Kristina Church, senior investment strategist, sustainability at Lombard Odier Investment Managers, shares her views on the impact of the current oil shock on industries’ progress in transitioning towards a low-carbon economy
In this current environment of uncertainty and volatile commodity prices, the most sustainable companies are going to outperform the market and generate strong investment returns.
The corporate world is bifurcating into two types of companies – which we refer to as the Eagles and the Ostriches. Eagles will focus on multiple bottom lines – not just profits but also people and the planet. It is important to identify transitioning businesses and solutions companies that can react to a shifting environment — whether that be low oil prices, increasing demand for electric vehicles, or digital solutions for remote working as a result of the current pandemic. It is vital to avoid the Ostriches – those oblivious to the need to react and transition to more sustainable business models.
We recognise that the future economy will still require the harder-to-abate, carbon-intensive industries – but that they will have to transform and transition. We will still need steel and cement to build infrastructure to protect cities from greater climate damage, or to develop urban areas to accommodate the rising urban population. Indeed, addressing climate change requires that we continue to invest in these industries so that they are able to invest in their own transformation to lower carbon-intensity. While the value proposition of low carbon technologies may have shifted to a certain degree as the oil price has fallen, we do not see this derailing the Climate Transition, which is already underway, powered by multiple market forces.
European oil majors including Shell, Total, Repsol and BP are already embarking down the path toward emission reductions and the diversification of their businesses into renewables, e-mobility and other energy services. Some oil companies may choose to trim capex for the energy transition in the near term, but others may choose to signal their longer-term strategy and double-down on diversification across the broader energy sector. For instance, Shell, in the midst of the recent oil price collapse, announced the most ambitious plans of all oil majors to become a net-zero emissions company by 2050.
Green solutions are becoming cheaper, which in turn is fueling more investment into green technologies. Solar technology is 90% cheaper than a decade ago, wind energy is 85% cheaper and electric vehicle batteries are 90% cheaper. For many years we have known that smog, water pollution and climate change are harming our health, the economy and society, but the solutions were relatively expensive. The low oil price could provide the perfect opportunity to remove rebates on oil (as the consumer will not feel the impact while prices are reduced) and/or implement an effective carbon/pollution tax.
A dramatic transformation is already underway in the transport sector. Historically, a significant fall in the oil price could have slowed the transition to clean mobility, by encouraging greater vehicle usage, more carbon-intensive transport options, and shifting the cost dynamic away from electric vehicles. The market dynamics for mobility are fundamentally different today.
On a total cost of ownership (TCO) basis, the fall in oil prices should intuitively push consumers towards combustion engines as the value proposition of an EV becomes less attractive in the near term. However, policy action is disrupting this dynamic as fleet average targets for CO2 are fixed at the international level and will penalize auto manufacturers heavily if not achieved.
The environment for consumer sentiment also looks increasingly complex, particularly in light of the economic damage created by the covid-19 pandemic. Today, only 10% of the cost/mile of driving comes from fuel, with the remainder a combination of depreciation, insurance, maintenance and taxation. With battery costs falling sharply, electric vehicles are becoming more cost-competitive with combustion engine vehicles, even in a lower oil price environment.
Whilst an increase in the availability of low-cost loans and capital makes investments in energy efficiency and renewable technologies more attractive, any change in the availability and cost of credit could have a strong negative effect on vehicle demand. In previous recessions, the auto industry was hit hard as consumers delayed buying new vehicles, or switched to smaller vehicles (that typically emit less CO2). With plentiful, cheaper options for mobility as a service (MaaS) today – such as shared e-scooters, e-bikes, micro-transit and ridehail, some consumers could jettison the car entirely. Similarly, other modes of long-distance and discretionary transport, in particular air travel, are closely linked to consumer confidence.
The economic impact from the covid-19 pandemic could have a significant, dampening impact on demand for carbon-intensive transport. It is also likely to change the mobility mix and, in doing so, help accelerate the investment opportunity in lower-carbon and shared transport. We expect to see an increased regulatory focus on harder-to-abate, freight and long distance transportation, as well as the potential for a shift in consumer sentiment towards more sustainable modes of travel.
All of which gives us confidence that the Energy and Transport Transitions are well underway and will continue to present multiple investment opportunities, even in a low oil price environment.