Monday, December 28, 2015

Market Reaction to COP21 Deal: Fossil Fuels Crash while Renewables Soar

As predicted renewable energy stocks soared while fossil fuel holding have continued their slide after the announcement of the COP21 agreement. At the Paris climate summit a total of 195 countries effectively agreed to end fossil fuels and transition to renewable energy. This worsens an already grim forecast for fossil fuels and improves the prospects for even more growth in renewables. While clean energy is the clear winner fossil fuels are the clear loser post Paris. Due to the deal that was struck at COP21, the fossil fuel industry is facing a $33 trillion hit to its expected revenues over the next 20 years.

While it has long been known that fossil fuels are the leading cause of both pollution and climate change, it is now unavoidably obvious that petrochemicals are also a bad investment. Conversely renewable energy is both good for the environment and a tremendous investment opportunity.

The oil industry and by extension the banks have reason to be nervous. Wall Street is feeling the pinch from low oil prices and firms that finance oil have ongoing concerns about impending defaults associated with the poor outlook for fossil fuels.

As reported by CNN Money long before the Paris conference, banks that finance the fossil fuel industry were already hurting. Bank of America reported $46 billion in commercial credit exposure to the energy industry up from $41.5 billion in 2014. After the COP21 deal the financial outlook for fossil fuels worsened considerably. The worries associated with these debts were also exacerbated by the positive outcome at COP21.

"[Banks] are going to lose money on the loans they've made. That's pretty evident -- whether oil prices go to $30 or $80 a barrel," said Dick Bove, an analysts who covers banks at Rafferty Capital.

Banks like JPMorgan Chase (JPM) are having to put money aside to deal with the impending wave of defaults. Wells Fargo (WFC) mentioned the "deterioration in the energy sector" and Bank of America (BAC) said that it is preparing to deal with troubled commercial loans in its oil and gas portfolio.

Oil represents around 3 percent of big banks' total loans and if they start calling in credit it will be the death knell for a number of oil companies.

There could be an increase in bankruptcies "if the financial sector gets scared or handcuffed," said Riccardo Bertocco, a partner at Bain & Co. who specializes in oil and gas.

While fossil fuels are tanking renewable energy companies are seeing big upticks due to the Paris deal. When the markets opened on Monday December 14th after the signing of the COP21 agreement on Saturday December 12th, fossil fuel stocks tumbled while renewable energy soared. The Paris deal reiterated the reality that the era of fossil fuels is rapidly being replaced by renewables.

According to Reuters, “The MAC Global Solar Energy Index was up 4.5 percent. The iShares Global Clean Energy exchange-traded fund, which allows investors to trade a basket of renewable energy stocks, rose 1.4 percent. The U.S. Oil & Gas Index fell 1 percent before reversing losses, and was up 0.2 percent as oil edged higher after plumbing the lowest levels in about seven years."

Shares of companies that produce coal also took a hit. For example Peabody Energy Corp. plummeted 12.6 percent. Investors are understandably worried about stranded assets post COP21. 

Portfolio manager Thiemo Lang of Zurich’s RobecoSAM told Reuters the Paris agreement “will help boost the mid- to long-term fundamentals in renewable energy generation, especially solar, while making any further investments in fossil fuels increasingly vulnerable.”

Wind and other forms of renewable energy are expected to keep climbing as are electric cars, battery makers and efficiency focused products and services. 

"Without question, solar is positioned to make the single biggest contribution of any industry to carbon reduction goals – more than wind, more than efficiency, more than any other technology on the horizon," SunPower Corp Chief Executive Officer Tom Werner said.

Shares of SunPower increased by 8.7 percent, while First Solar Inc gained 5 percent.

"So for those companies, renewable energy policies and goals created around the world create a lot of opportunities, regardless of the landscape in the US," said Alex Klein of IHS in Cambridge, Massachusetts.

As reported by RenewEconomy, oilEnergy analysts from the UK-based investment bank Barclays said the COP21 agreement will "result in a boost to renewable energy, and will cause a rethink from investors about new investments in fossil fuel sources."

They quote lead analyst Mark Lewis who says "the implications for the fossil fuel industry are profound, and will likely cause it to suffer a loss in revenue of around $US33 trillion out to 2040 over business as usual." The push towards decarbonization will cause the oil sector to lose $22 trillion, the gas sector is expected to lose $6.1 trillion and the coal sectors will lose $5.7 trillion. These loses will come mostly from fossil fuel investments that will not move forward.

The Paris deal will increase concerns about the risks of fossil fuels and investors are expected to exercise greater caution. To illustrate this point the Bank of England has announced that it will avoid over-investment in what appear to be stranded fossil fuel assets.

‘The upshot of the Paris Agreement will be a tightening of climate policy over time that should speed up the deployment of renewable and other zero and low-carbon energy sources and thereby accelerate the transition to a low-carbon global energy system that is already underway in any case,” Lewis says in the report.

“The message from our analysis for fossil-fuel companies is that they will need to be increasingly cautious regarding future investments in high-cost, high-carbon projects, as these are the ones most vulnerable to future stranding under any future policy tightening of the carbon constraint.

“Moreover, given the sheer size of the numbers we are talking about here, it would not require a policy outcome in future climate negotiations to be fully in line with a 2°C world for the appropriate investment profile for fossil-fuel companies to change significantly.”

Indeed, Lewis says the COP21 deal will “significantly lower fossil-fuel investments and much higher clean-energy investments” than the trajectory the world is on at the moment.

“With the Paris Agreement now committing the Parties to a more ambitious long-term temperature objective than ever before, and to five-year reviews of their INDCs (country pledges) as a way of getting on track to meet that long-term objective, the ground has been laid for an ongoing tightening of climate policies globally over the next few decades.”

Lewis pointed to the decision by The Financial Stability Board creation of a Task Force for Climate-Related Financial Disclosure (TCFD) to be chaired by the former mayor of New York City, Michael Bloomberg. The task force will help to create a consistent global reporting standard for companies on the climate-related risks they are exposed to, and give financiers s the information they need to allocate capital as efficiently as possible.

“We think this will lead to increased pressure on companies to monitor and disclose their carbon risks, and to greater awareness of and attention to the carbon intensity of different companies on the part of investors.”

The deal not only signals an end to fossil fuels it heralds the beginning of a brave new expedited phase of renewable energy growth.

“We know where we’re going now,” Bill McKibben said. “No one can doubt that the fossil fuel age has finally begun to wane and that the sun is now shining on, well, solar."

The oversupply and reduced demand that we saw in 2015 will keep oil prices low in 2016. A revised analysis from JPMorgan Chase (JPM) indicates that "oil prices will remain low for longer."

The glut of coal and declining demand in places like China will make coal even less attractive to investors. A more stringent regulatory environment will put significant downward pressure on all fossil fuel stocks. Cheap, clean renewables will replace dirty and expensive forms of energy and we will see more investment and new technologies will come online which will drive prices down even further.

The goal of the Paris agreement is to keep temperatures from increasing more than 1.5 degrees Celsius. Sewn into the deal is an agreement to review national emissions reduction pledges every five years. So we can expect that the current level of emissions reductions promises will be followed up by even more drastic reductions so that the world can keep temperatures from exceeding 1.5 C.

To help keep temperatures within these limits it is expected that fossil fuel subsidies will come under increasing scrutiny in the aftermath of the Paris conference. The combination of existing emissions reductions, improved commitments, regulation, the elimination of subsidies, and carbon pricing will continue to exert even more downward pressure on fossil fuels.

The demise of fossil fuels will accelerate the ascendancy of renewable energy.  Investors can no longer ignore the risks associated with fossil fuels or the opportunities associated with investing in renewable energy.

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