Are fossil fuels creating an asset bubble?

Although it’s easy to forget amidst all the hype around US production figures, we’re now several years into the uncharted territory of peak oil. Conventional oil production has plateaued, and we are increasingly reliant on unconventional oil to meet demand.

Unconventional oil is more expensive, and the fossil fuel companies are investing record sums to bring new supplies to market. Between 2000 and 2008, global investment in fossil fuels doubled to $950 billion a year. $200 billion of that is from the US, where 20% of private fixed investment goes into fossil fuels. That’s the same proportion as house building, points out Ambrose Evans-Pritchard of the Telegraph, one of the journalists who has covered this most extensively.

The trouble is, all this huge investment is not getting a return quick enough. Fossil fuels require massive infrastructure and it always takes a few years to pay off, but today’s big projects have much higher break-even points than in the past. The oil costs $80 or $90 a barrel to produce, and requires high oil prices to turn a profit. Arctic oil projects break even at $120 a barrel – anyone investing there is betting on a world of very expensive oil, which in turn depends on the optimistic scenario of a global economic boom.

Fossil fuel companies saw their upstream costs increase by 12% a year between 2000 and 2012. That’s a major squeeze. They haven’t wanted to cut back on dividends and choke off further investment, so they’ve been taking on debt, re-purchasing their own shares and selling off assets instead. This has masked the underlying reality that the profitability of fossil fuels is not nearly as certain as one might expect.

If there is a long period of growth in the global economy over the next few years, this will all pay off. Rising demand from China and elsewhere will gently raise the price of oil and the companies will make their money back in due course. But if the economy continues to just bump along, or if there’s another crisis, then the oil price won’t rise to meet the high costs of unconventional oil. We may discover a huge sub-prime situation in the fossil fuels industry, one that may unravel just as spectacularly as the US housing bubble.

Climate change adds a whole layer of perversity to all this, because we know we can’t afford to burn all those fossil fuels anyway. The interests behind that $5.4 trillion in fossil fuel investments over the last decade are now directly at odds with what is best for the planet. If the global economy grows and the oil companies see a return on their investment – the positive outcome from a business point of view – we’ll have scuppered any chance of preventing runaway climate change.

If we act to prevent climate change, on the other hand, we risk precipitating a global crisis as the trillions tied up in fossil fuel reserves become worthless. This isn’t just a problem for rich investors, when you bear in mind that a sizeable slice of most people’s pensions depends on big energy and extraction corporations.

This is a conundrum, for sure. The analysts at Carbon Tracker have some ideas for how to deflate the carbon bubble slowly. As individuals, we might want to look at where our pensions are being invested.

3 Comments on “Are fossil fuels creating an asset bubble?”

  1. Neil September 3, 2014 at 2:25 pm #

    Quite agree, see this post for an interesting take on it. It also looks to me like gas reserves have peaked even with US shale gas.


  1. The consequences of a low oil price | Make Wealth History - December 4, 2014

    […] will be in projects that are now losing money. As I wrote a couple of months ago, that’s a subprime situation and a financial crisis risk in […]

  2. Climate change at the wellhead and the tailpipe | Make Wealth History - February 9, 2015

    […] a lot of wasted effort, that may be beginning to change. The markets are becoming aware of the risks to fossil fuels, especially as renewable energy gets cheaper. The Keystone XL debate in the US has dramatically […]

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