When discussing climate change and the climate risk associated with it, the focus is typically on the impacts of extreme weather events, such as more intense flooding, hurricanes, extreme heat, drought, etc. There has been less focus on climate related impacts to a community, when the threat of climate change shifts our industry base and the way we do business. In communities that are focused on resource extraction, such as oil and gas, what are the impacts to this community when regulations and consumer preferences shift us away from the use of this resource? There has been recent examples of how the market shift from coal to natural gas has significantly impacted communities that are dependent on coal for economic sustainability. As electric power generation switched from coal to natural gas across the country, due to lower natural gas prices, coal communities have suffered.
We are now seeing similar shift in consumer and investor preferences that may have a similar impact on communities that rely on oil and gas for their livelihood. Oil and gas companies are feeling significantly more pressure to measure and report on their risk related to climate change. This is being driven by organizations such as the Financial Stability Board’s Task Force on Climate Related Financial Disclosures (FSB TCFD). As these disclosure recommendations are being refined and published, large global companies have asked members of the G20 countries to follow the recommendations of the TCFD. Governments are asked to accept and implement the task force guidelines which would require companies to disclose their climate risk. They are expected to disclose physical, liability and transition risks to investors, lenders, insurers and other key stakeholders. This increase in transparency will inform market participants, whether they be investors, insurance companies or consumers. Improved knowledge of these risks will likely shift investment and consumer behavior, potentially to the detriment of the disclosing organizations and the communities where the operate.
As market shifts, both through change in consumer preferences and regulations, there is significant risk of stranded assets for oil and gas companies. These companies will find it more difficult to continue to produce from their fields and bring their product to market. Further, increasing regulations will increase operating costs and reduce consumption of petroleum-based products. This could particularly be the case, as the transportation sector shifts toward electric powered vehicles, 78 percent of oil consumed in the United States goes toward transportation. Natural gas will likely be less impacted by this shift to an electric vehicle fleet as it is still seen as the primary fuel for our country’s base load electric power. However, that is not guaranteed as we see the price of renewable energy and batteries continue to decline rapidly. As these technologies continue to evolve and integrate, the cost and intermittency that has plagued the viability of these technologies largely goes away.
So if you are a community dependent on the oil and gas sector, such as Houston, how do you adapt to this climate risk? Houston will not only see greater direct climate risks from flooding, extreme heat, hurricanes, and even droughts, it is also likely to be impacted by the shift from carbon-based fuel sources.
The City of Houston has significant financial liabilities that are difficult to keep up with even in good economic times. The unfunded pension liability and the $1.7 billion in road bond debt, accruing $200 million in annual interest are good examples of the liability. The real vulnerability Houston faces is that although it has diversified economically to a greater extent than the 1980’s, 70% of its economic base is still dependent on the oil and gas sector; the region also has over 50% of the refining capacity in the United States.
The most recent decrease in prices demonstrated how vulnerable the upstream market is to price shifts and the impact on the Houston economy. During the 2014 drop in oil prices, the Houston region lost over 77,000 jobs in the oil and gas industry, largely upstream positions. This blow was softened a bit due to mid-stream and downstream oil and gas activity. Much of the opportunities shifted from west Houston to east Houston. However, Houston is now facing a much more significant issue. The drive to disclose climate risk in the oil and gas sector and the growing momentum to divest in oil and gas companies by large investment firms, is going to impact the entire oil and gas sector, upstream, midstream and downstream.
Climate risks from a changing climate, and climate risks due to changing market preferences, will be a significant issue for the City of Houston, its industry and residents. Will oil and gas companies make the shift to more diversified energy companies to increase portfolio diversity and lessen risk? Will the City of Houston start taking seriously its climate vulnerability and risk and prepare its infrastructure and community for a rapidly changing climate? ? Will it make a more concentrated effort to attract new innovative industry sectors? Unfortunately, the answer to all of these questions appear to be not really. There is some talk, but the reality on the ground indicates otherwise.