Monday, April 25, 2016

Investor Warning: Fossil Fuels and the Risk of Stranded Assets

It is becoming increasingly apparent that fossil fuels represent a substantial risk that should make investors wary. Fossil fuel reserves, including oil, gas and coal will be rendered obsolete in the coming decades, leaving investors holding valueless investments. A plethora of peer reviewed science tells us the curbing fossil fuel use is key to climate mitigation.

From widespread calamitous coastal flooding to devastating extreme weather events the need to urgently act on climate change has finally been accepted by every nation on earth. The economics of climate action is sound. A cost benefit analysis reveals the overwhelming logic. We must the eradication of fossil fuels as soon as possible. The impetus to act on climate change, once dismissed by some, is now a fact of life for all thinking people.

There is already downward pressure on the fossil fuel industry and this will only intensify in 2016 as we begin to see policy shifts and new regulatory regimes. The Paris Climate Agreement formally signals the end of fossil fuels

We are already seeing trillions of dollars being divested from the fossil fuel industry. Much of the money divested is being reallocated to renewable energy, the primary competition for the fossil fuel industry. Investments in fossil fuels need time to mature, however post Paris time is the one thing that fossil fuel investors do not have.

The IPCC Synthesis Report indicates that the burning of fossil fuels must be completely ended by 2100. We must work quickly to radically reduce our use of fossil fuels because the longer we wait the more it will cost. We also risk surpassing dangerous tipping points from which we will not be able to recover.  Simply put we cannot continue to burn fossil fuels if we hope to stay within the 2C upper threshold limit. 

The concerns about fossil fuels and stranded assets were reviewed in an April 8, 2016, CBC Business article by Don Pittis in which he warned investors about the dangers of fossil fuels. As he explained, the issue of stranded assets is not merely the concern of environmentalists, it is central to shrewd analyses of the investment community. Concerns about stranded assets are coming from all quarters including mainstream, credible sources, like Mark Carney, governor of the Bank of England.

Research from the Canadian Association of Petroleum Producers has already announced a $50 billion drop in Canadian oil and gas investment in electrical power plant generation from fossil fuels. However, there are implications for the oil sands and pipelines.

As explained in the CBC article, a Oxford University study indicates that after 2017, fossil fuel powered electricity generation may "not be able to run long enough to pay off their capital costs, turning them into stranded assets." This study expands the stranded-assets concept to include what economists call capital.

"Investors putting money into new carbon-emitting infrastructure need to ask hard questions about how long those assets will operate for, and assess the risk of future shutdowns and writeoffs," says Cameron Hepburn, one of the academics involved in Oxford study.

"If the 2 C target is to be taken seriously, then current and future assets will have to be written off before the end of their economically useful life (become stranded assets) or we will have to rely on large-scale investments down the line in carbon capture and storage technologies that are as yet unproven and expensive," says the report.

While the Oxford study is focused on electricity generation the implications extend to the fossil fuel industry as a whole. According to Duetsche Bank at least half of all known fossil fuel reserves will need to be kept in the ground to stay within our carbon budget. 

"For their own financial benefit, what investors must consider is whether the climate risk has been properly calculated into the future income stream." Pittis wrote. "If investors in power plants, pipelines and new oil development go ahead without proper regard to climate risk and find those assets stranded, they will be worth less than advertised."

The Financial Times covered the same study and reported:
"Virtually all new fossil fuel-burning power-generation capacity will end up stranded... A similar logic can be applied to parts of the capital stock."
Carbon dioxide remain in the atmosphere for centuries so we must appreciate not just annual emissions but their cumulative totals or the global carbon budget.

The Oxford paper states that capital stock created after 2017 would break the global carbon budget. However the Financial Times article suggests that the Oxford study is premised on some optimistic assumptions and therefore it may be more difficult to keep temperatures from rising beyond the 2C upper threshold limit. This assessment suggests that the risks are even greater than those presented in the Oxford research.

Why would any sane investor put his or her money into a source of energy that is doomed to be shut down?

As explained in the FT article:

"[G]iven the longevity of a large part of the capital stock, the time for decisive change is right now, not decades in future."

As reported in the Green Market Oracle, just ahead of the Paris Climate Agreement two reports corroborated concerns about stranded assets.  One of these reports come from the Think Tank, Carbon Tracker and another comes from Critical Resource, a firm that advises fossil fuel companies.

The Carbon Tracker report indicated that more than 2.2 trillion worth of fossil fuel projects are at risk of being stranded. Anthony Hobley, chief executive at Carbon Tracker said:

"Our report offers these companies a warning [about] avoiding significant value destruction,"

The top four countries at risk from stranded fossil fuel assets are the US at $412 billion, Canada at $220 billion, China at $179 billion and Australia at $103bn. The companies with the greatest exposure are Shell, ExxonMobil and Pemex.

Despite these risks, $1.3 trillion is being spent on new oil projects and $124 billion is being spent on existing projects. We need to start with a moratorium on new fossil fuel development.

Daniel Litvin, MD of Critical Resources said.

"The critical mass point could be as soon as a couple of years down the road, which is pretty soon for an industry that has been around for 100 years."

How can the oil industry fail to see the writing on the wall? The fossil fuel industry would not be the first that failed to see clear signs of its demise. Hobley pointed to the demise of Kodak and Blockbuster as illustrations.

In the past decade, the emissions implied by the investment in power generation have been rising at 4 percent a year. The math behind this investment growth when partnered with the need for climate action make investing in fossil fuels a fool's errand.

The Risks Associated with Stranded Fossil Fuel Assets
COP21 and Stranded Fossil Fuel Assets
Fossil Fuel Divestment and Stranded Assets
Infographic - Stranded Fossil Fuel Assets
Oil is a Bad Investment
The Fossil Fuel Industry has Reason to be Nervous
Fossil Fuels are a Clear and Present Danger
Study on the Fossil Fuel Industry and the Bursting of the Carbon Bubble
Graph of Fossil Fuels GHG Contributions
The Cost of Carbon
Now is the Time to End our Reliance on Fossil Fuels
Fossil Fuels are making the Planet Uninhabitable
Fossil Fuels are the Most Hated Industry in the US
Exxon is not the Only Bad Apple: The Whole Fossil Fuel Industry is Rotten to the Core

1 comment:

Nancy said...

It's the biggest bubble ever. Smart money needs to hedge their risk by moving money into renewables and out of fossil fuels in a paced but expeditious fashion. Policy, which results from politics at this moment seem favorable in supporting those investments to deal with Climate Change. So from a risk standpoint, oil is not to big to fail - and will. Fund managers not aware (or in denial) of the geopolitics of this are the problem. Investors Beware.