Why oil firms should worry more about climate change

THE oil industry has much to fear from the Paris climate deal of 2015, which aims to limit temperature rises to less than 2°C above the pre-industrial era. To curb carbon emissions, demand for fossil fuels will have to drop in coming decades. That is likely to push down oil prices and the value of investments that firms have made based upon them.

A report published on August 6th by Sarasin & Partners, an asset manager in London, suggests that oil firms are assuming that decarbonisation will be limited and are thus overstating their assets. Sarasin notes that eight European oil giants all used long-term oil price assumptions of $70-80 a barrel, rising by 2% a year with inflation to $127-145 by 2050, to price their assets. But that does not appear to assume any drop in demand. The International Energy Agency predicts a price of just $60 by 2060; Oil Change International, an activist think-tank, estimates one as low as $35 (see chart). Oil firms could face a sticky mess of forced writedowns.

The picture is complicated by the fact that in Europe oil firms can choose their own long-term prices, whereas in America regulators compel firms based there to use the average price over the past year, which is nearing $70. Executives in both places have their reasons for thinking that prices will be higher than the worst forecasts, particularly as the world is set to miss the Paris goals.

Setting those aside, prices are likely to be lower anyway in the next few decades, says Adam Pilarski of Avitas, a consultancy. There will be ups and downs to do with geopolitics. Prices are up from $26 in 2016 to over $70 mainly because of Venezuela’s meltdown and better co-operation between Saudi Arabia and Russia. But the economics on the supply side are clear: plentiful reserves and the falling cost of technology for extracting oil will soften long-term prices.

Natasha Landell-Mills of Sarasin says oil firms should be more transparent about the risk this poses to assets and profits. Other fund managers, such as Aviva Investors, echo that view. In Europe oil bosses are preparing for lower prices, though they are still unwilling to say as much. Shell and its British rival BP are aiming to make new projects break even at just $40. Investors are more worried about the American firms. Rising prices have lured them to start splurging on pricier projects. America may be leaving the Paris deal, but escaping its impact on global oil prices is harder.