A series of recent Forbes articles intend to cast doubt on the relevance of stranded asset risks to investors. Mark Fulton, research advisor to Carbon Tracker, responds.
In a recent Forbes article by Michael Lynch, the following statement was made: “So, the claim that fossil fuel resources must be left in the ground to avoid climate disaster and therefore have minimal value should be treated with enough salt to make Michael Bloomberg apoplectic. The majority of those making the claims appear to be doing so out of wishful thinking, and few show evidence of serious analysis as opposed to emotional appeals to save the planet, avoid catastrophe…”
Certainly at the London-based Carbon Tracker Initiative, who has been frequently cited as a key source of the “carbon bubble” narrative that Mr Lynch also refers to, we believe we represent some of the “few”. Having assembled a number of ex-financial market analysts, Carbon Tracker has carried out extensive financial research – in particular our cost curve supply and demand analysis – into the multifaceted and complex issue of climate, carbon and energy markets. This analysis has been cited in FT Lex, The Economist, the New York Times and many other publications including Forbes.
Our analysis is based on industry databases – Wood Mackenzie and Rystad Energy – to ensure we are drawing our conclusions from the same numbers as other analysts and companies. This has shown us that a demand profile consistent with the IEA’s 450 Scenario, (equivalent to a 2⁰C of warming scenario) over the next 20 years would not require 24% of business as usual capex across coal, oil and gas, Importantly, the dollar risk is skewed towards oil and gas, and the avoided emissions weighted towards coal. Due to its greater capital intensity, oil and gas would see up to $2 trillion of capex economically stranded in the next decade – not giving a return above capital costs- if the industry just assumes BAU and gets it wrong. In valuation terms price is dominant over production, as Paul Spedding — former Head of HSBC Oil and gas research and research advisor to Carbon Tracker — has repeatedly shown. Misreading demand leads to oversupply, lower prices and value destruction.
In particular Carbon Tracker’s emphasis has been on the potential for demand misread by the fossil fuel industry, leading to unneeded capital expenditures, oversupply and wasted capital. This is standard economic and market analysis. High cost, high carbon loses. This Forbes piece covered our gas analysis, which highlighted that a number of high cost LNG plants would be surplus to requirements – including the $40bn Browse LNG project just shelved by Woodside with multi-billion dollar write-downs.
Projects such as Browse LNG and Shell’s Carmon Creek (also shelved) show that even proved reserves are not immune to financial stranding. Our research suggests there will only be more of this to come over the longer term if the demand misread continues to create boom and bust cycles. This shows how it is not as black and white as the ConocoPhillips representative cited recently by Forbes suggests.
“Companies are valued on their proved reserves,” said ConocoPhillips chief economist Marianne Kah, “and no company has more than maybe six years of proved reserves, seven at the most. And we’re talking about carbon as a much longer-term issue… There’s a pretty good chance we’re going to get to use those seven years of reserves.”
Again as our analysts point out, strictly speaking it is the discounted expected revenues from producing oil and gas that is dominated by oil prices, reflecting expectations of future trends rather than the simple proved reserves number, upon which oil and gas companies are valued. The focus on proved reserves — which certainly extend more than seven years for some companies — is not meaningful.
On the demand side we have also unpicked the traditional demand assumptions in terms of the decoupling of energy and economic growth. We also analysed the potential for technological advances and policy to change the structure of energy markets and the mix of power sources. Carbon Tracker produced an analysis in its “Lost in Transition” report, which addresses those risks. Just recently the IEA pointed to the decoupling between emissions (fossil fuels) and GDP as Chinese and US coal use declined with gas and renewables increasing their share. The recently released five year plan by China makes it plain they plan to continue decarbonizing their economy while making it more efficient.
The kind of reaction shown by Mr Lynch is typical of those who believe in never ending growth for fossil fuels. Their “mantra” is simply that if population and GDP are going up in the emerging economies, fossil fuels must do well too. Careful analysis shows decoupling is happening and real. A disruptive energy transition is already underway. Of course fossil fuels will remain a substantive part of the energy system in the next 20 years. But markets and investors are focused on changes at the margin. Climate policy is playing a role but technology and costs are the powerful drivers. Fossil fuel providers with cheap supply will push it into markets. Those with high costs and high carbon content will feel the brunt – as Wood Mackenzie noted in December 2015, two-thirds of coal production is loss making. This is economics, not emotion. Go ask the US coal industry, and debt holders of shale companies and utilities in Europe.
Mark Fulton, Research Advisor Carbon Tracker, Ex-Head of research Citigroup US & Australia, Ex-Head of Research Deutsche Bank Climate Change Advisors.