To explore, or not to explore

To explore or not to explore. This piece considers whether it is now time to stop exploring for new fossil fuel sources. Asset owners and managers are facing increasing pressure, from groups ranging from campaigners such as Make My Money Matter, to international organisations such as the United Nations, to commit to not financing new fossil fuel exploration. This position is backed up by the International Energy Agency (IEA) in their Net Zero by 2050 roadmap and most recently the International Institute for Sustainable Development (IISD) who stated that planned new oil and gas investments are “incompatible with a 1.5C Warming Limit”.

Just to be clear there is a difference between 1) investing in existing fields (for maintenance for example), 2) continued development (that has already started but could take years to complete and start producing) and 3) new exploration. So far, the IEA Net Zero by 2050 scenario only states that the latter, new exploration, is not required. Given this activity is a small fraction of total oil and gas industry capital expenditure, and that new capital raisings are not specifically for exploration, there is a need to address whether there is a role for the investment industry in this debate.

Why would we continue to explore? The answer is to find cheaper, less destructive fossil fuels. Essentially this means exploring for cheap sources of gas so we could shut down dirtier coal and tar sands operations. Would we stop using the dirtier fuels, or would we end up burning both the old and new fuel? The possibility that we burn both is the argument for stopping new exploration. Absent a change in incentives (ie a new, higher carbon price) the world may end up with more greenhouse gas (GHG) emissions (and therefore higher temperatures) not less1. The Intergovernmental Panel on Climate Change (IPCC) have cautioned that existing fossil fuel infrastructure is “already sufficient to breach the 1.5C limit”.  Therefore, prudence or the precautionary principle, argues for no new exploration of fossil fuels, to ensure the best chance that humanity does not tip the climate.

Essentially, it is easier to prevent fossil fuels being burned if we do not know where they are, than trying to persuade owners of existing operations to strand their own assets, or persuading governments to introduce a high carbon price that makes those assets unprofitable. Beyond this headline statement is a host of difficult detail.

For example, banning new exploration might contribute to an energy supply and demand imbalance, and therefore increase the likelihood of a disorganised transition. Energy shortages can lead to a worse outcome for the climate. See, for example, the emergency substitution of gas with higher emitting coal due to the conflict in Ukraine. The underlying assumption appears to be that humanity has a right to as much energy as it needs and wants. However, unconstrained energy use and limiting temperature rise may be incompatible2.

Another concern is that implementing a “no financing of new fossil fuel exploration” policy is problematic as most financing is to an issuer not a specific project. Moreover, 1.5C pathways are light on detail, particularly at the asset level, which also makes such a policy difficult to action. And sectoral pathways assume fossil fuel energy demand falls into line over time, which is unlikely at least in the near term.

All things considered, if we don’t support such policies there is an implicit assumption that investors will act in a way that supports the transition instead of short-term financial gains. Historically, this has not been the case. Allowing additional exploration and development of lower cost fossil fuel sources may reduce the expected cost of the transition but it also increases the risk that the transition does not happen at all.

Given the high level of these thoughts, and the absence of ‘exploration securities’, is there a practical role for the investment industry here? We think there is. We would like to see a step-up in stewardship and engagement through which the industry communicates its desire for no new financing of fossil fuel exploration (thereby lowering stranding, systemic, non-transition and portfolio risks). This works on the supply side. At the same time, it is equally important to address demand. So, there is a new role for the investment industry in lobbying, advocating, and engaging for demand side constraints to reduce the likelihood of energy imbalances.

On balance, therefore, it seems wisest not to explore.

[1] Higher temperatures increase the risk of triggering climate tipping points as discussed in Pay now or pay later?, Thinking Ahead Institute 2022.

[2] The idea of energy rationing, or constrained demand, is considered within another of our investment insights, Phase down or phase-out | is there a difference?