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Potential threat looms to investment World’s central banks could pose threat to oil companies should they follow ‘carbon bubble’ theory put forth by Bank of England KAY CASHMAN Petroleum News
According to Daniel Yergin, a potential threat looms for international oil companies from an unexpected source - the world’s central banks.
Yergin, vice chairman of IHS Markit and a long-time respected energy industry authority, sees efforts to force publicly listed oil companies to produce information about their exposure to the so-called “carbon bubble” as misguided.
The issue was raised about a year ago by Mark Carney, governor of the Bank of England, and chairman of the Financial Stability Board, at Lloyd’s of London, who said in a September 2015 speech that climate change - specifically “transition risk” - could threaten the world’s financial stability through a sudden and significant collapse in oil company asset values.
Carney argued that the transition to non-carbon-emitting energy sources could “render the vast majority of (oil gas and coal) reserves stranded,” as a result of the world’s transition to non-hydrocarbon forms of energy.
Argues oil company investments to become worthless “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. This is a deeply flawed theory,” Yergin said in a recent press report in The National, prior to his presentation at the Abu Dhabi International Petroleum Exhibition and Conference.
An energy transition that “unfolds over decades does not constitute abrupt systemic risk to the financial system,” Yergin and IHS senior economist Elena Pravettoni said in an October IHS report on the issue, “Do Investments in Oil and Gas Constitute ‘Systemic Risk?’”
The calculations of other central banks and fiscal experts have differed from Carney’s, including that of his predecessor as governor of the Bank of England in 2012.
Nonetheless, Carney’s position has started to gain traction due to his influential position as chairman of the Financial Stability Board, a G-20 group of 20 developing nations that have tasked themselves with improving risk management in the world’s richest economies.
A key consideration in this debate is the valuation of oil and gas reserves.
IHS analysis “demonstrates that oil and gas company valuations are primarily based on reserves that will be produced and monetized over a 10–15 year period - a relatively short time frame in which an energy transition is unlikely to unfold,” Yergin and Pravettoni reported.
“Furthermore, the recent oil price collapse has proven to be a high-stress ‘stress test’ for the oil and gas sector. According to IHS Herold, 82 global oil and gas companies lost 42 percent of their market value from June 2014 to December 2015 - equal to $1.4 trillion in market capitalization. Yet, this fall has had minimal systemic impact on the global financial system thus far. Since oil prices fell below $100 per barrel in September 2014, the Dow Jones Index has risen 6 percent,” Yergin and Pravettoni reported.
IHS found that about 80 percent of the value of most publicly traded oil and gas companies is based on their proved reserves, which account for roughly 20 percent of the resource base of global international oil companies by volume. Their valuation is based on the present worth of expected cash flow from projects and reserves that will be produced in the short to medium term (typically monetized within 10–15 years) and are consequently at minimal risk of being stranded.
“Therefore, there is little risk of oil and gas companies being overvalued by potential climate policy restrictions,” IHS determined.
Public companies hold 7 percent of world’s reserves Moreover, the alarm over stranded reserves and company valuations fails to take into account the reality that publicly traded international oil companies represent only a small percentage of the world’s total reserve base. Only 7 percent of total world oil and gas reserves are fully accessed by these firms - the vast majority are controlled by state-owned national oil companies. Their reserves “are clearly not part of investor portfolios and therefore would not create any direct risk to private financial investors,” IHS determined.
Enlarged focus since 2008 The growing focus on climate change by central banks is occurring at a time when independent central banks “are coming under the spotlight for taking on more expansive roles in general. Some critics have argued that this new (G-20) initiative represents an overextended reading of their mandate to protect the financial system from systemic risk,” IHS said.
Traditionally, central banks have been concerned with inflation and price stability, economic growth, and employment objectives. The focus on climate change followed the financial crisis of 2008. Since that time, central banks have gained greater responsibilities, expanding their regulatory reach in financial stability and protecting the economy from systemic risk. The term “systemic risk,” which also gained wider currency after 2008, denotes, in the words of the International Monetary Fund, a risk that has the potential to lead to a “broad-based breakdown in the functioning of the financial system.” It is also defined by the breadth of its reach across institutions, markets, and countries and is intertwined with the notion of an immediate financial collapse,” IHS reported.
Carney and former New York mayor Michael Bloomberg, whom Carney asked to oversee a task force to look into the financial risk of climate change, will report in December on whether to recommend the adoption of a code for climate reporting by oil companies.
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