The 2023 energy year in review
In many ways, 2023 feels like the eye of the hurricane threatening the reliability of the American electric grid. It was the first year since 2019 that rolling blackouts didn’t…
A recent article by Goldman Sachs explains how so-called green banking practices are pushing up the price of oil.
The article states:
Even as oil prices climb higher, the flow of money into new oil and gas projects has stalled as investors increasingly avoid industries that produce fossil fuels and heavy carbon emissions. That breakdown between energy prices and capital expenditures is likely to prop up the cost of a barrel of oil, but it could also help support the transition to low-carbon energy.
This first paragraph is an admission that high energy prices are not an unfortunate side effect of the Biden administration’s whole-of-government attempt to reduce carbon dioxide emissions.
In reality, high energy prices are the point because the administration thinks high costs are necessary to stimulate investment in alternative technologies, as you can see in the interview below.
Your research shows that the link between higher energy prices and capital expenditures has broken down. What severed that connection?
Michele Della Vigna: “The capital markets engagement on climate change has reached very high levels. We can measure it in many ways, like climate change shareholder resolutions where the approval rate went from 10% to 40% during the past 10 years. And this drives a complete divergence in the cost of capital of high-carbon versus low-carbon energy projects. We estimate there’s been a divergence of 15 percentage points in the cost of capital. This is just to give you an indication of how extreme the impact is of the capital markets focus on climate change.
Because of this shift, the industry finds itself severely capital constrained on traditional hydrocarbon investment in different ways. For smaller exploration and production companies it’s about getting financing. For larger integrated oil and gas companies it’s about decarbonizing. But either way, none of these companies can scale oil and gas projects the way they used to. And if you think that most companies effectively are forced to embrace a carbon budget, a carbon budget ultimately leads to less oil and gas development, leads to higher hurdle rates, or cost of capital for these projects, and automatically means that whatever the cash flow available may be, capital expenditures are restrained.
This severe restraint on capex in oil and gas is what breaks that historical relationship, and, even in a tight oil and gas market, prevents the creation of new oil and gas fields. That prolongs the up-cycle and brings what we call the “revenge of the old carbon economy,” because this creates supply tightness and ultimately generates what could be one of the most interesting commodity up-cycles we’ve seen in decades.
Higher oil prices are absolutely consistent with a push for decarbonization that comes from the capital markets.”
At the GS Global Strategy Conference, your colleague Jeff Currie said investors are also influenced by the recent history of investment losses in energy. Is that another reason capital isn’t going into this sector?
Michele Della Vigna: It is a very reasonable comment. But interestingly, if you look back to previous recoveries, you used to see a doubling of capex within two or three years. This time around, we think capex in two or three years will barely go up in oil and gas by 20%. So something is not just cyclically but is structurally different here.
Now, there will be other avenues of capex. If you included low-carbon investments, you would see a bit more capex recovery because there is a shift to low carbon but still nothing like the capex increases we’ve seen in previous up-cycles.This suggests higher prices for energy in the longer term. Does that help or hurt the transition to low carbon energy?
Michele Della Vigna: It definitely helps to accelerate the energy transition. The more expensive the hydrocarbons, the cheaper the low-carbon alternative becomes. To give you an idea, our carbonomics cost curve came down last year by 12%, almost entirely driven by the higher cost of the traditional hydrocarbon-based technologies. So it does help from a relative perspective, but it also creates affordability problems which could generate political backlash. That is the risk—political instability and the consumer effectively suffering from this cost inflation.
But from a pure economic perspective, higher oil and gas prices accelerate the energy transition. They just do it in a way that can be disruptive from a social perspective.
It is interesting to see how analysts at elite financial institutions like Goldman Sachs think, and it is amazing how utterly wrong they can be about their prognostications for the future.
The idea that high costs for oil, natural gas, or coal will make lower-carbon alternatives more affordable is laughable, especially because these same financial institutions rarely support new nuclear power, which is the only energy source that could conceivably benefit from high fossil fuel prices.
For wind and solar, their energy output is so erratic that they will be poor substitutes for fossil fuels. Additionally, the material intensity of the metals and minerals needed for wind turbines, solar panels, and battery storage facilities is so large that rising fossil fuel prices will cause the price of everything to increase, including these technologies.
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