Rathbones’ Matt Crossman says fossil fuel reserves have quietly stepped off the agenda
Sometimes a memory of a moment creeps up on you when you least expect it. For me that happened on train reading a PDF a few weeks ago – nothing particularly new there, many of us only get to read on public transport away from the stream of notifications. You might be familiar with this feeling – when a concept stands out in a piece precisely because it was incredibly important and you haven’t heard it for a while.
So to give you the context – I was reading an excellent report from Principles for Responsible Investment and Chronos – Climate data and net zero: Closing the gap on investors’ data needs. And nodding through agreeing with every sensible recommendation one stopped me in my tracks. Under the heading “facilitate data comparability” the authors state investor needs for data providers to “develop and agree a common approach to assess and report fossil fuel reserves”.
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We used to talk about reserves all the time. Now we spend our days stressing over value At risk models, weighted average carbon intensity, embedded emissions and endless pass the parcel arguments about dealing with Scope 3. Reserves have quietly stepped off the main agenda. Why? Are they any less fundamental to an investment case for companies in the energy and mining sectors?
I was there in the room when Carbon Tracker’s simple but seismic Carbon Bubble report was launched. Sometimes you just know an idea will shape a moment and so it proved. A report distilling complexity into a simple, stark and actionable thesis. Put simply, all the fossil fuel reserves in every listed company balance sheet in the world if extracted would exceed the carbon budget. So we have a classic valuation bubble risk. If that was true in 2013, why has this crucial observation been starved of the limelight?
Our experience of engaging with energy companies on net zero proves the carbon bubble needs to return to investor dialogue on climate change. It’s the ultimate material long term financial risk. And it’s still being ignored. We have gotten more complex in our asks – through TCFD notably – about how companies are planning for the future. We ask about emissions scenarios and models – but what we are really driving at is that not all companies will be able to produce everything that’s on their books. But each individual dialogue unveils a collective delusion.
It feels like every company we speak to thinks it will be the one to extract the last barrel of oil. Every one points to a net-zero scenario in 2040 where fossil fuels play “a role” in the global economy and so justifies their continued capex accordingly. But long-term investors should be mindful of the risk to these assumptions, IEA models see fossil fuels shifting from supplying 80% of primary energy demand today to around 20% by 2050. Instead of each company thinking wishfully that it will corner as much of that 20% as it needs, why aren’t investors challenging the industry on how it will respond to such a significant potential cut in demand for its products?
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And the prospects get worse the more you consider the inefficient nature of using fossil fuels in thermal generation – as we shift to directly generated energy like solar and wind we will need less total energy to meet projected demand because these new technologies are far more efficient. Further, we now have a world where national oil companies can hold their reserves into private markets. Surely, in this age of heightened geopolitical instability, these reserves have a higher likelihood of being produced over those of the listed oil companies? Of course there is the risk that the world may not meet its net-zero ambition.
Put simply, it’s time to return focus on ‘the carbon bubble’ now
Net-zero targets, escalation frameworks and engagement plans on climate change have their place – but they shouldn’t starve the vital, material discussions of bandwidth. It’s time to pick up the climate bubble baton from where we left it, standardise our approach to categorising fossil fuel reserves and work out how exposed our portfolios are to this real world, material risk.