Ellis: What kinds of questions should financial advisors, who are working with long-term investment strategies for their clients, be asking companies in the oil, gas and coal industries about these firms’ assets?

Hobley: They should be asking those that are managing their clients’ money the extent to which they understand the business of those oil, gas and coal firms. At Carbon Tracker, what we’ve increasingly found is that many shareholders, the asset-owners of those companies, have been asleep at the wheel for years.

We understand that for decade after decade, coal, oil and gas companies produced a great return with a low risk and low beta, but that has changed dramatically. The return on capital being produced from oil and gas companies has been going in one direction, down, over the last few years, certainly the last five years. I think many shareholders thought they didn’t need to understand the business model of these companies. The share price of all oil and gas companies would go up if the oil price went up, and the share price would go down if the oil price went down. No one fully understood which companies were better run, had a better return on capital, were more efficient in employing capital, and so on. 

Ellis: You spoke earlier about the carbon budget. What should financial advisors know about another term Carbon Tracker often refers to, which is stranded assets. When you use that term, what are you referring to?

Hobley: A stranded asset is an asset that is not going to produce the financial return anticipated. It doesn’t necessarily have to be as black and white as an asset that stops production and has been completely mothballed. It can be something like the Kashagan Oil Field, which has taken many years to develop, has gone massively over budget, and probably will never return the investment on capital that has been poured into it. It may end up producing oil, and for years, but it has destroyed a significant amount of the capital that was put into it.

Ellis: In the last couple of years, we’ve seen a significant decline in the price of oil, which had a negative effect on the valuation of oil and gas stocks. In this new report that you’ve just released in the U.S., you warn of risks to shareholder value over a longer trajectory. Say more about that report.

Hobley: Yes, let’s run through some of our research history. When we did our original stranded assets and carbon bubble work, in 2011 and 2013 it got a lot of traction. People understood there’s a risk here, but the response, probably quite rightly, was the devil’s in the details. What that means at the individual project and company level is why we then raised capital, employed a team of former investment bank analysts, bought the commercial data on all of the world’s oil, gas and coal projects, started looking at the financials of all the oil, coal and gas projects, and produced carbon supply cost curves.

We found that there was a very high correlation between high-cost projects and high-carbon resource content. What we also found, which surprised us, was the sheer number of projects being sanctioned that would need a high oil price to ever turn a profit, somewhere between $100 and $150 a barrel. 

One of the key justifications for that capital expenditure was the energy demand models being produced by the companies themselves and even the IEA. We looked at those models and did a piece called “Lost in Transition,” which looked at the assumptions that underlined the energy demand models.

We concluded there was a degree of group think, where companies would pick assumptions for GDP growth or population growth that were at the highest end of the spectrum. Yet at the other end of the spectrum, they would pick the most pessimistic projections for the growth of technologies that would destroy demand for their products, like solar, electric vehicles, storage and wind.