With the much-hyped United Nations climate summit known as COP26 coming to Scotland at the beginning of November and energy prices leaping from one high to another, you might be forgiven for wondering, whatever your view of climate change, whether attempts to curb the production and use of fossil fuels might just have something to do with their prices rising so vertiginously of late. Not at all, comes the retort from the more evangelical wing of the climate lobby, this latest crisis just shows we need to switch to cleaner energy sources more quickly.
Even Fatih Birol, the head of the International Energy Agency, claimed that “clean energy transitions are a solution to the issues that we are seeing in gas and electricity markets today — not the cause of them.” Such views fail to hold up to scrutiny, as even a cursory look at the IEA’s own statistics would confirm.
Governments around the developed world have vowed to dramatically cut the use of fossil fuels and have put in place rules and timetables to do so. For better or worse, they have been egged on not just by those fearful of dramatic climate change, but by an investment community that wants to earn decent returns and feel virtuous at the same time. Hence the huge vogue for environmental, social and governance (ESG) funds, a catchall term for a group of concerns that have very little in common except a zeitgeisty moral flavor. Companies that dig and drill stuff out of the ground and sell stuff that produces lots of gases generally don’t find favor in ESG funds, even if those companies have lovely governance structures.
To be sure, low energy prices in recent years have played their part, but a far bigger reason for the significant underperformance of energy companies in global equity indexes over the past decade has been government regulation and the general demonization of energy company assets. Is it any wonder that these companies have hugely cut investment, not just for new fields but also for getting the most out of existing ones? Oil and gas exploration investment almost halved between 2015 and 2020, according to the IEA. Overall investment in fossil fuels fell to $588 billion last year from $1 trillion in 2015. Admittedly, that drop was exacerbated by the COVID-19 pandemic, but the truth is that, even on the IEA’s numbers, investment has been falling for years.
Current investment is woefully inadequate to keep pace with likely global energy demand in coming years. Apart from last year, overall energy demand has grown by about 2% a year for the past 10 years and is likely to continue to expand at least the same rate, according to BP Plc. Most of the increase in demand has come from emerging economies. You can see this in the demand for oil products such as gasoline, jet fuel and the like. Among the 34 members of the Organization for Economic Cooperation and Development — basically a rich-country club — such demand has been flat for the past 10 years. In non-OECD countries, it has been rising by 3% a year. In China, it has been going up by 5.5% a year, and there seems almost no interest from the country’s rulers to tie themselves to curbing the use of fossil fuels.
The trouble is that renewable energy accounts for a tiny fraction of overall energy supply. The growth in renewable sources of energy fails to even meet the growth in overall global energy demand. Read that sentence again. The IEA itself says that with current policies and timetables in place, investment in oil and gas needs to be hundreds of billions of dollars higher every year just to meet likely demand. Absent such investment, you shouldn’t be surprised if energy prices go higher — probably a lot higher. The current surge in natural gas prices is probably just the start. Sure, higher prices will bring forth some extra investment, but it seems unlikely to be anything close to enough. And it may well come in areas such as coal that are cheaper than, say, natural gas to keep running, but also far more polluting.
Without a sensible, realistic investment strategy — and timetable — for producing renewable energy, the effects of shunning investment in traditional energy sources are likely to be little short of catastrophic if I’m only half right. Sharply higher energy prices will mean, among other things, much higher transport costs, much higher heating bills and much pricier food. Overall inflationary pressures will continue to rise. Higher energy prices will at some stage cause a global recession, as they did in the 1970s. All this will hit the poor and the poorest countries the hardest.
Many political systems in the developed world are already decidedly strained. In the U.S., the U.K. and continental Europe, the schisms between the haves and have nots, the left and the right, and the consensus among those who consider themselves elites and the rest has been as wide as anything I can remember. Fast-rising energy prices and global recession are likely to bring some of them to a breaking point. Governments and ESG investors can feel as virtuous as they like. But willfully-blind ignorance about the consequences of their actions — deep recessions, broken societies and millions more going hungry — doesn’t make them any less immoral. The road to hell, after all, is paved with good intentions.
Richard Cookson was head of research and fund manager at Rubicon Fund Management. He was previously chief investment officer at Citi Private Bank and head of asset-allocation research at HSBC.