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Talk is Cheap: Towards Active State Ownership in the Fossil Fuel Industry

The combustion of fossil fuels for energy is by far the largest source of greenhouse gas emissions and the energy sector will need to change in order for long-term de-carbonization to succeed. So, it is disappointing that there has been little concrete climate action from the fossil fuel industry, despite commitments to the Paris Agreement. The energy transition is undeniably a complex process and the use of fossil fuels cannot be abruptly ended. There needs to be a managed decline of fossil fuels while supporting clean energy deployment. Our economies are deeply entangled with fossil fuels, as government budgets and other parts of the economy such as the financial markets and pension funds are dependent on fossil fuel investments.

Yet, this also provides an opportunity as the energy sector is unique compared to other polluting sectors in the economy. Due to fossil fuel’s relation with energy security and economic development, a large share of companies that extract, refine and distribute fossil fuels as well as companies that generate power and manage utility infrastructure are state-owned. Even after the wave of privatization in recent decades, state-owned enterprises (SOEs) still account for 62% of global electricity generation capacity installed or under construction.

State ownership in energy is especially common in emerging economies, of which some are the fastest growing CO2 emitters worldwide. In these countries, such as China, India and the South-East Asian states, SOE’s provide about two/thirds of all electricity output. In Europe state ownership of energy, output is still 45%. The majority of climate policies look at the state as an active regulator, but because of the prevalence of state-ownership, the state should also be a leading economic actor, as shareholder and investor, on the supply side of energy.

Fossil Fuels are a Risky Business

Active state ownership fits the general trend towards more active economic ownership in the energy industry, where there are increasing calls for divestment or engagement through activist shareholding. Recently the financial sector increased its pressure on oil and gas groups. Private investors, such as asset managers and pension funds are calling for clarity on the risks of long-term fossil fuel expansion and the business strategy for the transition towards clean energy. This summer, private oil and gas groups such as Royal Dutch Shell, Exxon Mobil, and Chevron, faced shareholder resolutions asking them to take an active role in the energy transition and push for reaching international climate change goals.

This is not due to growing moral consciousness in the financial industry, but mainly due to a stronger link between climate change and investment performance. Climate change does not only present an impact risk by itself but also presents fossil fuel companies with a transition risk through probable changes in policy, market, reputation and technology. Yet, while the energy transition will continue as the global community is recognizing the need to reduce emissions, oil and gas companies continue to invest in fossil fuel assets. These assets can be left unexploited or decline in value due to actions to reduce climate change, turning these assets into “stranded assets.” Stranded assets will have lower value than was originally expected by the company and its shareholders, and is often not reflected in companies’ risk management policies.

Major fossil fuel companies’ scenario planning and forecasting is not in line with the 2° target of the Paris Agreement. Their scenarios are based on the assumption that this limit is impossible due to the current lack of regulation, while many of the same companies oppose these regulations through lobbying. The forecasts also continuously underestimate the growth of renewable energy and other technical developments, allowing ongoing carbon-intensive investment. This raises the question if fossil fuel companies are accurately reporting and forecasting to investors and shareholders in line with the risks, and whether they are putting both the economy and climate at greater risk through portraying false confidence in the long-term viability of the industry.

Because of these concerns, private shareholders are engaging with energy companies to adjust their forecasting and demand transparency on their business models. Even international bodies such as the Financial Stability Board are encouraging climate change-related risk disclosure on long-term financial viability of fossil fuel companies. Yet, governments actually own over half the global fossil fuel assets and control around 70% of oil and gas production through SOE’s. If not owned by government, a large share of government revenue comes from taxes and royalties paid by fossil fuel companies. Additionally, the stability of major areas of the economy, for example, insurance and banking, are financially entangled with extractive industries. This means that actually those most at financial risk of stranded assets are governments, their citizens and taxpayers themselves and not private investors.

Meanwhile, we are continuing down the same path, as the global pipeline of fossil fuel projects aimed to satisfy the rising demand for power will take us far beyond the internationally agreed temperature limits of to below 2°. Even though the pipeline of power generation projects, both planned and under construction, includes more green energy projects, there is still 1.5 times more fossil fuel capacity in this pipeline than zero-carbon capacity. More importantly, SOEs still account for half these pipeline projects in fossil fuels. This, however, also implies their potential SOE’s have to encourage change.

Alignment of States’ Policies

SOEs should seek to fulfill social and environmental objectives, beyond profit maximization and the economic rationale of minimizing the risk of stranded assets. It is inherently inconsistent for governments to commit to climate action, and continue to pursue solely economic objectives as a player in the market. A cross-cutting approach to climate change will require governments to align government’s economic, energy and environmental agendas. Ownership action from government does not have to entail divestment.

One of the priorities should be to align the mandates of energy sector SOEs with the Paris Agreement to adjust the pipeline to reflect the 2° goal. Governments can then encourage SOEs to diversify their portfolios and increase investment in renewables, energy efficiency improvement of plants and electricity grids, and carbon capture and storage techniques. Economic diversification through investing in renewable energy will also help SOEs to decrease the financial risk to their revenues and thus the economy as a whole. Most importantly, SOEs can thus encourage a more sustainable economic model, as the large share of SOEs in the energy sector shows the importance of their investment decisions for the future of the entire sector.

As environmental change accelerates, energy SOEs need to align with promised climate policies and disentangle the economy and thus engage society in not only polluting but also long-term financially inviable fossil fuels.