Many mainstream institutional investors have realised that climate change is not just a threat to planet earth, it’s a threat to the wealth of their clients.
Upcoming investors of the oil industry are worried about the long-term returns of fossil fuel energy sources due to their inexperience. The European utility sector has seen billions of euros wiped off its market cap by the roll-out of renewable energies like wind and solar. The reason why wind and solar energy pose a threat to the energy system is that they have a “short-run marginal cost of zero”. Basically, the energy itself arrives for free. Almost all of the costs of wind and solar energy are in the infrastructure required to capture it and these capital costs have been dropping over the last few years.
This is not the case for oil and gas though, so these sectors will have to recognise that the economics of renewables are becoming quite irresistible.
To prove the point, take for example an investor who has $100 billion and this individual must invest in oil or renewable energy, to power vehicles.
Ultimately wind and solar projects will produce 4 times more useful energy at the wheels than oil will at $60 a barrel of diesel vehicles. The ratio is less favourable for petrol vehicles because the renewable investment will produce about 7 times more energy. As time progresses and electric cars become a trend, the long-term break-even oil price required for gas to remain competitive as a source of mobility could fall as low as $10 a barrel.
The important point is that in time, the returns upstream oil projects will decline eventually as oil is forced to compete with energy sources that produce at much lower costs. Yes, the oil industry is flourishing now and enjoying massive scale advantages over wind and solar but in time this will change.
It is key to notice that there is a competing energy source with short-run marginal costs of zero that’s environmentally cleaner and will be able to replace almost half of the global oil demand. The economics of energy is looking bright and the same cannot be said for oil.