New analysis from climate finance think tank Carbon Tracker warns the recent rebound in oil prices could lure international oil giants into spending billions on new projects that could quickly become stranded assets.

Carbon Tracker warns in a new report — Managing Peak Oil: Why rising oil prices could create a stranded asset trap as energy transition accelerates— that the price rebound could be short lived under the influence of climate action-led government policy and the accelerated build-out of renewables technologies worldwide.

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For its analysis, the group used a non-linear scenario, where oil demand grows in the short-term before falling rapidly, while it also used the Inevitable Policy Response’s forecast policy scenario commissioned by the UN’s PRI (principles for responsible investment), which is consistent with limiting global temperature rise to 1.8 degrees Celsius.

Carbon Tracker warns under its "high investment" scenario that companies sanctioning projects based on a breakeven price of up to $60 per barrel could risk some $500 billion worth of investment becoming stranded.

The financial analyst group warns if oil prices fall to an average of $40 per barrel after 2026, some $530 billion of investment would be squandered on hydrocarbon developments that were “no longer commercial” under the "high investment" case.

However, it adds it believes its $40 per barrel price assumption is conservative, adding an oil price of under $30 per barrel could see upwards of $1 trillion of investment being wasted.

New developments ramp up as demand drops

Under Carbon Tracker's ‘high investment scenario’ projects approved with a breakeven price of $60 per barrel – in line with European majors’ present price forecasts – would initially help meet short-term oil demand up to 2026.

However, it also warns these projects would hit peak output “just as demand starts to decline significantly”, triggering “heavily oversupplied market prices to plummet and high-cost projects to risk becoming stranded”.

The Carbon Tracker report spotlighted a number of potentially exposed big-ticket oil and gas developments that rely on breakeven oil prices of over $50 per barrel, but will only start producing late this decade.

These include: Kuwait Petroleum’s $7.5 billion Lower Fars heavy oil project in Kuwait; ExxonMobil and Shell’s $6.7 billion Bosi project in Nigeria; Petrobras, Shell and Galp’s $3.1 billion Tupi project in Brazil; and ExxonMobil, Equinor, Galp and Sinopec’s $3 billion Bacalhau project in Brazil.

“Companies may see high prices as a huge neon sign pointing towards investment in more supply," said Carbon Tracker oil and gas analyst Axel Dalman, who was also lead author on the think tank's report.

"However, this could become a nightmare scenario if they go ahead with projects which deliver oil around the time that demand stars to decline. Shareholders could face catastrophic levels of value destruction as prices fall."

Climate goals could limit demand growth

In the report, Carbon Tracker warns that short-term demand growth could see even greater reductions in a bid to keep the goals of the Paris Agreement alive and limit global temperature rises.

"Policy action is likely to strengthen post-COP26, while the rapid adoption of EVs (electric vehicles) will potentially further weaken demand,” the report warns.

"Companies basing sanctioning decisions on bullish short-term signals thus risk significant over-investment, seriously impacting shareholder value. It wouldn’t be the first time that the industry has fallen into this trap."

Mike Coffin, head of oil and gas at Carbon Tracker, said: “We know demand will weaken as the policy response to the climate crisis and deployment of new technologies accelerates. For companies to effectively manage this transition, they must resist the temptation to invest heavily on short-term price signals.

“Failure to acknowledge the sea-change risks wasting huge amounts of capital, delivering sub-par returns to investors, and locking-in emissions that take the world beyond Paris goals.”

Shale to shine in the short-term?

The report concludes that the “best route” is to stick to a conservative approach to long-term investment and meet short-term demand with shale developments, which can be ramped up quickly, but contribute less to long-term oversupply given their typical high rate of decline.

Shale projects typically have shorter lead times than other oil and gas developments. Shale projects can come onstream in months, compared to a development lead time of three-to-five years, or more, for deep-water developments, while smaller onshore projects can have lead times of one-to-two years.

In the report’s ‘managed investment case’ oil companies would only give approval to long-term projects up to a $30 per barrel break-even, meeting short-term demand with fast-track production from shale projects with a break-even of up to $50 per barrel.

“This would satisfy most short-term demand up to 2026, leaving a supply gap of 2 million barrels a day that the [Organisation of Petroleum Exporting Countries] and other producers can meet by deploying spare capacity,” said Dalman.

(This article first appeared in Upstream’s sister publication Recharge.)