Oil's Future Draws Blood and Gore in Investment Portfolios
Al Gore has come a long way from the Inconvenient Truth raconteur who in 2006 extolled the “leaves rustling with the wind” and talked about boiling frogs as a metaphor for humanity in need of a "rescue."
Gore has been fighting climate change since he co-sponsored the first congressional hearings on the subject in 1976. While his essential aim hasn’t changed, his tactics and rhetoric have. Flush with cash after making $70 million in the sale of the Current TV network, Gore is buddying up to investors, working to change their minds about billion-dollar climate risks lurking in their portfolios. Gore, snubbing trees, is now a hugger of Wall Street.
“We're already seeing the impact on some carbon intensive assets -- we've seen it in Australia, we've seen it in Canada, we've seen it in the U.S.,” Gore said by phone from London on Oct. 29, a day he spent promoting a new report as chairman of Generation Asset Management, the investment firm he co-founded with David Blood. “The time has come to question how people avoid the risk.”
Gore isn’t alone in having a sort of come-to-Wall-Street moment. Last month 70 investors representing $3 trillion of assets under management sent letters to oil-and-gas companies asking them to disclose plans for adapting to a world that may be edging closer to peak fossil fuels. That’s the point when humans stop increasing their annual burn – either because the environmental danger makes it too costly or because buildings and cars run more efficiently. Bloomberg New Energy Finance says peak demand could happen in 2030.
The risk: Oil and coal companies worth more than $7 trillion may be sinking billions of dollars today into projects that will never make sense to finish.
Environmentalists see international climate talks -- which continue this week for the, ahem, nineteenth year -- as key to containing climate change. But even without a sweeping agreement, the global shift toward cleaner fuels and more-efficient gadgets is under way. That’s something investors were talking about even before environmentalists like Gore came into the conversation.
'Undertow of Demand Destruction'
In 2013, so-called carbon-asset risk “went from a conceptual possibility to a sort of near-and-present reality,” Nick Robins, head of the Climate Change Center at HSBC Holdings Plc in London, said in a phone interview. He wrote a research note in January valuing the risk of "unburnable reserves": the oil and coal on companies’ balance sheets that will be too expensive to extract. “There is this undertow of demand destruction going on through technological improvement. That’s certainly not fully priced at the moment.”
In other words, Teslas and solar panels are eroding the future value of black gold, and investors are ignoring the risk. This isn’t Greenpeace or the Sierra Club, or even Al Gore. It’s HSBC. And that's not the only bank raising a warning flag for fossil-fuel investments.
“The end is nigh” for global oil-demand growth, proclaimed a Citigroup report in March. Standard & Poor’s cautioned that a patchwork of policies that cut demand for fuels could lead to outlook revisions and downgrades in smaller oil-and-gas companies as early as next year, with a similar shock to the majors in 2016. Goldman Sachs’s advice to oil companies: “invest only in medium-/high-return projects, spend the rest of their cash on buybacks and focus on per share growth.” Translation: prepare to shrink the business.
The shift in assumptions about fossil-fuel demand started with coal. Cheap, abundant and packed with energy, coal was the dominant energy source that powered U.S. manufacturing from the late 19th century through World War II. It was also responsible for the smog that clouded cities, the mercury that tainted U.S. waters, and more than 40 percent of the CO2 emissions that are heating the planet.
In the U.S., coal demand has fallen near a 20-year low, squeezed by clean-air regulations and displaced by cheaper, less carbon-heavy natural gas. The coal industry has long assumed that the ballooning Chinese economy would make up for U.S. declines for decades to come. That’s no longer certain.
A Fall With No Recovery
In June, Bernstein Research’s Michael Parker and Purdy Ho took a hammer to the already brittle coal outlook with a 140-page analysis, “The Beginning of the End of Coal.” Chinese fuel-efficiency standards are already tougher than those on the U.S. auto fleet, and a newly vocal middle class is pushing back against suffocating smog. Parker and Ho wrote that a push toward cleaner energy will lead to “the unthinkable:” falling demand for coal beginning in 2016.
“All industrialized societies eventually decide that, while cheap sneakers are nice, the environmental damage caused by uncontrolled industrial activity is no longer tolerable,” the Bernstein analysts wrote. “Coal demand in China is about to start falling, and the global thermal coal market will never recover.”
The price of coal has fallen by more than half since a peak in mid-2008. The coal companies represented in the Stowe Global Coal Index are trading at a third of their 2008 high, according to Bloomberg data.
There’s a general consensus among climate scientists that global temperatures can’t rise more than two degrees without causing irreparable damage. Roughly two-thirds of the planet’s proven fossil-fuel resources must remain buried to meet that goal, according to the International Energy Agency. The top 100 coal and 100 oil-and-gas companies had a combined value in 2011 of $7.42 trillion, much of which was based on reserves that can never be used, according to a Carbon Tracker report that first made the case for “unburnable carbon.”
Royal Dutch Shell, which has been moving its oil portfolio into cleaner natural gas, is already planning ahead. Whenever the company evaluates a new project, it bakes in $40 a ton for the future cost of carbon emissions, Destin Singleton, a spokeswoman for Shell, wrote in an e-mail.
Bucking the Consensus
Not everyone says fossil fuels are in trouble. Hal Quinn, the president of the National Mining Association, told Bloomberg reporters in Washington last month that even in the U.S., coal use will continue unabated through 2020 as larger, more efficient plants supplant older ones.
Exxon, the world’s biggest energy company by market value, forecasts that global coal demand will peak in 2025 but that oil demand will remain strong through 2040 and beyond. Exxon plans to invest $185 billion in energy projects in the next five years. The company says that so-called unconventional supplies of oil -- deepwater drilling and oil sands extraction, which are more expensive and pollute more CO2 -- will increase 30 percent by 2040.
To be sure, the peak-carbon hypothesis is just one hypothesis. It’s difficult to predict what fossil-fuel demand will look like as the global population climbs 30 percent by 2050 and more than 3 billion energy-hungry consumers rise into the middle class. The U.S. Energy Information Administration stresses the uncertainty of future fuel prices, but even the agency’s “low oil price” analysis see crude oil around $75 a barrel for the foreseeable future.
Statoil, Norway's biggest oil company, sent a response to the letter from 70 concerned investors. In it, Statoil says that even if the world takes aggressive action to limit global warming by 2 degrees, oil will continue to be the primary energy source for decades to come. New sources of oil will need to be discovered and developed to replace the current ones as they dry up.
"Statoil considers climate change a key corporate risk which will have industry-wide impact," the company wrote to investors. "We consider our portfolio of assets to be fairly robust with respect to climate regulations."
Investors have grown numb with the idea that energy demand will continue to grow for the next four decades, said Craig Mackenzie, head of sustainability at Scottish Widows Investment Partnership in Edinburgh. Some are beginning to call the consensus view for future demand into doubt, he said. “Things have changed quite a lot in the last year.”
Scottish Widows, a division of Lloyds Banking Group, has about $230 billion of assets under management, including significant holdings in oil and mining. It’s the fifth-largest shareholder of Royal Dutch Shell Plc, according to data compiled by Bloomberg.
The biggest uncertainty in future projections, said Mackenzie, is how soon China’s economy will shift from one that builds steel plants and highways and cities to a service economy that relies on iPhones and fuel-efficient cars. Most investors mistakenly think that’s still decades off, he said. According to the Bernstein report, China's services sector, which is one-sixth as energy intensive as the industrial sector, already accounted for 45 percent of the economy in 2012, up from 39 percent the prior year.
Hits to the Bottom Line
While coal is the biggest polluter, oil investments could turn risky in a hurry, according to HSBC's Robins. That’s because, despite an already remarkable 2.5 percent annual increase in fuel efficiency, cars still have room for rapid improvement. If the global auto industry continues to be prodded by fuel-efficiency standards such as the ones President Barack Obama finalized last year, demand for oil could get sucker punched.
HSBC’s analysis shows what might happen if demand falls. Robins and two colleagues assumed an aggressive price drop to $50 (oil currently trades around $94 a barrel). Companies with reserves that are more expensive to extract are at the greatest risk. The effect on European oil majors varied greatly in the analysis, from a 17 percent drop in the share price of Statoil to just 1 percent decline for BG Group.
Scottish Widows, one of 70 signatories of letters to oil-and-gas companies, has already sold off its stocks and bonds in coal.
“We as an institution are very concerned about climate change and would like to see stronger policies to address it,” Mackenzie said. “But the specific decision not to hold coal stocks is driven entirely by financial decision-making. And I do mean entirely.”
Climate talks resume this week in Warsaw. The meeting will work toward a treaty that would limit CO2 emissions in all nations. The goal is to complete the language of the agreement in 2015, with targets that would take effect five years later. Veterans of the talks concede that even with a successful deal, the treaty by itself would probably be insufficient to keep global warming under the 2 degree Celsius target. Change needs to start sooner.
“In the market today, many have a misinformed view that carbon assets will not be stranded until there is a global treaty establishing a uniform price on carbon,” Gore said. “That’s wrong.”