How climate change termination risk could affect Chile

Fossil energy stocks overperformed last year due to the so-called termination risk linked to the effects climate change has on financial markets, which can have consequences for fossil fuel importers such as Chile.

Termination risk arises when a business is close to termination and is at risk of becoming a stranded asset. In this situation, investors slow down spending, which, in turn, leads to reduced supplies and higher prices in the short term – and increased returns.

In the case of fossil energy stocks and the looming fossil phase out, investors are focused on consolidating short-term gains from reduced supply, Robert Engle, emeritus professor of finance at University of New York, told an event hosted by Universidad Católica de Chile.

Brent prices averaged US$89/b in 2023, compared to US$101/b in 2022 and US$50/b in 2020, when demand collapsed due to the COVID-19 pandemic.

Since then, some producers have scaled back their output, while supply has been more uncertain in the face of geopolitical conflicts. 

“If the US were to apply a comprehensive carbon tax, then this rise in profitability from energy companies from the response to termination risk would be much less dramatic,” Engle, who won the Nobel Memorial Prize in Economic Sciences in 2003, said.

“Chile imports oil. Oil companies face termination risks. Chile is going to face higher prices that way,” Engle said in response to a question by BNamericas on how termination risk affects the country, which aims to become carbon neutral by 2050.

Engle highlighted that higher fossil energy prices could speed up the transition to renewables, but policy must provide guidance. 

“We bet heavily on hope, but hope is not going to get us where we need to go. We need a big transformation,” he said.

Engle also said that countries that depend on fossil energies are being incentivized by termination risks to use the short-term gains and diversify their economies.