Regardless of how much time Exxon Mobil Corp. wants to spend weighing the risks of climate change, its investors are now demanding it. In what promises to be a landmark disclosure, Exxon, the world’s largest publicly traded oil company, has agreed to provide the market with an assessment of how changing legislation around carbon emissions will affect the value of its oil and gas reserves. Taking a cue from the industry leader, other producers, such as oil sands players Suncor Energy Inc. and Canadian Natural Resources Ltd., are expected to follow suit.
Exxon, of course, is no stranger to carbon emissions. It’s been a world leader in that area since its inception as Rockefeller’s Standard Oil. Indeed, since the Industrial Revolution a remarkably short list of only 90 companies accounts for two-thirds of all human-made carbon dioxide emissions. Among this exclusive group of top tier carbon-spewers, Exxon (in all its corporate guises) ranks an impressive second among publicly traded ones, accounting for 3 per cent of overall emissions. First place is held by another member of the Seven Sisters, Chevron Corp.. When the world’s governments finally get serious about putting a price on carbon, it’s safe to say that these carbon-emitting giants, and their shareholders, will feel the squeeze most of all.
Investors won’t have to wait for Exxon’s disclosure to get a sense of how emissions constraints will affect the valuation of the company’s oil and gas reserves. The International Agency in its 2012 World Energy Outlook outlined the magnitude of the shifts in fuel usage that will be needed to hold the level of atmospheric carbon to 450 parts per million. That’s the threshold that scientists warn we must not cross if we’re to hold the increase in average global temperatures to no more than 2 degrees Celsius. If the planet gets hotter than that, they say, we can all brace ourselves for all manner of climate-inspired nastiness.
By 2035, the IEA estimates that world coal consumption needs to fall by 30 per cent from current levels, while global oil usage will have to drop by 12 per cent. If those projections are even remotely accurate, what do you think that will do to coal and oil prices?
Here’s a hint. During the last recession, world oil demand fell by 3.4 million barrels a day between the first quarter of 2008 and the second quarter of 2009. During that time period, crude prices retreated from nearly $150 (U.S.) a barrel to, briefly, below $40. The plunge was short-lived and certainly there were other recessionary factors at play, but the precipitous drop is still instructive.
The IEA’s projected decline, which would unfold over the next two decades, would involve a drop in global oil demand more than three times as large as the one seen during the Great Recession. It may take longer to get to, but if world oil demand is going to fall by more than 10 per cent then oil prices are certain to head lower as well.
Are we going back to a world of $40 oil? If so, it won’t be because oil has suddenly become cheap and plentiful. On the contrary, oil will never have been scarcer. At that price, the vast majority of the world’s oil supply, from the Canadian oil sands to the shale oil of the Bakkens, will no longer be economically viable to produce. The only places that will be pumping barrels at those prices will be low cost producers in the Middle East.
Falling prices for fossil fuels are a death sentence for oil, coal, and natural gas producers. When prices go up it opens the door to new sources of supply that were previously too expensive to extract (Alberta’s oil sands are a case in point). Falling prices, in contrast, cause supply to be shut in and turn what were once considered proven reserves into stranded assets that remain in the ground.
A world in which carbon emissions are constrained because of climate change legislation is a world of much lower prices for coal and oil. Falling prices will also bury the Exxon’s of the world. Much of the value of any oil company is based on the proven reserves it holds in the ground. When prices go lower those assets will become stranded – which is exactly what will happen to shareholders as well.
Jeff Rubin is a former chief economist of CIBC World Markets and the author of the award-winning Why Your World Is About To Get A Whole Lot Smaller as well as The End of Growth.