Retiring Pensions from Oil

In early January 2016, media reported that Saudi Arabia was considering selling shares in Saudi Aramco. Saudi Aramco is the state-owned company that controls the oil under Saudi Arabia, all 261 billion barrels worth; those reserves make it — even at current low oil prices — the world’s most valuable company.

The idea that the Saudi kingdom would sell even part of Aramco is astounding. Saudi Arabia gets 80% of its government budget from oil, and almost half of its economy is oil revenue. Selling Aramco would be much like the United States selling the East Coast states plus Texas: it demands an explanation.

By selling stock, the Saudis clearly prefer money now — for shares — rather than money for oil, spread out over future decades. Why?

Partial explanations exist.  For instance, the Saudis can produce oil cheaply and would like to eliminate their higher-priced competition. [But, in the long run, why should they worry much about competition that has higher production prices?  Saudi production prices are low, and most of the world has much higher production prices.  Note that there are three sets of numbers floating around: marginal production prices, average production prices, and the price needed to balance the government budget.  The last is less relevant.]  Or, perhaps other oil producers want to pump oil as fast as possible, and the Saudis cannot convince them to slow down. But, these explanations only push the question “why?” back one step.

As the deeper reason, perhaps the Saudis fear that there may be permanent glut of oil, because of shrinking demand. That fear is reasonable: solar and wind renewable technologies, in some places and at some times, already produce cheaper electricity than fossil fuels. And, continuing technological improvements will only drive renewable prices downwards.

Another reason the Saudis should fear a permanent oil glut is the recent Paris Climate Agreement (COP21). One hundred eighty-seven countries have pledged to use either less fossil fuels per dollar of GDP or less fossil fuels in total. One of those 187 pledges comes from Saudi Arabia, and — interestingly — it mentions diversifying its economy away from oil exports and towards “ambitious programs for renewable energy”.  [Though, admittedly, their imagination doesn’t move very far away from oil.]

The scientific background for this is that humanity has discovered more coal, oil, and gas than we can allow ourselves to burn [IPCC]. In order to meet the 1.5 or 2 degree Celsius (3F or 4F) targets set at the Paris Climate Accord, we need to leave at least 70% of known fossil fuel reserves underground.  And, while it’s difficult to consider switching energy sources, it may be beginning to happen.

The question that must fascinate all the world’s oil producers is “who gets to sell the 30% of the oil that we can afford to burn, and who ends up with the 70% that needs to remain underground?” So, if Saudi Arabia (and other oil producers) began to suspect that the world might eventually stop buying oil, the sensible thing would be to sell it off as soon as possible. It would become a race to sell as much as possible while there is still a demand for it. That may well be what’s actually happening, and it may explain a sale of Aramco.  [If you think about it, this is yet another tragedy of the commons, where the “commons” are people who want to buy oil.]

This uncertainty in oil [Uncertainty?  Such a biased choice of word.  It’s as if the stock market is “certain” and the physics of climate change is “uncertain”.  Quite the reverse in fact.] is especially important for long-term investments like pension funds. The best scientific prediction is that we shall need to stop burning fossil fuels sometime around 2040, and that date is within the investment horizon of pension funds and 401(k) investments. A 30 year-old employee today will be just 54 in 2040; if retirement investments buy stock in fossil fuel companies today, what happens after 2040, when its time to sell and there may no longer be a demand for oil, and thus no fossil-fuel profits?

The sensible and safe thing to do is to divest retirement funds away from fossil fuels. Investing almost anywhere else makes more sense. In 2040, we’ll still be growing food, we’ll have some kind of cars, we’ll still be wearing clothes, we’ll carry some kind of phone. But, we had better not be pumping oil. If Saudi Arabia is beginning to get out of the oil business, we may want to do the same.

[So, what could go wrong with this scenario?  Only that we wait too long.  Eventually, the impacts of climate change will be so obvious that we will do whatever is necessary to stop burning fossil fuels.   Of course, there is a risk that governments will bail out fossil fuel companies, but that’s hardly likely to turn them into especially good investments.  If it’s done, just enough will be done to keep the markets from collapsing and keep the oligarchs comfortable.]