Slowly but surely people are beginning to wake up to the fact that combating climate change is going to cost rather a lot of money. This at least is an improvement on the seemingly widely held assumption that all that is required is governmental agreements, legislation as a result and a willingness to turn the lights off more often or buy a bicycle. Sad to relate, the problem will require not merely replacing our current electricity supply with renewables, but will equally require a great deal more power capacity than we have now to provide the necessary heat required for our industrial processes.

We are not simply changing our oil, gas and coal consumption for industry, domestic heating and transport, but effectively electrifying most of it. Electric cars alone will enormously increase power demand. We are in effect abandoning combustion as a source of energy. Furthermore, we are abandoning combustion as a source of that electricity at the same time. Or at least that is what we hope to do.

The implications for global finance are interesting. If, for example, we simply switched off all fossil fuels tomorrow and everybody simply refused to buy them, as Greta Thunberg might well like, there would be a spectacular banking crisis. This would be because all oil, gas and coal assets would be stranded, or effectively worthless. As a result, all bank debt including company bonds to such companies would be worthless too. The apparent result would be a collapse of pension funds also and it would knock the 2008 banking crisis into the proverbial cocked hat.

In this regard an interesting study is currently circulating commissioned by Australia’s Sunrise Project for the One for One campaign. This proposes that there should be a 1,250% risk weighting for all new fossil fuel exploration and extraction. Forget the curious percentage number. What it actually means is that for every dollar a bank lends to, say, an oil company, it would have to have a dollar in reserve to cover losses. There is a lot to be said for this idea and certainly the banks should be wary of some of the wilder ideas for hydrocarbon extraction.

However, to say that this banking reserve build up is necessary to prevent an inevitable financial crisis of enormous proportions in, say, 2030, when $2.2 trillion of banking debt to the fossil fuel industry suddenly becomes worthless, is perhaps taking things a tad too far. The report predicts that there could be 18.7 million job losses and the necessity of a government bail-out of $6.8 trillion, which seems a little low!

For a start, the idea really comes from two simple examples. The first is the origin of the 2007-8 banking crisis and the second is what happened in the US fracking explosion. In essence, the banking crisis was the product of a massive increase in mortgage lending, which collided with innovations in the finance industry. An increasing number of these mortgages became “sub-prime” and were packaged into collateralised debt obligations (CDOs) and then moved around as credit default swops, with very little hard backing. The securitisation of bad mortgage debt was near criminal. It was not like lending to a large oil company with a long track record, or a coal company with proven geological reserves.

Where the study does have a point is in the US shale boom. The rapid increase in fracking came as a big surprise, not least because it reversed America’s dependency on OPEC imports which had dominated US economic concerns for decades. However, the shale oil industry created its own financial demise when it produced so much so quickly, lowering the price by 70% in 2015. Many of the frackers went bust. And they did indeed end up owing $200 billion to the bankers, but then the bankers had very little idea what fracking was all about.

They made the assumption that this was pretty much the same as what the majors were doing. In fact, fracking produces a rapid and large flow of oil very quickly, which then fades, equally rapidly. To continue at the same site requires much more fracking, which becomes progressively much more expensive. The gains are very short term. The socio-economic effects, as the study points out, did lead to high unemployment and a collapse in the US land rig market. And in the enthusiasm of the moment, a lot of investors did lose out.

However, as far as the majors were concerned, the low oil price increased debt from around $1 trillion in 2006 to $2.5 trillion in 2014 largely as a result of the fracking boom’s effect on price. But it has since fallen back substantially, not least as a result of high prices from the invasion of Ukraine, but also because few people are more aware than the companies of the anti-fossil fuel sentiments hurtling around the planet. Capital expenditure reductions and debt repayment became the order of the day.

Senior BP management recently announced that it no longer saw its “reserves to production ratio” as any kind of indication of success. Given that the R&P ratio used to be the heart and soul of oil company share prices, this is a revolution in thinking. For a start, worldwide exploration to maximise “proved reserves” used to be the sine qua non of a company’s value, regardless of whether it could actually be produced. It justified the presence of some companies in countries that were not always easy to operate in since leaving meant a reduction in the R&P ratio. Shell in Nigeria comes to mind. The fear was that investors would see that production was rising faster than reserves and the company was running out. On the other hand, a healthy R&P ratio was an indication of its longevity. In the 1980s, this was a strong element in investor confidence, particularly when spooked by the fear that “oil was running out” made most notably by the Club of Rome with its dire predictions about future supplies. A high R&P ratio meant ever increasing profitability as prices rose.

According to the US Energy Information Administration, major oil companies have a rough R&P ratio of around 50 years, but there are plenty of reasons to be cynical about this. For a start, reserve figures fall into three categories; proven 90% likely, probably 50-90% likely and possible at 10-50%. To throw them altogether in publicity, as some companies used to do, would mean the oil industry was marching into eternity in terms of supplies.

These fears no longer apply. Oil is assuredly not running out. Yet there are plenty of examples of misplaced confidence about reserves, the most obvious one being that Venezuela has by far the most oil on the planet, with 300+ billion barrels of the stuff. At rather more than Saudi Arabia, these numbers suddenly appeared when Hugo Chavez announced them in 2011. Sadly for Venezuela however, this was after this president had summarily fired half the workforce of PDVSA in 2002 for opposing him, thereby losing most of its expertise.

Had they still been around, these oil men, who mostly fled to Mexico when they could, would have told their president that at least 150 billion barrels included in his number was American Petroleum Institute (API) gravity 10 or lower. Found in an enormous “oil field” in the Orinoco Basin, this crude is so thick it does not float on water or indeed flow much at all. The extractable amount of high value gasoline and diesel in it is low and its value consequently lower still. The old PDVSA had attempted to market it mixed with water as Orimulsion as a power station fuel, without much success and much controversy. Either way, for the sake of the planet this stuff needs to remain where it is and it is likely to do so.

Equally, of course, companies can be so sure of their proved reserves that they can spend a fortune trying to actually find it. A favourite has to be the magnificent “dry hole” drilled by SOHIO at Mukluk in Alaska, back in 1984. The company spent $1.5 billion drilling to a depth of 9,860 ft in 50 ft of water and were so sure of success that they invited the world’s oil press to come and celebrate its completion. As things turned out they got a bubble of gas and a lot of salt water. So costly was this to the company that it eventually led to its complete takeover by BP, who ironically had a stake in a nearby field called Kuparuk, where Mukluk’s oil is now thought to have migrated underground.

The point here is that SOHIO’s adventure in Alaska, of which the Mukluk fiasco was the crowning glory, was the final result of a massive $5 billion debt financed expansion, which paid for it. Had Mukluk been the huge find that was a 90%+ near certainty, then the entire expansion into Alaska would have been justified and the bankers would have been paid off. The losses were the result of not producing hydrocarbons, rather than a reluctance to buy them.

Much the same applies to Venezuela. Chavez made his reserves announcement shortly after two years in which the country’s external debt had been rising at well over 20% per annum. If this reassured the bankers, they were mistaken. When he took over in late 1997, Venezuela’s external debt was $44 billion and the country was producing 3.4 million barrels a day (mbd) of crude. When he announced his reserve calculations, the debt had risen to $116 billion and crude output had fallen below 3 mbd. Since then, crude output has fallen below 700,000 barrels a day and the debt has escalated to over $185 billion.

If there is a lesson here for bankers, it is that oil is not the sure-fire bet that it looked to be in the 1970s when rumours of chronic scarcity were generated by the Club of Rome’s “Limits to Growth” analysis mentioned above. This is not the place to examine this in detail, but it is worth noting the effects of this kind of semi-abstract global analysis. For a start, the impact of the study on resources was precisely the opposite of what was intended.

While the authors saw their work as a warning about the impact of economic and population growth with the avowed intention of slowing it down, in terms of resources the reverse happened. In terms of oil at any rate the combination of fears about “Peak Oil” combined with the political effects of OPEC’s embargo drove the hydrocarbon industry to much greater efforts to find it. In 1973-4, oil prices rose from $3 a barrel to $12 and the hunt for more took off, most notably in the North Sea and this was increased in 1979, when prices tripled again. Much the same can be said about other resources and the technology for finding them has improved enormously in the past 50 years.

The net result has been that the “scarcity of resource” argument has rather disappeared from political discourse, while it has certainly more justification now than it did in 1970. That said however, there is one formidable difference between the scarcity of resource argument and the arguments about climate change. The reality of scarce resources drives up the price of the commodity, while arguments about climate change, which demand that it is left in the ground, do not. The former is a physical constraint on its use. The other is a legally enforced restriction and its price or lack of it will depend on who obeys it.

The One for One study is thus valuable for shining a light on the potential financial effects of climate change requirements, even if the impact is unlikely to be the anticipated gigantic banking “kaboom” on Tuesday 1^stJanuary 2030. It is however a useful note to bankers that the world is changing and that this change is likely to accelerate and they might be advised to change their concept of risk.

In relation to this, another extremely valuable report from Reclaim Finance, called “Throwing Fuel on the Fire”, has pointed out that the global finance industry is still shelling out enormous sums to the fossil fuel industry and accusing them of hypocrisy. Since the foundation of the Glasgow Financial Alliance for Net Zero (GFANZ) was formed by 450 organisations in 45 countries in April 2021 aimed at reducing lending on fossil fuels, the banks et al have been merrily lending on oil, gas and coal projects regardless. The sum quoted is $269 billion and the projects discovered amount to 137 billion new barrels of oil equivalent and some 92 GW of coal-fired power capacity.

The report accuses the banks of “greenwashing” and being “climate arsonists” and they can certainly be accused of spreading abbreviations like confetti; having created NZBA, NZAM and NZIA standing for “Net Zero everything to do with money” under the wing of GFANZ. But there is another factor that ought to be mentioned here. Like every other industry, finance has a dynamic of its own. It can’t stop lending and investing or ceases to exist. Your pension is dependent on this process. What is undoubtedly missing is $269 billion-worth of solar and wind investment opportunities proposed in the current state of play.

They are obviously out there somewhere, but they are as yet not quite on the scale of lending $10 billion to Saudi Aramco and they are not always popular. The largest 850 MW solar array in the US at Battle Born, Nevada was cancelled in 2021 and EDF renewables 400 MW array in Ohio went down in December 2022; both to local opposition. Meanwhile a desirable scheme to link solar power from Australia’s Northern Territories to Singapore, via a 4,500 km cable is stuck in the financial mire, in spite of the fact that it would provide 15% of Singapore’s electricity at 1.75 GW and cost $21 billion. Instead, Singapore is opting to put solar panels on 50 of its diesel buses, or 11% of the fleet, which is calculated to save up to 200 tonnes of carbon dioxide output a year.

You see the problem? There is a lot of money out there looking for investment and GFANZ is a good idea, but it needs investment proposals and big, well-calculated schemes. The fact that wind power in Europe is making a fortune might just be the kick in the pants that the financial community needs. Algeria alone has huge solar potential right on Europe’s doorstep.