The decision by leaders of the G7 nations that fossil fuels should be phased out by the end of the 21st century is a hugely important milestone. The likes of Rex Tillerson, Exxon Mobil chief executive, and John Watson, boss of Chevron, must have spluttered into their coffee when they read the news this morning. Their shareholders have some serious thinking to do.
With this declaration, orchestrated by German chancellor Angela Merkel at Schloss Elmau on Monday, governments have recognised publicly that burning carbon-based fuels belongs to the past.
However briefly, they have established a vision of a future economy based on the world’s abundant solar, wind and water power. No one of this seniority or authority has said anything like this before.
But 2100 is a long way off. What will be the near term results?
Brace for the backlash
The first is likely to be resistance — swift, broad and sustained — because large parts of the economy and the world are geared at present to a fossil fuel-driven economy.
States will be a bigger problem than companies. But private oil and gas interests will fight the idea.
The heads of BG, BP, Eni, Shell, Statoil and Total showed foresight last week by calling for carbon pricing to discourage high carbon investments and stimulate low carbon technologies. For the moment, they are ahead of governments on the climate curve. But whether they will remain there as the world looks ahead to a world without even gas remains to be seen.
Exxon and Chevron are way behind, having recently distanced themselves from carbon pricing. “It’s not a policy that’s going to be effective because customers want affordable energy,” John Watson was reported as saying.
In the face of opposition, the G7 leaders and those who support them will have to hold fast, develop and strengthen their arguments.
A critical test will come with the next US presidential administration. If it sticks to President Obama’s policy, there is a good chance a trajectory towards zero emissions will become permanently accepted. The alternative is a risk that the US will repeat its failure to ratify the Kyoto Treaty of 1997, which set the fight against climate change back two decades.
Pricing in obsolescence
The second effect will be in financial markets. UK and eurozone equity indices have fallen on Tuesday, but several of the leading energy stocks including Shell, Total and GDF Suez have fallen slightly further.
This does not prove anything in itself. But the G7 declaration will have many financial repercussions in the coming months and years.
Until now, the idea of oil and gas reserves as stranded assets — resources that can never be used if the world is to avoid disastrous climate change — has remained marginal. Academics and NGOs might endorse it — even the Bank of England’s Mark Carney — but hydrocarbon producers could still afford to ignore it.
No longer. An end date has been set. If the world sticks to the course the G7 have outlined, reserves that cannot be used in the next few decades will be less and less likely ever to be used.
This does not mean oil companies are valueless, that they cannot serve society’s needs, or that all investors should divest from them straight away. But it does fundamentally change the way oil and gas investments, including the equity and debt of oil companies and service providers, have to be assessed and valued.
Both the stranded asset concept, driven by the search for accurate valuation, and the push for divestment by ‘deep green’ investors — whose main aims are moral and political — are likely to gather strength in the next few years.
The hydrocarbon industries will probably respond with a big increase in investment in carbon capture and storage — a so far embryonic technology that might extend the useful life of fossil fuels.
They will also, if they are wise, transform their portfolios by buying and building clean energy infrastructure. It took Vivendi just 20 years to change from a pure water company to a media and telecoms group, with none of its original assets.
Stiffening resolve
Third and most importantly, the G7 declaration helps set the tone for the vital global policy debate of the next six months, leading up to the UN climate summit in Paris in December.
Setting a target of zero emissions by 2100 does not make it achievable. That will require enormous work.
Part of it is a technological challenge. But 85 years ago, there were no computers, jet aircraft, nuclear power, robots, space flight or bioengineering. Considering that wind and solar power exist on a large scale already, it is no stretch to imagine that the world can run on green energy by 2100.
The real difficulty will be the unprecedented political effort and imagination needed to secure agreement.
Even the best deal possible in Paris will be inadequate to prevent grave climate change. However, some kind of binding framework could be established, which can be revised later and made more stringent.
Crucial elements should be: agreement by reluctant countries that the treaty will need updating at regular intervals; acceptance that both developed and developing countries will need to cut emissions; and acknowledgement that ultimately, cuts of 20% or 40% are not going to be enough.
As the G7 leaders have implicitly recognised, there is too much carbon in the atmosphere already. Only very low or zero emissions will allow the concentration to fall.
Green financing ahoy!
If, as it appears, the G7 are heading to Paris in an ambitious frame of mind, that makes it more likely they will also make fresh efforts to live up to a pledge made in Copenhagen in 2009, which they have so far ducked.
This is to channel $100bn of financing from developed to developing countries every year, to finance green technology and protections against a changing climate.
A deal on this still needs to be thrashed out, but when it does, there is likely to be increased space, and incentives, for private sector capital to flow to green projects in the emerging world.
As the World Bank’s climate envoy Rachel Kyte pointed out in March, realising that goal could give the green bond market, which so far has merely rebranded existing capital flows, a genuine purpose and urgency.