Ink Research November 21, 2022 - The United Nations Sharm el-Sheikh Climate Change Conference, also known as COP27, wrapped up over the weekend with a surprise. In the draft decision, the conference made a big concession on the role that fossil fuels would play in the transition to a low-carbon world. Instead of pledging to work towards the phase-out of fossil fuels as some participants had wanted, the conference formally emphasized, "the urgent need for immediate, deep, rapid and sustained reductions in global greenhouse gas emissions by Parties across all applicable sectors, including through increase in low-emission and renewable energy."
Practical considerations were likely the driver behind the shift. While some rich developed countries may still feel they have the resources to eliminate fossil fuels quickly, many other countries do not see a realistic pathway to eliminate fossil fuels in time to address global warming. Ultimately, it is reducing emissions that is the objective, and the global community now seems to be accepting that broad innovation instead of full fossil fuel substitution will have to lead the way to get emissions down.
We believe that could have significant implications for the future valuations of oil & gas stocks. Over the past few years, the group has been subject to a climate-related valuation discount. Not only were many Energy sector stocks shunned by big funds due to ESG concerns, but there was also a perceived risk that the industry would be shut down entirely due to climate policies. The latter outcome now seems unlikely on the back of the COP27 decision. Importantly, ESG rating agencies may have to rethink their criteria for penalizing oil & gas stocks. Natural gas focused companies in particular could be seen in a new light by the ESG crowd if they are deemed to be low-emission energy. While it remains to be seen which fossil fuel companies will be seen as having low emissions, the industry seems less at risk today of being completely shut down than it did even a week ago.