How Climate Change Could Destroy Energy Companies

Climate change may have been responsible for Hurricane Sandy's $60 billion-plus in damage. It also may be to blame for last summer's drought that cost another $77 billion. Maybe chalk up record-high temperatures, flooding, and wildfires in Australia to a changing climate. But could stranger weather destroy hundreds of billions in companies' value?

It's possible. A lot of the energy reserves that sit in the ground might not be able to be extracted if policy to mitigate climate change aggressively targets limiting carbon dioxide emissions. And a lot of energy companies' value comes from their proven reserves.

Climate primer
The goal of only a two-degree Celsius increase in global temperature, which was the agreed-upon goal in Copenhagen in 2009 to avoid the worst of climate change, is based on an atmosphere with 450 parts per million of carbon dioxide. With a two-degree increase, global sea levels are expected to be more than 20 feet higher and the entire ice sheet over Greenland will eventually melt. But at the rate the planet is currently headed, global temperatures could rise over six degrees Celsius.

To achieve this two-degree goal, the International Energy Agency writes, "No more than one-third of proven reserves of fossil fuels can be consumed prior to 2050... unless carbon capture and storage (CCS) technology is widely deployed." It continues, "Almost two-thirds of these carbon reserves are related to coal, 22% to oil, and 15% to gas."

Trying to determine what that means for individual companies would be a tough task for individual investors, but, thankfully, HSBC took on this task for European-based companies. The study is more of a thought experiment than hard analysis because there are so many variables, such as how policy would restrict energy reserves and which companies would be affected most. But for long-term investors, it's a good question to explore -- especially with President Obama's recent emphasis on climate matters in both his inauguration speech and his new pick for chief of staff.

Chopping value in half
According to FT Alphaville, the report imagines a world with less demand for oil and gas with a much more efficient transportation sector. Due to less demand, the prices of oil and gas fall and companies abandon projects that are too costly to pursue. This leaves a portion of proven and probable reserves, or P2 reserves, in the ground. Just how much?

Company Proven Reserves (mmboe) Estimated Unburnable of P2 Reserves
Shell (NYSE: RDS-A) 14,250   <10%
BP (NYSE: BP) 17,748  25-30%
Total (NYSE: TOT) 11,423  10-15%
Statoil (NYSE: STO) 5,426   15%
Eni (NYSE: E) 7,090  10-15%

Source: Company listed reserves; FT Alphaville.

Shell makes out the best of the European companies from the estimates, only restricting a bit less than 10% of its proven and probable oil and gas reserves. BP, on the other hand, leaves more than 25% of its proven reserves in the ground. Total, Statoil, and Eni fall in between. 

These numbers don't seem so bad, until you look at how a cut in reserves and prices affects the market capitalizations of each company.

Shell, BP, and Total lose between 40% and 50% of their market caps. Eni's market cap is more than cut in half. And Statoil faces more than a 60% drop in value. For those looking at energy companies as guaranteed bets on an energy-hungry future, considering the potential of regulation, especially from the European side, is a must.

As Hurricane Sandy sparked a conversation on climate change's role after affecting millions, similar weather events could quickly change political climates elsewhere in favor of environmental restrictions. Take China's current smog issue, which has led to cancelled flights and closed factories, and may lead to clean air legislation.

But inertia is a strong force
Even with more climate advocacy, the world is still far from hitting the two-degree and 450 ppm goals. Globally, we would need to decarbonize at an annual average rate of over 5% through 2050, while we only managed to decarbonize 0.7% in 2011. So, the way things currently are, two-degrees looks far from doable, and energy companies likely will realize the worth of their reserves.

However, there's also the possibility that if technologies like those that capture carbon improve, both energy companies and those worried about climate change could realize a world that's mitigated effects to both market caps and marsupials. Climate doesn't have to be a zero-sum game, and companies that remain sustainable far into the future are likely to give investors the most returns.

Investing for a different future
If you're on the lookout for some currently intriguing energy plays, and question that demand for oil and gas would ever decline, check out The Motley Fool's 3 Stocks for $100 Oil. You can get free access to this special report by clicking here.


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