Divesting from Fossil Fuels: Last One Out Loses
Tom
Konrad, Contributor A new report written by Nathaniel Bullard at Bloomberg New Energy Finance (BNEF) highlights the difficulties large institutional investors would have divesting from fossil fuels. What it does not specifically discuss is that these difficulties could lead to large financial losses for investors who see the difficulty of divesting as a reason to delay. Just as we can't easily fill up our cars with solar power instead of gasoline, the report points out that there is no asset class that can directly substitute for oil and gas in large institutional portfolios. A person with a short commute can simply ditch gasoline for renewable fuel by riding a bike, and small investors can easily divest from fossil fuels without sacrificing growth or yield by using small capitalization stocks and yield cos. People with long commutes have fewer and more expensive fossil free options. The report shows how the size of many institutional investors' portfolios also limits their divestment opportunities. The relatively high yield of oil and gas stocks is the most difficult to replicate, even at its level of 2.41 percent, which the report describes as “not enormous.” According to the report, the only sector with a higher average yield is REITs (at 4.55 percent). REITs have a total market capitalization of less than a third of oil and gas stocks, so it would be impossible for more than a fraction of large investors to replace their oil and gas holdings with REITs. The Instructive Case of Coal In contrast to oil and gas, the report makes the point that because the market capitalization of coal companies is much smaller, divesting from coal alone is much easier than divesting from oil and gas. The report states that “Coal equities are less than 5 percent the total value of oil and gas equities, and have already trended down nearly 50 percent in the past five years...as a result, divesting from coal would be much easier then divesting from oil and gas.” The report's author Nathaniel Bullard, told me in an interview that divesting from coal would have been more difficult just three years ago. He says, “U.S. coal has had clear indicators of future change in place for a while…Some coal equities have lost 90 percent of their value since 2011...This much diminished size means that... the same number of shares will represent a much smaller portion of an investor's overall portfolio relative to 2011.” Hold High, Sell Low? To put it more bluntly, investors who have already lost their shirts in coal stocks will have a much easier time selling their much-diminished holdings today than they would have when coal stocks were at their peak. Ironically, it's easier to sell low and buy high than vice-versa, especially for investors who manage large pools of money. It does not take a multi-million dollar salary to know that waiting until your stocks have fallen by half before you sell is a suboptimal investment strategy. Despite past “clear indicators of future change” and lower estimates of future coal demand due to air pollution regulations in the coal industry, institutions like Stanford are only now beginning to divest from the sector. Most have not yet budged. Are Oil and Gas Next? The report begins with a quote from an executive who describes the divestment movement as “one of the fastest-moving debates I think I've seen in my 30 years in the markets.” If this fast-moving debate leads to fast-moving divestment, the sheer size of institutional oil and gas holdings would lead to a scale of the selling that could easily drive down prices of oil and gas stocks as fast as coal stocks have fallen over the past few years. The divestment movement was only in its infancy when coal stocks peaked in 2011, so divestment has been only a minor contributor to their decline. Bullard attributes most of the decline to fundamental factors, such as low gas prices and (to a limited extent) wind power in the US, and concerns about air pollution in China. That said, the long term fundamentals of oil and gas are not favorable. Industry costs are rising as producers shift towards unconventional sources such as tar sands and tight oil and gas which are extracted with relatively expensive techniques such as hydraulic fracturing (“fracking”). Meanwhile, high fuel prices are beginning to reduce average driving distances in mature markets such as the US and Europe while the declining costs of efficiency technologies such as hybrid and electric vehicles further lower demand. In the fastest growing vehicle fuel market, China, air pollution concerns have led the government to aggressively promote “new energy” vehicles, particularly hybrids and EVs. Natural gas faces increasingly inexpensive competition in electricity markets from wind and solar generation. That, combined with technologies such as storage, smart grid, demand response, and better transmission which make it easier and cheaper for these variable sources to supply a larger portion of electricity demand with less reliance on dispatchable generation such as natural gas, hydropower, and biomass-fired electricity. The fundamentals of all fossil fuels will be further undermined if the world ever makes a concerted effort to rein in carbon emissions. At the moment, the prospects for large scale regulatory moves seem dim, but at some point the increasing costs in terms of falling crop yields, widespread and severe heat waves and droughts, ocean acidification and the like will lead to political action. At this point it will almost certainly be too late to avoid significant economic and human costs from climate change, but that does not mean that it will not help us avoid even greater damage. And the longer we delay taking substantive actions to curb greenhouse gas emissions, the more draconian those actions will have to be. Drastic moves to curb carbon emissions will have even more drastic effects on the fundamentals of fossil fuel industries. Conclusion In part because it is so hard for large investors to exit fossil fuels, it is unlikely that a majority of such investors will move to divest before they have lost a large portion of their current holdings to price declines driven by the fundamental factors outlined above and selling from more motivated investors. Some of the factors listed above, such as concerted political action to curb carbon emissions, may take a long time to be felt. Other factors, such as the declining cost of renewable energy and efficiency technologies and the increasing costs of fossil fuels are moving energy markets today. When these factors will begin to hurt oil and gas stocks is unclear, but the coal industry shows that, although divesting is hard, it does not pay to wait too long. This is where the analogy to replacing fossil fuels in your commute by buying an electric car breaks down. With electric cars, the more people own them, the easier and cheaper they will be to use: growth in charging infrastructure will rise with the adoption of plug-in vehicles, while higher volumes should help bring down their initial cost. In contrast, it pays to be first rather than last when divesting from fossil fuels. While it is possible to be too early, at some point the worsening fundamentals of fossil fuel industries and/or a large scale divestment movement will undermine the value of all fossil fuel stocks. Those who divest sooner will have much more money to invest elsewhere than those who delay because divesting is just too hard. Fortunately, small investors have it easy. Divesting, for once, is a place where the small investor has the advantage on Wall Street.
Comment:
United States is a fascist nation, with government of,
by, and for too big to fail international corporations,
very much including fossil fuel firms (9% of GDP is
energy, about 20% value added by utilities, about 30%
small enough to fail extractors of fossil fuel, about
50% too big to fail fossil fuel firms). We don't have
time to waste fighting King Coal or BIG OIL.
Politically, federal government would do well to do
exploration and paper work to identify as many
economically feasible sites for both direct and enhanced
geothermal systems as it can. Some direct geothermal
sites are already spoken for. For the rest, feds should
hire too big to fail coal firms to do drilling and
fracking (they have drilling and fracking rigs and
crews) until either US Navy funded R&D to find
sustainable cost-competitive substitutes for petroleum
succeeds and it can buy patents and get BIG OIL started
mass-producing (at least ten years), or all drilling and
fracking rigs and crews of King Coal are set to work on
geothermal wells. With 37% of electricity coal-fired,
and maybe enough geothermal to replace 10% of electric
power, geothermal will be able to replace only a bit
over 25% of coal-fired electric. King Coal has already
put its foot down about any carbon tax. Our fossil fuel
firms might be willing to accept a tax on energy
regardless of carbon footprint, IF most of revenue is
dedicated to items that will help them--Buying as
mineral rights maybe at $100/short ton carbon content
fossil fuel displaced by prohibitive tariff effect of
tax, buying smart grid electronics, HVDC transmission
lines and tunnel to put them in (King Coal must remember
how to make tunnels from when coal mines were all
underground), energy storage, wind turbines, and solar
systems from MIC firms and selling it to utilities on
30-year mortgages with mortgage payments used to buy
fossil fuel displaced by equipment, repairing and where
needed replacing transportation infrastructure
(transportation is major user of petroleum products),
maybe low income heating energy programs to help poor
pay for energy. Our military leaders claim renewable
energy will do more for national security than they can
do with weapons of war and that they have some military
pork they want to exchange for renewable energy. Those
utilities with the most coal-fired generators to replace
should get 30-year mortgage deals on MIC manufactured
replacements first and pay only same interest as feds
pay for 10-year bonds. Geothermal is dispatchable. Wind
and solar need energy storage to integrate them into
grid. There are at least two forms of waste to energy:
Sewage, manure, and other easy to rot waste that will
largely turn into methane with some encouragement
(methane is natural gas--just younger); and less easy to
rot wastes, like forest wastes that can be chipped and
burned like coal in a combined heat and power unit.
California would do well to gather forest wastes, give
cones of bishop pines and any other pine cones that need
to be roasted to get the seeds out to tree farms willing
to do the roasting, planting of seeds, and raising of
seedlings, rather than go on losing so much to wild
forest fires for the sake of those pine trees.
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September 4, 2014