It appears global financial institutions are beginning to price in the energy transition and associated climate risks — except when it comes to oil and gas. 

That’s a key finding of an important new study released by a team of researchers led by Ben Caldecott at the University of Oxford Smith School of Enterprise and the Environment. Poring over financial transaction data that spans two decades, the team sought to answer a basic question — are financial markets pricing in climate risk? The answer it turns out is not that simple and frankly, a bit disturbing.

Lenders are indeed wary of coal, warming to clean energy

First the good news — clean energy finance is getting cheaper and coal finance is getting awfully expensive. The most eye popping results the study had to offer were in global loan spreads for thermal coal power generation, which saw an increase of 38% over the past decade plus. When compared to the spreads for offshore wind, which declined 24% over the same time period, it’s clear that lenders have turned on thermal coal generation, making it increasingly more expensive to build and operate. But while coal is receiving the brunt of investor scrutiny, the oil and gas industry has not suffered the same fate.

Lenders don’t seem to be concerned with oil and gas, at all

The big counterintuitive finding from the Oxford team is that while financing costs for coal have gone up, they haven’t budged for oil and gas. In fact, for certain segments of the oil and gas industry in certain parts of the world, they’ve actually fallen. Yes, just as the world is beginning to grapple with the unfolding climate crisis, financing new oil and gas infrastructure has been largely untouched by financier concerns — or even steadily getting cheaper.

Take upstream production for example. The Oxford team found that global financing costs for oil and gas production have remained basically the same, rising by only 3% over the same time period. But dig deeper and they found that offshore oil production in Europe — the supposed bastion of progressive climate action — actually fell by 30% when comparing the average of the past two decades. The same falling cost of finance held true for onshore oil production in India, China, the Middle East and North Africa. Basically everywhere, oil financing has been getting cheaper exactly when it needs to be getting more expensive.

But forget the climate rationale. This finding is hard to square with basic economic logic. Remember this is an industry that just faced an epic financial bust replete with negative pricing and the collapse of some of the industry’s biggest companies. But while what’s going on with oil is problematic, the bigger and more disturbing story is what’s specifically been going on with gas infrastructure finance in one particular region: North America.

To finance or not to finance a wave of new U.S. gas infrastructure?

As it turns out, North American new gas plant finance has been getting steadily cheaper, with loan spreads falling by 28% over the past decade, while coal plant finance has been increasing. Moreover, it turns out that onshore gas production also saw a decrease in its cost of capital of 9% over the same time period.

As they say, money talks and these loan transactions speak volumes about what financial institutions believe or don’t believe about the energy transition in the U.S. and its inherent risks. Financiers clearly see the writing on the wall for coal and they’re acting on it. But they are either blind to many of the same risks facing gas infrastructure or they’re ignoring them for reasons that are not entirely clear.

Exactly why financiers seem to be ignoring climate risks associated with oil and gas is a question we need to answer and quickly. With over 100 GW of planned new gas plants in the United States (needing $100 billion in new finance) what U.S. financial institutions lend to, and at what cost, will have long term repercussions for the energy transition. If that planned wave of gas plants enjoys a low and falling cost of capital, it's yet one more unnecessary headwind for the Biden administration seeking to decarbonize the power sector by 2035.

Unfortunately it is a headwind being generated by the biggest banks on Wall Street, who unsurprisingly are the largest financiers of fossil fuels in the world. Those same institutions actually lobbied for bailouts of distressed oil and gas companies during the pandemic because their exposure to the industry was, to put it mildly, not insignificant. In a perfect world, with plenty of time to achieve a clean energy transition, it’s possible and even likely that these recalcitrant institutions would adjust their lending, as they have with coal, and penalize oil and gas. But time is the one luxury a Biden administration doesn’t have.

Perhaps more importantly, as our understanding of climate change and its financial risk has grown, it’s clear that this is not just a threat to climate goals, it’s a threat to the integrity of the financial system itself. Because the more we continue financing assets that will inevitably become stranded, the more we are laying the tinder on which the next financial crisis will burn. Based on what the Oxford team has found, and the lack of financial regulation we’ve seen to date that would help avoid these speculative investments, we’re laying the groundwork for an inferno.