Cian Hennigan

This month, the CEO of US energy company Chevron, Mike Wirth, came out with a robust statement against the current pivot in energy production away from fossil fuels to renewable energy. He exclaimed that “The reality is, [fossil fuel] is what runs the world today. It’s going to run the world tomorrow and five years from now, 10 years from now, 20 years from now”. This view has been publicly shared by Jamie Dimon, CEO of JP Morgan Chase. He recently stated in a Congress testimony that his bank would not be uninvesting in fossil fuel companies, as doing so would be a “road to hell for America”. These views are motivated by the desire to increase fossil fuel supply to alleviate price pressures created by the current energy crisis. However, they are in conflict with the longer term climate issues facing energy companies. The traditional energy sector requires intricate investment and reform to change their business models from non-renewable to renewable, which places a major amount of responsibility on lending institutions to invest in a sustainable way. Governments are currently investing in renewable energy at an increased rate, in the hope of reaching climate goals set by international pacts such as the Paris Agreement. Although government investment is secure, the energy crisis provides the first significant test of the banking industry’s commitment to Environment, Social and Governance (ESG) practices. Early investment in renewable energy will likely lead to significant future profits for lenders due to the finite nature of our current energy system, and will help to alleviate some of their reputational downfalls in the last 15 years. Despite this, short-term deviance to fossil fuel investment is lucrative for banks and their shareholders if prices remain elevated. This dynamic will greatly impact the rate at which our societies can rely completely on renewable energy.

The current geopolitical tensions have come at a fragile time for a transitioning energy sector. The evaporation of Russian gas supplies to the European market has severely reduced energy supply. This has put direct upwards pressure on prices, fuelling the cost of living crisis. Over the past year, energy prices in the Euro Area have been the main driver of the increase in the Harmonized Index of Consumer Prices (HICP), which is the main measure of inflation for the Euro Area. The annual HICP specifically related to energy prices was measured at 38.3% in September, with overall inflation measured at just over 10%. Governments have directly responded to the increase in prices, such as Germany introducing a €200 billion energy aid programme which will place a cap on gas and electricity prices. An EU wide energy aid programme is currently being considered by the EU.

It is likely that energy costs will remain elevated into the future, with many warnings of a worse crisis in the winter of 2023. European natural gas storage is likely to be completely depleted by next spring, and the current uptake in Liquefied Natural Gas is not forecasted to be able to fully replace the loss in energy supply from Russian gas. Firms and households will have to prepare to reduce energy consumption by a considerable amount, which will have a severe impact on industrial production and growth in Europe. A rapid development in Europe’s renewable energy sources is key to reducing exposure to spikes in fossil fuel prices according to IMF researchers. This development will require a significant amount of investment, both from public and private sources. It is not understood what the investment balance will look like in an energy sector dominated by renewable sources, but it is intuitively likely that both will be important in financing the transition.

From a public angle, investment commitment is quite clear. National governments will look to make it convenient for energy companies to build renewable infrastructure such as wind turbines and solar panels. These policies will come in the form of both direct investment and polices that make it more financially lucrative for renewable energy infrastructure to be built. The switch away from fossil fuels will also allow governments to reduce their expenditure on energy caps on fossil fuels if geopolitical tensions persist and prices remain elevated. If fossil fuel prices begin to fall, it is necessary that governments continue to use carbon taxes to promote the continued transition to renewables. The REPowerEU initiative by the Commission also provides a much needed commitment of funds from the EU, along with an overarching strategy for the European response to a changing energy market.

The finance sector has begun to understand their ESG responsibility in recent years, with an industry led alliance called The Glasgow Finance Alliance to Net Zero (GFANZ) being created last year. This alliance looks to improve ESG standards and practices within the finance industry. GFANZ have also decided to collaborate with the UN under their Race to Zero agenda, to align GFANZ to the climate goals of the UN. There has been a strong uptake by banks to join GFANZ, and as a member they must set intermediate ESG targets and annually report on their progress to net-zero. These commitments include the clause that all operational and investment portfolios must be net zero by 2050. The energy crisis is the first real test of these commitments, and how seriously banks are taking sustainability. Various ‘greenwashing’ scandals have thwarted the impact of ESG efforts and shown the importance of the clear messaging surrounding sustainability practices. 

As part of the alliance, banks have agreed to help clients in carbon intensive sectors transition to a more sustainable business model. Oil and gas companies fall under this umbrella but have been earning windfall profits due to increased energy prices. The upsurge in profits has led to a 15% increase in lending to fossil fuel companies in the first nine months of the year, according to Bloomberg. There has also been some push back by GFANZ members against the implementation of legally binding ESG agreements, initially suggested by the UN. GFANZ stated that all members can follow their own governance structures, essentially ruling out this possibility. GFANZ is co-chaired by former Governor of the Bank of England, Mark Carney. According to Carney, the transition to renewable energy is a complex task that requires bold action by governments and financial institutions. He has expressed that “to limit warming to 1.5°C, projected clean energy investment must run at four times the rate of fossil fuel investment by the end of this decade. That will require a tripling of the current pace of clean energy investment”. Understanding the sluggish movement so far in the financial industry shows the glaring reality that banks will always act in a way that sustains profitability and satisfies shareholders. GFANZ is a fledging alliance, and the current crisis is the first major test of its stability and purpose.

In the short term, banks may use the excuse of protecting consumer prices to continue profitable investments in fossil fuel companies. That being said, it seems like an extremely risky long-term strategy for any financial institution to go against the macro trend of renewable energy investment. Transitioning energy companies is a suitable role for banks, but the finance industry has struggled in the past with understanding it’s responsibility to stakeholders other than their shareholders. The underlying uncertainty will yield tentative action by many banks until their peers proceed, but those who wait too long may diminish future earnings. The future of energy production lies in renewables, but the timeline and journey to that point is unclear. How quickly we move as a society will be directly related to the decision making of those with lending capabilities.