Liebreich: Deepwater Horizon – Fossil Fuel’s Chernobyl?

By Michael Liebreich
Chief Executive
Bloomberg New Energy Finance

Three months ago, I described the Magnificent Seven decadal themes that we expect to propel clean energy’s progress between now and 2020. One of them was the occurrence of “Black Swans”: unpredictable game-changing events that will transform the energy investment landscape for countries and companies.

At the time, I will confess, I was thinking of Black Swans like breakthroughs in technology, the rapid propagation of new business models, and the de-bottlenecking of particular policy hold-ups. I also had in mind situations in which the industry might reach some sort of network-benefit, positive feedback breakpoints, allowing it to take off unexpectedly strongly in some sectors: for instance, a fall in PV costs to below retail power prices, or an increase in electric vehicles connected to the grid, thereby allowing a step change in demand response.

What I did not consider back then is that there is a second sort of Black Swan that could also impact on the roll-out of clean energy: negative Black Swans – terrible, tragic accidents, which challenge our ability to continue with business as usual.

First and most obviously, Deepwater Horizon is a disaster for BP, wiping nearly 50% or some $90bn off its stock market capitalisation and doing untold reputational damage. It is too early to know the extent of the direct costs to BP, but it is clear they will be well into the tens of billions of dollars to stop the leak, pay for the clean-up, compensation and punitive damages. Unless the escape of oil is stopped in the next few weeks, our estimate is that it will end up somewhere in the $30bn to $40bn range, and almost certainly above the $20bn figure ring-fenced in agreement with the US government last week.

Although the direct costs do not appear to jeopardise BP’s survival, the spill does mean it will face a battle to explain to the markets how it expects to operate in the aftermath. BP’s US operations are absolutely key to its business; it is going to be mired in lawsuits long after the oil stops fl owing and Louisiana’s beaches are cleaned up. Management will be distracted, and it will be a brave politician who gives BP a clean bill of health to resume drilling, or awards a new concession.

And we must remember, this is not any old oil company. Last year, BP overtook Exxon to become the biggest producer among the international oil companies (IOCs), with only Saudi Aramco and other national oil companies (NOCs) exceeding it in output. BP is a major supplier of energy products around the world and a leading player in the energy markets. It generates substantial cash, reinvesting heavily to maintain its production capacity and reserves, and it provides substantial dividend yield to shareholders and tax take to governments – not just in the UK, but also in the US and elsewhere.

It employs over 80,000 of the best-trained and most capable people in the energy industry. Anything that reduces BP’s ability to operate, or its access to resources, is de facto going to have a significant impact on the energy sector. In terms of clean energy, BP has built one of the leading positions in the industry, in particular in biofuels, US wind and solar project development.

The process may have started in a high-profile way under Lord Browne, but continued quietly on Tony Hayward’s watch, with investments continuing at an average of $800m per year. Any squeeze on BP’s ability to invest in clean energy will have a measurable negative impact on the sector.

The impact of the Horizon Deepwater spill, however, goes far beyond the direct effect on BP. Around the world, governments are reviewing their plans and permitting processes, and will be adding new regulations. The Cullen Report in the wake of the Piper Alpha disaster in the North Sea in 1984, which killed 167 people, resulted in 106 changes to safety regulations. Deepwater Horizon will result in a similar rethink. In economic terms, new regulations will tilt the cost curve more sharply upwards: the marginal barrel of oil is an offshore barrel, and it is easy to see new regulations adding 5% to 10% to the costs of deep offshore drilling and extraction. This could add $5 or more to the price paid for every barrel of oil.

The International Energy Agency has talked in recent years about a supply crunch in the oil markets around 2015. The likelihood that deep water oil may now not be extracted in the anticipated quantities will certainly heighten the pressures. The upward impact on oil prices will most serve to enhance the economics of biofuels, but also electric vehicles and plug-in hybrids – and they in turn will drive the need for energy-smart technologies. It is Christmas every day the oil continues to flow in the Gulf for Elon Musk of Tesla and Shai Agassi of BetterPlace.

It is also extremely good for Saudi Arabia and others sitting on oil that is cheap and easy to extract – the left-hand side of the cost curve – as they get the benefi t of higher prices without the extra costs. On the geopolitical front the spill is a negative, as it increases income for Venezuela and Iran, and reduces the extent to which the US will use its own resources to replace foreign oil. “Drill, baby, drill” is not looking like such a smart slogan these days (except to Sarah Palin, who still stands behind it).

The impact on the market for natural gas is more complex. Gas producers should benefit from higher oil prices – many contracts are still linked to the oil price, though for how long is a subject of intense debate. There is also some noise about moving US transport towards LNG/LPG, but there has been little momentum in this direction. However, the brightest star in the gas firmament, shale gas, is also a technologically complex beast, and subject to great fears about its potential to pollute water tables.

Deepwater Horizon may encourage tentacles of increased regulation to reach out towards shale gas as well as offshore oil. The implications for another future technology, carbon capture and storage could be subtle. On the one hand, the spill could raise fears of some disastrous CO2 leak from underground. However, out-weighing that may well be a calculation by energy policy-makers and oil companies that using captured CO2 from power stations for enhanced oil recovery could be a less risky option to increase oil production than deep water drilling.

However, the most significant and longest-lasting implication of the Deepwater Horizon spill may well be in the way it changes the way we think about energy security. Company boards need to spend some time asking the question: “Could what happened to BP have happened to us? And if so, what should we do differently?”

Governments the world over need to rethink all of the pinch-points in the fossil and nuclear supply chains, or risk the consequences. Is it not fascinating that the defining crisis so far of this presidential term – like Hurricane Katrina for President George W Bush’s second term and Iraq for his first term – should be energy and environment-related?

For the great US public, the crisis is likely to tip the scales back towards taking action on climate and energy. The BP spill may not be about greenhouse gas emissions, but it has certainly reignited a sense that the current path is unsustainable, that big energy has to be put in its place. President Obama sought to catch this mood in his 15 June speech, saying that the spill demonstrated the need to end the US “addiction to oil”, using virtually the same language as his predecessor. He looked upon the Senate to move beyond partisan wrangling to pass the energy bill already voted through the House of Representatives (or at least the part of it that contains a federal Renewable Electricity Standard). If the situation in Louisiana provides the cover for one or two Senators to swing behind an energy or nergy and climate bill, it will have historic implications indeed for our sector.

Tragic Black Swan events like Deepwater Horizon form a dark backdrop to the story of the world’s drive to clean energy. They are overwhelmingly more likely to hit centralised, polluting, dangerous technologies, operating in desperately difficult environments, with many of them deployed in risky parts of the world. A look at the history books shows it is not bad luck that Deepwater Horizon happened in the dirty energy industry: something on this scale could have happened in hardly any other industry.

However, Deepwater Horizon is not an event the clean energy industry should welcome or celebrate. We must remember that 11 people lost their lives in the explosion, and thousands of people are losing their livelihoods. Financial compensation is no substitute for a good job embedded in your community, or for the loss of a loved one. And the soiling of some wonderful coastline is no cause for joy either.

If the current situation on the US’s Gulf Coast is not the oil industry’s Chernobyl, it is at least its Windscale or Three Mile Island. But the clean energy industry will be measured on whether it can empathise with the people affected by its unstoppable development. Hubris is always punished.

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About Bloomberg New Energy Finance

Bloomberg New Energy Finance (BNEF) is an industry research firm focused on helping energy professionals generate opportunities. With a team of experts spread across six continents, BNEF provides independent analysis and insight, enabling decision-makers to navigate change in an evolving energy economy.
 
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