Waking up to risk taking in the global energy system

Jeremy Leggett

The long-awaited fifth IPCC scientific assessment of climate change poses society with big questions, once again, about how to handle high-consequence but slow-burning risks. We have a worrying collective tendency to be blind to the kinds of risks that can crash economies and imperil civilizations, as demonstrated by the shocking history of the financial crisis and its dismal prolongation.
In my new book, The Energy of Nations: Risk blindness and the road to renaissance, I argue that the conventional energy industry is repeating the failing. The challenges that this throws up for the philanthropy world are profound. But the opportunities are also substantial.
The energy incumbency – that nexus of Big Energy executives, financiers and their institutional and political supporters who keep fossil fuels dominant in energy markets – are guilty of an institutionalized risk blindness that, unless action is taken, will lead to an inevitable global crash. We the people remain largely blind to their systemic risk taking, just as we were in the case of the financial sector’s gross risk taking in the run-up to the financial crisis.
Most foundations focus their work in the energy arena on climate change and reducing emissions. But the risk taking by the energy incumbency extends across much broader terrain than this, which makes it much more vulnerable than if its collective irresponsibilities were limited to carbon emissions. Let me explain what I mean.
Where I’m coming from
I used to be a creature of the oil and gas industry. As a geologist on the faculty at Imperial College, I was funded by BP and Shell among others, and worked on shale, among other things. But my research was on the history of the oceans, and hence ancient climates. Because of this, I became worried about society’s over-dependency on fossil fuels early. I quit Imperial to become a climate campaigner in 1989 and set up a solar business in 1999. I joined a private equity fund investing in renewables in 2000. Since oil prices began their inexorable rise in 2004, I have watched captains of the energy and financial sectors at work as the financial crisis has played out and the risk taking has built in energy markets. I have concluded that too many people across the top levels of government and business are closing their eyes and ears to systemic risk taking.

The Energy of Nations

In my book, I recount the histories of four systemic risks, intercut with diary extracts. Here I will outline each risk and the implications for the philanthropy world.
Risk one: climate change
The first and biggest risk is climate change. We have way more conventional fossil fuel than we need to wreck the climate. Yet much of the energy incumbency wants us to pile unconventional deposits such as tar sands and shale gas on the fire. I have found it terrifying to see how people like the CEOs of Shell and BP get their heads around that one, meanwhile abandoning solar energy just as it begins to look promising. This is a depressing index of how entrenched the energy incumbency has become.
For years now almost all philanthropists and grantees have focused their efforts on international efforts to curtail emissions. To date this has not achieved the results we want: global emissions have gone on rising. What we have managed to achieve, after the expenditure of much foundation cash, is a degree of better transparency on how much carbon is burned, where and by whom. But this has not slowed the overall emission rate.
Of course, continuing with the same strategies does not guarantee continuing failure. History is not necessarily destiny. But there might be more promising fronts open to us.
Risk two: a carbon bubble in the capital markets
When carbon fuels are transformed from resources to reserves by coal, oil and gas companies, society allows them to be accounted as though they are assets at precisely zero risk of losing value over time. But the fact is that if we are to have a chance of keeping global warming below two degrees – the commonly assumed danger threshold that many policymakers aim to stay under – then most of this carbon fuel is essentially unburnable. If the policymakers do what they say, the value of most carbon fuels can never be realized: they are essentially a bubble of falsely inflated value in the capital markets.
I am chairman of Carbon Tracker, a financial think tank that aims to align the capital markets with international climate policymaking. We want the risk of unburnability to be at least recognized across the financial chain: by regulators, accountants, actuaries, ratings agencies and all other players. We also want asset owners, including foundations, to start questioning allocations of capital by carbon fuel companies wanting to finance exploration programmes that will further inflate the unburnable carbon bubble.
Encouragingly, some financial institutions have already begun reducing investment in fossil fuels. Examples are the Norwegian insurer Storebrand and the Swedish state pension fund AP4. Others have stayed invested, but are now demanding that cash be deployed not to inflate the carbon bubble but as dividends: money paid back to investors so that they can invest it in something more useful and more profitable if they wish.
Growing numbers of people think that this line of attack is more likely to achieve a breakthrough on climate change. It is very different from pressuring companies and governments to measure emissions. It aims to divert, and ultimately turn off, the dysfunctional river of capital flowing to carbon. This is an area ripe for foundation support.
Risk three: a shale bubble
We know how depressingly good we are at allowing bubbles to inflate in the capital markets, as shown in the last 13 years by the dot.com bubble and the financial crash. There is another candidate for a bubble: the so-called ‘shale boom’ in gas production. This will surprise many people who rely on received energy incumbency wisdom. But they tend not to know about all the gas industry losses or the rapid production drop-off in increasingly expensive wells.
Even if the US shale phenomenon isn’t a bubble, is it an exportable phenomenon? Given the emerging environmental downsides, the water resource requirements, and other factors, almost certainly not.
There is great scope for the philanthropy world to foster debate over systemic risks such as this – some foundations are already actively funding projects in this area. It is distressing how easily the energy incumbency pushes comforting narratives out to receptive ears in government, the corporate world, and the public.
Risk four: oil depletion
In my view, we are also courting disaster with our assumptions about oil depletion. Most of society favours the energy incumbency narrative that there will be adequate flow rates of just about affordable oil for decades to come. I am in a minority who don’t believe this.
Man seems hardwired to prefer good news to bad. But the reality of oil supply and demand has not substantively changed since the IEA (International Energy Agency) began issuing a series of dire annual warnings in 2005. Global conventional crude oil production flattened out at around 74-75 million barrels a day in 2005 and has remained essentially flat since. Additional unconventional liquids – which are not equivalent to crude on several important counts – bring the global total to around 91 million barrels per day.
The new US shale oil production has counterbalanced the decline in crude production by barely 2 million barrels per day – and producing this has required more than half the world’s oil rigs outside Russia and China. Worse, detailed studies suggest that oil production from US shale cannot increase much more. Nearly all the best spots have already been drilled.
Yet demand continues to rise, driven by the growing economies of China, India and the Middle East. In order to meet it, prices will have to rise higher still, testing the global economy’s ability to sustain growth.
There were few whistleblowers in the run-up to the financial crash, and they were vilified. Today ‘peakists’ – believers in premature peak oil – tend to be shunned by most players, including foundation funders. This needs to change: softening the blows from an oil shock involves the same tools as abating climate risk.
The road to renaissance
Looking at all this systemic risk taking, I see a major shock or shocks in the energy markets as being unavoidable within the next few years. But the news is not all bad. I do believe that there will be a road to renaissance in the rebuilding. On that road, we will have to nurture clean energy industries and strategies as though mobilizing for war. Emerging experience in Germany and elsewhere gives increasing credibility to the view that modern economies can be powered on a mix of renewables.
My parents’ generation amazed themselves at how fast they could mobilize tanks, fighters, bombers, warships – not to mention millions willing to drive them – under the gun. If we were to repeat that level of application, we could abate much of the horror that the IPCC warns of, and soften the inevitable shock/s. There is much the philanthropy world can do to prepare for this day – not least in going beyond the distribution of grants to the reinvestment of their endowments.
As I explain in my book, I expect we will have only one chance to get this right next time around.
Jeremy Leggett is chair of Carbon Tracker and founder and chairman of Solarcentury.
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