Energy transition = volatility

Oil and gas investment is simultaneously way too high and dangerously low

Two contrasting papers this week threw into sharp relief just how irreconcilable energy market stability and climate change mitigation can be. A brewing investment crisis threatens to spill over into a genuine energy supply crisis that could make the extreme market events of late 2021 look like a mere blip in hindsight. A huge hike in upstream oil and gas investment this decade would stave off the threat, but at untold environmental cost.

Oil and gas prices are notoriously spikey and prone to supercycles. The ongoing fallout from Covid-19 and a messy energy transition are intensifying price instability, both at a macro and micro level.

The International Energy Forum this week warned that “unprecedented uncertainty” around the energy transition is driving a trend of “pre-emptive underinvestment” in oil and gas supply that threatens to exacerbate wild price swings:

“Record price volatility and increasingly divergent long-term demand narratives are being amplified by a changing regulatory and capital market environment and ESG pressures. Combined, these forces are fostering … structural underinvestment for oil and gas supply.” – IEF

The IEF, which facilitates ministerial dialogue between 71 energy producing and consuming nations, said annual upstream capital expenditure levels must rise more than 50% over 2021 levels to hit $525 billion by 2030 to meet expected demand.

Cumulative capital expenditure would have to reach $4.7 trillion over 2021-2030 to prevent a supply shortfall, even if demand growth slows toward a plateau. This is mainly due to the need to offset field declines, the rate of which is increasing due to the switch to short-cycle production source such as shale.

Although the $4.7 trillion figure is below 2011-2020 cumulative capex of $5.5 trillion, there is plenty of reason to doubt whether the required capital will materialise.

Emerging risks include divergent long-term demand outlooks and external pressures on investment from policymakers and shareholders. This new environment is impacting decision-making, the IEF said, leading to structural underinvestment as companies look across an “obstacle-ridden landscape”:

“Ultimately the key risk facing markets is a mismatch between the speed of energy transitions and the speed and scale of underinvestment. Pre-emptively reducing investment in the upstream without reduced demand will result in more market volatility at a higher price band and economic disruptions that will bring political turmoil.

“When there is too little or too much supply for demand, prices become volatile and can set off a wave of unwanted boom-bust prices. Therefore, for a just and orderly energy transition, a decline in the supply of oil and gas should not be reduced ahead of a similar decline in the demand of oil and gas.” – IEF

A volatile climate

Is this another piece of ‘predatory delay’ from an institution captured by fossil fuel interests, or a genuine red flag that should concern, well, everyone?

The IEF report is notable in what it omits. There is no analysis of the compatibility of its upstream investment figures with the goals of the Paris climate agreement. It makes no mention of global carbon budgets or how to keep the world on track for 1.5°C or 2°C of average heating while meeting energy needs. The phrase ‘stranded assets’ is conspicuous by its absence.

By some estimates, burning all of the world’s already-discovered oil, gas and coal resources would push global heating towards a 4°C increase in average temperatures. This is leading academics who used to teach young geologists how to find oil and gas to call for an abrupt end to fossil fuel exploration.

David Waltham, a geophysics professor from Royal Holloway University of London, this week said a ban on new oil and gas fields “could be in the financial interests of fossil fuel companies” by saving on exploration costs and boosting the value of existing oil and gas fields:

“In contrast, continually adding new capacity to extract fossil fuels will lead to a price collapse when actions to combat climate change hopefully lead to greatly reduced fossil fuel demand. Such price falls would not only hurt oil company profits, but would also encourage additional fossil fuel usage and make climate targets even harder to meet.” – Professor David Waltham

On a wing and a prayer

The key word in the above passage is ‘hopefully’. Hoping that demand falls neatly in tandem with declining production means invoking the kind of extreme price volatility described by the IEF, with all the attendant negative economic consequences.

Waltham’s article does not consider how structurally higher prices would impact vulnerable consumers, spark social upheaval, or aggravate geopolitical tensions between energy producing and importing regions (think: Europe and Russia).

And then there is the question of how to roll out the many thousands of wind farms, solar arrays and battery storage projects that decarbonisation envisages when the costs of energy-intensive materials such as rolled steel, polysilicon and cobalt are skyrocketing amid widespread oil and gas shortages.

Nonsensical consensus

If squaring the climate and energy circle means choosing between near-term market chaos and slightly less immediate environmental collapse, then it should come as no surprise that governments are happy to commit to vague and distant ‘net zero’ targets while scrambling to put a lid on energy prices now – by whatever means necessary.

Weak political ambition could be seen as an implicit global consensus to tackle climate change slowly. The trouble is, not stating this explicitly leaves a yawning gulf between rhetoric and reality that ‘the market’ cannot navigate coherently. Rational economic actors are confused by conflicting messages.

As long as decarbonisation remains at odds with market stability, there is little chance of the IEF’s investment fears being assuaged — meaning the world remains on course for a messy transition. And even if trillions more dollars were flowing into new upstream projects, we would all pay a heavy environmental price for that last fleeting gasp of relative economic stability.

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Main photo by Soheb Zaidi on Unsplash

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