A cautious, managed approach to the energy transition is needed in the face of rising oil prices that could tempt oil and gas companies to make long-term investment decisions risking climate goals and costing shareholders dearly, according to a new report from Carbon Tracker published Thursday.

The report, entitled Managing Peak Oil: Why Rising Oil Prices Could Create a Stranded Asset Trap as Energy Transition Accelerates, considers the financial implications of a future in which oil demand increases into the mid-2020s and then falls rapidly.

Carbon Tracker said the report explores a non-linear demand pathway using the Inevitable Policy Response (IPR) consortium’s Forecast Policy Scenario (FPS), commissioned by the United Nation’s Principles for Responsible Investment, which is consistent with limiting the global temperature rise to 1.8°C.

The IPR FPS models oil demand growing at 1.6% a year to reach an additional 8 million barrels per day by 2026 compared to 2021 levels and then falling 3.5% a year to 2040.

The report finds that the best route to meeting demand while preserving value is to maintain a conservative approach to long-term investment and meet short-term demand with shale projects that can deliver new production quickly.

The report finds that the strong rebound in oil prices as the global economy bounces back from the COVID-19 pandemic is unlikely to last because governments’ climate commitments combined with the rapid switch to electric vehicles will drive down long-term demand for oil.

The price of Brent crude is currently reaching $90 a barrel compared to prices in the mid $50s a year ago. Investment bank, Goldman Sachs, forecasted that prices could reach $100 and anticipates trade per barrel at around $85 for the next several years.

However, the report warns companies to anticipate this shift and manage the decline.

If companies invest in high-cost projects with the expectation of continued high prices, the market could be severely oversupplied as demand falls, driving prices down.

“Companies may see high prices as a huge neon sign pointing towards investment in more supply. However, this could become a nightmare scenario if they go ahead with projects which deliver oil around the time that demand starts to decline,” Axel Dalman, Carbon Tracker oil and gas analyst and lead author of the report said. “Shareholders could face catastrophic levels of value destruction as prices fall.”

Growing risk of stranded assets

The report models two cases in a world where demand rises up to 2026 and then falls sharply to 2040.

According to a high-investment case, companies approve projects up to a breakeven price of $60 per barrel in line with European majors’ current price forecasts.

Although this meets short-term demand up to 2026, projects reach peak output just as demand starts to decline significantly, putting the projects at risk of being stranded.

If the oil price falls to an average of $40 after 2026, some $500 billion of investment could be wasted on projects that are no longer commercial and this amount could double based on a scenario in which prices are under $30, Carbon Tracker calculated.

Falling oil prices over the last decade have seen the average breakeven price for projects approved by oil companies drop below $40 a barrel, reflecting the companies’ growing awareness of the long-term implications of the energy transition underway, the report said.

According to the report’s managed investment case, companies only approve long-term projects up to a breakeven price of $30 per barrel and respond to short-term demand by favoring shale projects that can ramp up production quickly, approving them at a breakeven price of $50 per barrel.

“This scenario would largely balance the market as demand falls after 2026, meaning that there will be less pressure on long-term oil prices. If they averaged $50 up to 2040 no investment would be wasted,” it said in the report.

Even if long-term prices fell below this level, the report finds that this managed approach would waste far less investment than a high-investment strategy.

High-risk projects which rely on a breakeven oil price of over $50 and would only start producing late this decade include Kuwait Petroleum Corporation’s $7.5 billion investment in the Lower Fars Heavy Oil phase 2 project, ExxonMobil and Shell’s $6.7 billion investment in the Bosi project in Nigeria, the Tupi project of Petrobras, Shell and Galp in Brazil, and the $3 billion investment in Bacalhau and Bacalhau Norte also in Brazil of ExxonMobil, Equinor, Galp and Sinopec.

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