Well, we can’t say we weren’t warned. Panic selling swept major global stock-markets on Tuesday in what could be a foretaste of things to come, as investors suddenly woke up to the fact that the game has changed.
Fossil fuels and their associated investments are in decline, and the world is heading rapidly towards new and cleaner technologies.
A bunch of big stories this week highlight what is going on: VW, Shell, Glencore, BHP, Origin Energy and AGL. All linked by a common thread - their exposure to fossil fuels. It prompted a warning on the financial risks of climate change by Mark Carney, the governor of the Bank of England.
The biggest news, of course, was VW. As we reported on Monday, the VW cheating scandal, where it sought to defraud regulators and millions of consumers on a massive scale over the level of its diesel car emissions, could likely signal the demise of the diesel engine.
But it could go further than that: it could see the rapid demise of the petrol engine too, and the use of fossil fuels in passenger vehicles altogether.
As more diesel car manufacturers came under scrutiny overnight, Fitch Ratings, an international credit agency, said the dominance of the internal combustion engine could come under pressure from a fundamental change in consumers and regulators’ attitude toward emissions and fuel efficiency.
“The Volkswagen scandal could therefore accelerate the underlying growth of vehicles with alternative powertrains, including fuel cells, electric and hybrid engines,” it said in a new report. That means the demise of both petrol and diesel cars, and the emergence of electric vehicles.
This is what the stock market is already telling us: Overnight, VW - a bastion of the Germany economy and the “made in Germany” brand, lost another 4% of its value, taking its total decline in the past fortnight to 44%, or more than $A50 billion.
The world’s biggest car-maker is still worth around $A72 billion, but as Alex Pollak writes in the SMH, it has $200 billion in liabilities, backed by the value of their vehicles. Those values are now under question.
Meanwhile, the share price of Tesla, the upmarket electric vehicle manufacturer that has become one of the world’s most valuable brand names, despite producing a fraction of the number of vehicles than its bigger rivals, is now worth $A44 billion.
The market is telling us a similar story about the coal industry. The plunge in the value of the world’s biggest non-government coal miner, Peabody Coal, has been well documented. It is down more than 90% in the past year, but even this fact hadn’t quite registered with the mainstream investor.
That was until this week, with the release of an Investec analyst’s report on Glencore that suggests that its equity value could be nil, and its Australian coal export business worthless. Others pointed to Glencore as potentially the commodity equivalent of Lehmann Bros.
Glencore and Peabody are particularly vulnerable because, like other companies, they are essentially financial constructs. Glencore in particular is a corporate put together by some very clever financiers. But when finance is leveraged at the top of the market, collapsing commodity prices can prove terminal for highly geared global structures.
As Greenpeace analyst Marina Lou writes in EnergyDesk, when Glencore purchased Xstrata two years ago in the biggest mining merger ever, chief executive Ivan Glasenberg commented, “To really screw this up, the coal price has got to really tank.”
Well it did. And many had predicted exactly that.
“Most coal companies did top of the cycle peak priced multi-billion dollar debt funded acquisitions, including Peabody, Glencore, Adani Enterprises,” adds Tim Buckley, from IEEFA. “These strategic errors have come back to haunt their shareholders with crippling share price declines.
The dramatic fall in Glencore - already down 77% in a year - in turn triggered a slump in energy stocks, in which Australian gas companies such as Origin Energy and Santos were hit particularly hard. Why? Because there is a real question - following the fall in international oil prices - about whether the $200 billion invested in LNG export projects will ever deliver suitable returns.
Origin Energy, whose share price has slumped more than half in less than a year, announced it would raise $2.5 billion in a heavily discounted share offer (25%), to shore up its balance sheet. It said it had to act quickly to ensure debt remained at sustainable levels.
As if on cue, Shell abandoned its search for oil in the Arctic. As Karel Beckman writes today, Shell is dumping the idea because of the “high costs” of the project, and the chance that regulators and governments might crack down on the idea.
As Beckman points out, neither of these can have come as a surprise. Critics have been warning for a long time that the costs of Alaskan drilling are prohibitive, and the “regulatory environment” in this part of the world will inevitably be unpredictable. Still, Shell went ahead and dropped $A2 billion on the idea.
And as HSBC and others have pointed out, it is not the only asset that is likely to be stranded. At current prices, trillions of dollars ($30 trillion in fact) of fossil fuel reserves will not be economic, and not exploited. The market has been given the numbers, it just seems that it is only now that it is paying attention.
Far from being peopled by “lefties” and “greenies”, many of these think-tanks have hired leading financial analysts and investment bankers, dumped by their international institutions because green research wasn’t making them enough money.
Their research has been ridiculed by vested interests in the mining industry, particularly the Minerals Council of Australia, and the ideologues within Australia’s Coalition government.
But last night they were endorsed by the Bank of England’s Carney, who warned that investors face “potentially huge” losses from climate change action that could make vast reserves of oil, coal and gas “literally unburnable”.
Carney focused on the “carbon budget” - a concept promoted by Australia’s Climate Change Authority, Carbon Tacker and others, but ignored by the Coalition government and most in the fossil fuel industry. It suggests that only one fifth to one third of the world’s proven reserves of oil, gas and coal could be safely exploited.
“If that estimate is even approximately correct it would render the vast majority of reserves ‘stranded’ - oil, gas and coal that will be literally unburnable without expensive carbon capture technology, which itself alters fossil fuel economics,” Carney said, pointing to the upcoming Paris climate talks as a catalyst.
“A wholesale reassessment of prospects, especially if it were to occur suddenly, could potentially destabilise markets,” he said.
Emma Herd, the new head of Australia’s Investor Group on Climate Change, says: “The need to evaluate investments against a commitment to limit warming to two degrees Celsius must now be embedded in mainstream financial decision making”.
Which is why other companies considered to be in the firing line are busy shoring up their defences. Origin did this by announcing a $2.5 billion equity raising, while BHP, whose share price is at the lowest level since the global financial crisis, is insisting that its portfolio will withstand any great move away from fossil fuels, even “extreme” and sudden shifts that could be precipitated by Paris.
BHP said its portfolio would remain robust if emissions decline to levels consistent with a 2°C world after 2030, as well as in a stress test that models the implications of more rapid change. But it is assuming higher demand for uranium, and for gas, at least in the short term, and carbon capture and storage.
It also describes the UN’s ability to get the world on course to meet the 2°C target by 2030 as a “shock event” that is “unlikely and extreme”. But it insists that its portfolio is strong enough to resist that too.
This “shock event,” BHP says, describes an initial delay in coordinated climate change action followed by a faster than expected move to a largely decarbonised world.
“It simultaneously considers the impacts of several significant technology developments, such as rising renewables and battery penetration, increasing energy efficiency and ambitious climate policies to put the world on an accelerated track to achieve the 2°C goal.”
That may come as a “shock” to BHP, but some would say that is the most likely outcome.
AGL, too, under new leadership, is trying to convince investors that it has matters in hand. On Wednesday, its chairman was forced to defend the multi-billion buying spree in the last few years that has made AGL the largest owner of coal-fired generation in Australia.
Gerry Maycock said the handsome profits from the coal generators would be used to invest in renewables “if and when” the investment climate for renewables improved. Of course, AGL had been the country’s biggest investor in renewable energy before those coal purchases, but such investments have slowed dramatically since AGL and other utilities pushed the Coalition government to cut or even remove the renewable energy target altogether. You reap what you sow.