trends – the falling oil price simply won’t be enough to put a stop to the current momentum.”
"At the moment, the carbon price is enough to make gas cheaper than coal and lignite in every country in Europe that has gas as an energy option. That really is astounding" – Mark Lewis
Those market forces include increasingly competitive prices for green technologies, consumer demand for sustainable products, and regulation.
“Regulation is a key difference from the last oil slump,” says Church. “Especially in Europe. Companies cannot not produce greener cars anymore, regardless of short-term cost dynamics, because governments have changed the rules.”
France, Norway, Denmark, the UK and the Netherlands are among a growing list of countries to announce plans to ban the combustion engine in coming decades.
In addition, Church points out that some governments also tax fuel to the extent that a depressed oil price won’t translate into notably lower prices at the petrol pumps. “If you look at somewhere like the UK, we’ve only seen a 3% drop in petrol price, despite such dramatic moves in oil, because of the tax component.” Therefore, she suggests, consumers’ heads won’t necessarily be turned by promises of cheap conventional vehicles.
Overall, it looks like the current downturn in oil prices could offer real opportunities for green investors or, at least, aren’t a death knell for the industry.
“Our key message has been an encouragement to stay the course,” says Crossman. “The fact is that, however severe the current situation, it will pass. And we’ve speculated for years with the management of these companies about some of these changes. 2020’s crisis is a dress rehearsal for the climate transition.”
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