New technologies and business models could accelerate the shift to a low-carbon economy, but prospects for such a shift are uncertain at a time when the fall in oil prices is challenging energy investment assumptions.
Current patterns of resource use are unsustainable. Research suggests that we are now consuming one and a half ‘Earths’ worth of renewable resources per year and on current trends will exceed three ‘Earths’ by 2050 . The global population is rapidly expanding and is projected to reach 9.6 billion by 2050 . Current fossil fuel consumption trends could lead to a global average temperature rise of 2oC by 2035, and more than 4oC by the end of the century. As today’s global economic growth model both relies on and drives these patterns of resource use, it too is unsustainable.
A broad consensus is emerging on the need to build a sustainable, carbon-neutral economy. Momentum is growing in the international climate negotiations towards agreeing a new global deal in Paris later this year. Among the elements being discussed is a long-term goal to achieve ‘net-zero’ emissions by 2050. Agreement on a new set of Sustainable Development Goals is expected in New York in September, to replace the Millennium Development Goals.
These are positive signals, but progress towards a sustainable future will require a combination of top-down and bottom-up activity. It will be individual and collective action – by governments, businesses and investors – that will translate global commitments into national legislation, develop new products and technologies, and shape commercial responses to energy market developments. In this context, the recent collapse in energy commodity prices is potentially significant.
Price signals and volatility
The fall in the global oil price since mid-2014, reflecting weak demand growth and rapidly increasing supply from unconventional sources such as shale oil, may be creating a structural shift in the market. If sustained, this could lead to a ‘new normal’ of low oil prices that would have major implications for energy investment and the competitiveness of different energy technologies. OPEC’s November 2014 decision not to limit production may also imply a future oil market driven more by economic fundamentals. As other resource commodity markets have shown, this is likely to mean more volatility – and again more uncertainty for potential investors.
It is not just oil that has been falling in price. Almost 60 per cent of the global gas trade is indexed to the oil price, so gas has also become significantly cheaper . In the United States the price of coal fell 40 per cent from its peak in 2008 to 2012, largely as a result of increased shale gas supply reducing demand for coal .
These developments, in turn, have renewed the policy debate around fossil fuel subsidies and the potential for new forms of carbon pricing. Although the G20 in 2009 agreed to remove such subsidies, there has been little progress since then . Fear of the impact on consumers is one of the main political barriers to tackling subsidies. However, the recent falls in fossil fuel prices have created a window in which subsidies could be reduced without raising consumer prices. The World Bank has emphasized the importance of reducing fossil fuel subsidies in oil-importing countries, to allow rebuilding of fiscal reserves for future economic stimulus. Recent action in India and Indonesia shows that some emerging economies might be serious about tackling subsidies .
The fall in the oil price, combined with the prospect of a global climate change deal in Paris, is also renewing interest in carbon-pricing mechanisms. Former US Treasury secretary Larry Summers has called for the United States to consider introducing a carbon price of $25 per ton, which could generate over $100 billion in tax revenue annually . In practice, new carbon taxation and fossil fuel subsidy reform both face serious barriers to implementation.
Investment and stranded assets
With their implications for company balance sheets, income streams, market capitalizations and creditworthiness, resource price changes and the potential for stronger environmental regulation are feeding through into investment decisions. The oil and gas majors have significantly scaled back their investment plans. The US government’s 2030 target for its power sector, and the possibility that China’s domestic coal use will peak before 2020, could depress future coal investment. Tougher environmental regulation, competition from new technology and downwardly revised projections of investment returns may result in ‘stranded assets’ – that is, legacy assets that are no longer commercially viable – in coal, oil and gas markets .
The debate on stranded assets matters, in part, because it asks fundamental questions about the relationship between government regulation and company valuations and creditworthiness. The stakes are extremely high: the top 200 fossil fuel companies have a market value of $4 trillion and debt of $1.5 trillion . The prospect of an increase in stranded assets raises concerns that fossil fuels could be the source of the next big financial crisis.
These are questions for investors, but also for governments, regulators, accountants and actuaries. Banks are not currently required to evaluate the risks posed by stranded assets when lending to fossil fuel companies; nor do securities regulations require companies to address such risks in their disclosures. However, the situation may now be changing. The European Parliament last year passed a directive on non-financial reporting by large companies, seeking to enhance transparency on social and environmental matters . Major credit rating agencies are researching the impact of climate regulation on corporate liabilities and sovereign risk ; and Mark Carney, the governor of the Bank of England, has recently launched an official inquiry into stranded assets .
Managing disruptive change
Changes in resource prices have varying implications for the transition to a low-carbon economy. Cheap oil is likely to make some alternative energy sources, such as biofuels, less competitive. For other renewable technologies the story is more complex. The cost of solar photovoltaics has fallen by 10–12 per cent per year for the last five years ; and electric car-maker Tesla’s new ‘Gigafactory’ may, on its own, reduce battery costs from $250 to $150/kWh by 2020 . The impact of cheap fossil fuels on these technologies is much more uncertain.
Renewable technologies are already disrupting the business models of traditional energy utilities. Last year in Germany renewables accounted for 22 per cent of all power generation, with a maximum of 80 per cent on a single day in May. In response to these changes, E.ON recently announced it was splitting into two: the main company will focus on renewables, distribution and customer solutions; upstream commodities and fossil fuel power generation will be spun off into a new company .
It is not just in the power sector that business is evolving. New models include the ‘circular economy’, where waste from one sector is used as an input for another, and distributed manufacturing through technologies such as 3D printing. By disrupting value chains, such ideas have the potential to aid the transition towards sustainability across a broad range of different resources. However, they may not get very far if lower resource prices reduce incentives to improve efficiency.
Ultimately, disruptive change poses challenges for all economies, but it also presents opportunities. Many rapidly growing emerging economies, for example, face concerns about falling into the ‘middle-income trap’, wherein growth stagnates as rising wages reduce competitiveness in bulk manufacturing. New growth models and technologies have the potential to address this problem. They may enable countries to raise productivity and increase competitiveness in higher-value-added sectors – while transitioning to more sustainable resource use at the same time. Achieving this, however, will require a rapid shift in investment focus to prevent economies, industries and companies from being locked into outdated development pathways based on unsustainable resource use.
 WWF, Global Footprint Network and ZSL (2013), Living Planet Report. The report estimates that we are currently in ecological overshoot – taking 1.5 years to regenerate the renewable resources we consume in a single year, a ratio set to rise to three years by 2050.
 United Nations (2013), World Population Prospects: The 2012 Revision.
 IEA (2013), World Energy Outlook.
 BP (2013), Statistical Review of World Energy.
 Elise Buckle (2012), Fossil fuel subsidies and government support in 24 OECD countries: Summary for decision-makers, 31 May 2012.
 World Bank (2015), Global Economic Prospects.
 www.carbontracker.org and www.smithschool.ox.ac.uk.
 Citi Research 2014.
 Morgan Stanley 2014.