By Mark Evans
The global stranded assets debate has garnered attention of late, after a number of high profile university endowments and pension funds announced plans to slash their exposure to fossil fuel investments.
Even Ali Al-Naimi, Saudi Arabia’s enigmatic oil minister, has weighed in, expressing his belief that Saudi Arabia will eventually have no need for fossil fuel power, and will instead turn to solar for power generation[1]. The debate centres around the question of whether fossil fuel investments will become “stranded” – no longer earning an economic return as a result of changes in the market and regulatory environment. The debate has been accompanied by a divestment campaign which seeks to encourage investors to dispose of their fossil fuel holdings or engage with companies to gauge this risk.
Beyond the headlines, actual divestment has been relatively limited. However, one fossil fuel in particular has fallen out of favour as the debate has intensified: coal. Most notably, it was recently announced that Norway’s $890billion government pension fund plans to divest from companies with more than 30% of revenues from coal mining operations by mid-2016, and now AXA, the insurance giant, is following suit.
The debate has moved beyond the fund management sector, with the Bank of England due to deliver a report to the UK government on the financial risk posed by a “carbon bubble”, later in 2015.
So what is the potential risk for investors?
Despite the rhetoric, the investment risk for non-coal fossil fuel investments is probably limited in the short term (the time over which fund managers have their performance measured), given how essential fossil fuels remain as a primary source of energy in the global economy. Analysis from BP shows that in 2014 oil met 33% of global energy demand, coal 30%, and natural gas 24%, while nuclear accounted for just 4% and renewables just 9%, of which c.6% was hydro-electric[2].
The absence of a coordinated, effective international policy on climate change also means that these assets are unlikely to become stranded in the near term. However, the carbon emissions cap agreed between China and the USA and the recent pledge by G7 leaders to cut carbon emission by 40 to 70 percent by 2050 may have an impact longer-term on the economic viability of these assets. Also of note is the fact that the fossil fuel market has already been subject to a form of extreme stress testing caused by low oil, coal and gas prices. The current over-supply in these markets is a proxy for a situation in which there is tighter carbon regulation, and there has been limited evidence of asset stranding, despite the spectacular battle for market share being played out in the oil market.
So is this a buying opportunity for fossil fuel companies?
All previous oil price falls have seen a significant recovery in oil prices and the share prices of oil and gas companies. And given there are few realistic substitutes for oil when it comes to transport, its largest end use, demand for oil is likely to remain robust for some time yet.
That said, things can change very quickly. We are seeing a possibly intensifying battle for market-share between different energy-commodities, which could erode returns across the energy sector. The biggest issue is growing energy efficiency, particularly in China. According to BP, global energy demand growth deteriorated in 2014, growing +0.9% vs a 10- year CAGR of 2.1%. Weak demand from China explains 50% of this slowdown[3].
At the same time, the cost of generating electricity from solar power continues to fall, making it a much more economically viable substitute to coal and gas generated power. Over the last three years, global solar installed capacity has more than doubled and installed costs have fallen by roughly half. In 2014, renewables made up 48% of the net power capacity added worldwide[4].
What is likely to worry fossil fuel investors in the near term, therefore, is not the prospect of climate change legislation per se, but evolving supply and demand dynamics in fossil fuel markets. Alternative energy technologies are likely to become increasingly disruptive, but they are just one piece in a much larger puzzle that includes a slowdown in Chinese energy demand, the resurgence of OPEC and the possibility of Iran’s return to the world’s oil markets. While the stranded assets debate may lead to further high profile divestments, we believe these wider dynamics are more likely to underpin the decisions of the vast majority of fossil fuels investors in the near term.
Mark Evans is a sustainability investment analyst at Jupiter Asset Management
[1] Reuters, http://www.reuters.com/article/2015/05/21/us-saudi-oil-climate-idUSKBN0O61Y520150521
[2] BP: BP Statistical Review of World Energy 2015 webcast
[3] BP: BP Statistical Review of World Energy 2015 webcast, Wednesday, 10th June 2015
[4] UNEP/BNEF, Global trends in renewable energy investment 2015
Comments