While many continue to discount calls for divestment and the value at risk from climate change, a growing body of work shows that value has already been lost and much more is in the balance.
There are five main and considerable new categories of risk to consider:
1. Geopolitics – Saudi Arabia’s decision to pump oil at will last year continues to this day and has been one of the main catalysts for lower oil prices.
Many analysts didn’t see this coming.
For example, this article pinpointed Goldman Sachs’s prediction of $90 a barrel prices in early 2015. Instead, oil is now trading for roughly half that amount having hit a six month low around $48 earlier this week.
This was likely at least in part due to the US becoming the world’s largest oil & gas producer in 2015.
Geopolitics is a key factor in trying to understand future power shifts and will continue to drive motivations perhaps the most important factor in the equation and not one factored into the UN’s global climate negotiations, which arguably dwarf this in significance.
2. Fuel Switching – Coal has met its demise in the US, largely because of the aforementioned supply of cheaper gas which has allowed power plants to switch from coal to gas. Fortunately, gas has a lower footprint than coal, including lower on local pollution, so gas figures to continue to thrive as an alternative, but for coal the end is clear. Piling on to this is regulation, even if tied up in lawsuits, such as the EPA’s Clean Power Plan.
Coal is sitting around in piles now, and the recent slowdown in the Chinese economy puts further pressure on the coal sector. Fund managers attempting to time the bottom of the coal market have gotten burned time and time again.
Here is the real risk to date – ignoring climate change as it affects regulation and the ongoing switching to cleaner fuels.
Even if climate change was a secondary issue in coal to gas switching, it is there as a clear barrier to coal being taken up again, and local pollution is another issue that won’t just go away.
Therefore, looking at fossil fuels with tunnel vision has been value destructive to those not looking at the whole picture. We will get back to this in a minute on capital expenditure.
3. Innovation – Then there is the issue of continuing innovation and changing cost curves of solar, wind and other energy innovation categories. Tesla vs. GM makes for an interesting comparison with Tesla up 1132% over the past 5 years, while GM was down 9.69%.
Solar innovation continues to be a driver of lower costs and new jobs. The danger here is that as with any new industry there will be many startups that fail, but if you are trying to find the next Google, you can only do two things – look top down at companies likely to scale a good idea such as IBM and GE are known to try to do, or look bottom up and see if you can reel in the next big fish.
4. Wasted Capital Expenditure – Ignoring climate risk has been especially finger pointed as a financial danger by the Carbon Tracker Initiative in London but it has been the lower price of oil that has put paid to the financial plans of the oil giants. For example, Chevron, regardless of its oil spill and pollution history has been financially outperforming its peers up until last year. That has changed as a direct result of overspending on new oil and gas exploration and the company is now underperforming its rivals ExxonMobil and Shell.
To help defend against their dividends, the top oil companies have been borrowing massively in 2015, to the tune of $31 Billion, and so how this gets spent is key towards future valuation. Shareholders in some case have started demanding cash back instead of spending on projects which may not prove to be financially viable.
5. Changing Perception – then there is the UN Climate Negotiations and the stance of the likes of Pope Frances, who is expect to address a joint session of Congress on this and other subjects next month. Young people, even if somewhat misguided in thinking divestment will be a positive driver of meaningful change as we have written here at length, will continue to put on pressure on the subject.