Financial Markets May Kill Off Fossil Fuels Before Governments Do

There is an interesting email from Bloomberg Green today. It discusses how the cost of capital is going up for fossil fuel companies and down for renewables. The concluding sentence goes like this: “Markets may end up killing off fossil fuels before governments do.” Why is that? Let’s dig into the details behind that rather startling statement.

The Cost Of Capital

I am no economist, so some of you may find my comments naive, quaint, or even flat out wrong. In general, when a business like Exxon wants to go mucking about with the Earth, drilling test holes here and there in search of new oil deposits, it turns to financial markets to borrow the money it needs to finance those quests.

Investors want to be paid back with interest. How much interest is usually determined by how risky the investment is. The higher the risk, the greater the interest. Bloomberg executive editor Tim Quinson writes in today’s email that a decade ago, the cost of capital for for developing oil and gas projects and for renewable projects was pretty much the same — somewhere between 8% and 10%.

Not anymore, he writes. The threshold of projected return that can financially justify a new oil project is now at 20% for long cycle developments, while for renewables it has dropped to somewhere between 3% and 5%. That’s according to Michele Della Vigna, a Goldman Sachs analyst based in London.

“That’s an extraordinary divergence which is leading to an unprecedented shift in capital allocation,” Della Vigna says. “This year will mark the first time in history that renewable power will be the largest area of energy investment.”

Why The Change?

The first question most people will ask is, why the change? Will Hares, an analyst at Bloomberg Intelligence, explains that pressure from ESG investors is the best explanation for the widening difference between dirty and clean. “Oil companies are finding it increasingly difficult to raise financing amid rising ESG and sustainability concerns, while banks are under pressure from their own investors to reduce or eliminate fossil-fuel financing,” he says.

This is resulting in more expensive debt financing (in some cases double-digit coupons), which, when coupled with depressed equity valuations, leaves most oil companies facing higher costs for capital, Hares adds.

The Conversation At COP26

It this a sick joke? Apparently there were more fossil fuel lobbyists in Glasgow last week that the number of climate conference delegates from any one of the world’s nations. If that doesn’t make you want to puke, I don’t know what would. These smarmy, smirking sycophants get paid to sabotage climate talks so the companies they represent can continue to poison the environment with the waste products that come from burning fossil fuels. They should all be hauled before the International Criminal Court and charged with crimes against humanity.

Future Investments In Renewables

In Glasgow last week, Della Vigna estimated about $56 trillion, or roughly $2 trillion a year, will be invested in renewable energy, bio-energy, and other clean energy infrastructure projects between now and 2050. Spending is expected to peak between 2035 and 2040, driven largely by expenditures on power networks, charging networks, building upgrades, and a massive expansion of renewable power sources such as clean hydrogen.

“It’s significant that such a large share of the financial sector has recognized its role in driving the climate crisis and the need to wind down its financed emissions,” Ben Cushing, a campaign manager at the Sierra Club, tells Bloomberg. “But achieving net zero by 2050 and staying within 1.5 degrees Celsius of warming means stopping financing for fossil fuel expansion today. That’s the key test for whether these commitments are aligned with reality.”

Managing The Spread

“Given this backdrop, the spread between oil, gas and coal and renewable energy will continue to diverge as banks change their financing habits,” says Quinson. In other words, while the politicians are all huddled around the free shrimp cocktail table in Glasgow, the financial community is about to do what they will not or cannot.

Banks and investment firms are not elected by anyone and answer only to the almighty dollar. When lending (and insurance coverage) to fossil fuel companies dries up, it’s game over for them. They can lie to Congress, they can pour money into the campaign coffers of crooks like Joe Manchin, they can fund groups like the American Petroleum Institute to their hearts content, but without access to capital that’s affordable, they are done. Finished. Kaput.

Numbers don’t lie and the bottom line is the bottom line no matter what some politician or lobbyist says. The cost of capital is a significant factor when calculating the levelized cost of energy from any source. When that cost goes up, oil, coal, and dirty methane ventures look a whole lot less attractive. There is an excellent chance the financial sector will put fossil fuels out of business long before our political leaders find the courage to act.