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Investors face up to a future of stranded assets Channels: Stranded Assets Companies: Carbon Tracker Initiative, Climate Change Capital, NASDAQ OMX, Schroders, Threadneedle Investments, HSBC, BHP Billiton, Mercer Investments, Norton Rose Fulbright, Hermes Investment Management People: James Leaton, James Cameron, Miguel Santisteve, Solange Le Jeune, Cathrine de Coninck-Lopez, Zoe Knight, Geof Stapledon, Kate Brett, Tomas Gärdfors, Victoria Barron, Graham Cooper, Peter Cripps Recent studies have warned that a range of fossil fuel assets could become ‘stranded’ because of high extraction costs or regulations to curb climate change. In this round table, organised by Environmental Finance, with support from HSBC, the Carbon Tracker Initiative and Climate Change Capital, participants discussed the risk to investors.
Participants
Peter Cripps: Perhaps we should start with the basics of the stranded assets debate and who better to do that than James Leaton of the Carbon Tracker Initiative. James Leaton James Leaton James Leaton: I am going to try and boil it down into something very simple which, essentially, is around demand and price. Obviously, if the fossil fuel sector is not adjusting supply in line with demand, that is going to affect prices going forward. So this is really about challenging assumptions. It is very common and easy to predict the future based off last year or the last three years but, with climate change, the one thing we know is that it cannot be the same. Either we have to reduce emissions or there are going to be increasing physical impacts. This year, therefore, we started doing cost curves for each individual fuel. We started with oil and highlighted some high‑cost, high‑carbon projects that needed more than $95/barrel to give more than a 15% rate of return. Since then, the Brent oil price has gone down to around $80. So that already demonstrates the value of stress‑testing projects against a range of prices. We then moved on to coal. It is not in a great state. Maybe a third of production for export is not even covering its costs at the moment. Obviously, the diversified companies have other commodities they can focus on and have already cut back a lot of their thermal coal investments. But some of the pure‑play operators in the coal or unconventional oil sectors do not have the options that the diversified mining companies or the oil majors have. I also think they are underestimating the pace of development of alternative technologies, and how quickly the costs are coming down. Peter Cripps: Do you buy into that, James and what will be the implications for investors? James Cameron: My way of looking at the stranded assets debate is similar but it is to do with properly understanding the systemic risk and accepting that it is very likely to be non‑linear, both in a climate sense and in a financial sense. James Cameron James Cameron That is really what a stranded asset looks like: it is what has happened when there has been a non‑linear shift and you are not ready; you have not managed it properly: it is just sitting there and it is worthless or is worth so much less that it has damaged your portfolio. When thinking about stranded assets and your asset‑allocation plans, you have to ask yourself: ‘Will there be a significant regulatory or public policy change that will alter the market conditions for the use of this commodity?’ At the same time, you have to find alternatives. It is unreasonable to expect large institutional investors to switch out of something into nothing. The right conversation when you are talking about alternatives is, ‘Can you deliver the essential service that human beings need?’ And, ‘Can you do it in a way that makes it rational for a re‑allocation to take place so there is no damage to the yield?’ The issue is not about the cost of the alternatives; the issue is about the cost of the transition; it is the infrastructure you have to build to make the alternatives really thrive, given the power of the incumbents. The big fossil‑fuel companies still command, not just enormous power in markets, but in our own consciousness about how energy is produced, how the things that we use every day are made. Peter Cripps: Do people feel that stranded assets are already here, or is this just a concept for the future? Miguel Santisteve: The view from companies is that we could be being over-optimistic on what can be done in the short term in terms of transitioning from fossil fuels into alternative energies, even though they accept that there is a need for such a transition. And, in many cases, they would disagree with the figures being used as proven reserves by Carbon Tracker. I think we all love the idea of renewable energy, but we need to realise that solar and wind energy currently represent only 1% of global energy production. And, unfortunately, I do not think the technology is there yet to replaceSolange Le Jeune Solange Le Jeune the use of oil in areas such as transportation, farming, mining, plastics etc. Solange Le Jeune: I think stranded assets is just a new term for a lot of thinking that has been going on for a long time. But also it is really a risk‑management tool. It says, ‘We have these assets here, what are the best ones? Which are the ones I really need, which ones are at risk?’ But it is not something we necessarily need to look at in the short term; it is a debate for the medium‑to‑long term Cathrine de Coninck-Lopez: I think some oil assets are stranded, right now. You look at the oil sands stocks and the situation is really quite bad. However, the market does not necessarily look at longer‑term trends. Therefore, if the oil price goes up in the next couple of months, there may be a buying opportunity for oil sands. So, I agree there is a timing issue. It is such an interesting time for the oil majors; why would you divest when the price is so low? If you really believe in the long‑term sustainability of your assets, you should be buying them, right? However, they are not. So that is the real question for me: why are they not buying those assets? Miguel Santisteve: Some of them already see the opportunity of investing in renewables. For instance, Total, the French oil & gas producer, is now the second‑largest producer of solar panels in the world through the acquisition of SunPower back in 2011. They are therefore getting ready for the transition. Geof Stapledon Geof Stapledon Geof Stapledon: We are a diversified mining company, so we have oil, gas and coal in our portfolio but we also have uranium and copper with the latter being used extensively in renewables infrastructure. So, in our portfolio, demand for some of our commodities will increase in the transition away from fossil fuels. However, even among the fossil‑fuel assets within the portfolio … we look at them asset‑by‑asset and all in the context of careful scenario planning around the way we value our businesses and the way we look at investment decision‑making for the future. So, for example, we have substantially completed the two major thermal coal projects we had in execution and the focus in our coal business is on continuing to improve the productivity of existing operations rather than investing in new mines. A large part of the coal assets we are keeping (after the demerger we announced recently is completed) is metallurgical coal which is used in steel making … and there will still be a future for steel. Miguel Santisteve: Oil’s ‘proven reserves’, as opposed to the more uncertain figures otherwise stated as ‘probable’ and ‘possible’ reserves, often only cover production of oil and gas companies for the next ten years. But we are talking about a transition that might take 20, 30, 40 years, so to speculate on whether those assets are actually stranded is where, I think, we might disagree. James Leaton: If you only look at a company based on their proven reserves, that essentially means they are stopping drilling tomorrow. But they are not; they are re‑investing the revenues from their proven reserves into new barrels – the unconventionals – which are not delivering the same return. That is why we have focused more, over the last year or two, on their capital expenditure plans. What they are spending now will not come on‑stream for ten, 15, 20 years so you have to look at the environment that might be in place then.Kate Brett Kate Brett Kate Brett: There is a disconnect in timeframes when we look at climate risk in our asset allocation modelling. We have looked at some different climate change scenarios and, actually, a lot of the physical impacts do not play out within the timeframe that investors are looking at. Investors tend to be focused on more immediate risks. Peter Cripps: What about the drivers of stranded assets? Many people see regulation as being the key to it. James Leaton: But, as we have already heard, we already have stranded oil assets in Canada without a global climate change deal and we already have US coal in decline, without a global deal. Cathrine de Coninck-Lopez: For the oil producers, in my opinion, it is not about regulation, it is all about price and disruptive technologies. However, regulations are an issue for the disruptive technologies. Just look at the US and the Production Tax Credits. It creates so much volatility and that is the real problem. From a regulatory perspective, there is a lack of clarity and a lack of consistent support for the new technologies. James Cameron: Every part of the energy sector is subsidised, so the subsidy debate is bizarre. You talk about subsidies being needed for environmental technologies but we have a totally different conversation about the subsidies that go into the extraction of fossil fuels. However, we are also seeing that subsidies are not really here for that long because most of the technologies have such low operating costs that the real issue is the capital spend and that is the transitional cost. The infrastructure is not designed for them, so that is an issue. But once they are built they have extremely low operating costs. Cathrine de Coninck-Lopez, Kate Brett, Solange Le Jeune, Geof stapledon Cathrine de Coninck-Lopez, Kate Brett, Solange Le Jeune, Geof stapledon Solange Le Jeune: Yes, regulations are very slow to emerge but companies have to anticipate the shift that will happen at some point. I would like to see more discussions along the lines of: ‘yes, the regulations are tightening. We need more clarity on asset‑allocation decisions; we need more clarity on what the strategy is as a result of, say, the regulatory pressure.’ Companies know some assets are stranded, such as oil sands, or the Arctic projects… and now they are stepping back because they can see this environment is just too much of a risk. However, many still say: ‘There is no regulation yet, and those alternatives are not making progress so we cannot switch from one to the other.’ But there is a risk with not shifting as well. If regulatory change comes more suddenly than they think, they would be in trouble. Tomas Gärdfors: The new EU goals for 2030 on carbon emissions, renewable energy and energy efficiency are significant moves forward. Alongside this there are new EU regulations to further support the required infrastructure to make it possible to reach these goals and to bring renewable energy to the markets where it is needed. European transmission infrastructure is a long‑term asset which is well suited to pension funds. This is a fantastic opportunity to invest in lower yielding but stable assets. James Cameron: I think that is a really interesting question: who is going to supply the capital, operate those assets, deliver clean energy infrastructure and avoid stranded assets as a result? Who is going to do that work if it is not the European utilities? At the moment, financial firms are buying assets but will they be operating companies? Will someone hop across from another sector? Who is going to come across and be both the financier and operator of clean energy infrastructure? Miguel Santisteve Miguel Santisteve Miguel Santisteve: I think this is a key topic in this debate. National Grid has recently warned us that there is a real risk of blackouts in the UK this winter. You therefore have to think, ‘What have we done in the last 10, 20 years in terms of new investments in electricity generation to get to this point?’ If we send out signals to the oil and gas companies, or the coal companies, saying, ‘Reduce capex, do not invest, take it easy,’ and we know that, just in the oil sector, the natural rate of decline of oilfields is something like 5–6% every year. So, if you stopped investing now, in ten years you would have half the oil production you have now. We need to have a plan in place because otherwise, in the same way that we see now the risk of an electricity blackout, we could face an oil crunch in 10 or 20 years’ time. I therefore think we need to be careful about the messages we send. Part 2, reviewing investors’ thinking about the relative merits of engagement and divestment can be found here. Environmental Finance is an online news and analysis service established in 1999 to report on sustainable investment, green finance and the people and companies active in environmental markets. Home Green Bonds Stranded Assets Renewables Debt Equity Carbon Investors Policy People Search Search options Stranded Assets - engage or divest? Channels: Stranded Assets Companies: Carbon Tracker Initiative, Climate Change Capital, NASDAQ OMX, Schroders, Threadneedle Investments, HSBC, BHP Billiton, Mercer Investments, Norton Rose Fulbright, Hermes Investment Management People: James Leaton, James Cameron, Miguel Santisteve, Solange Le Jeune, Cathrine de Coninck-Lopez, Zoe Knight, Geof Stapledon, Kate Brett, Tomas Gärdfors, Victoria Barron, Graham Cooper, Peter Cripps 08 December 2014 In the second part of a round table on ‘stranded assets’, organised by Environmental Finance with support from HSBC, the Carbon Tracker Initiative and Climate Change Capital, participants discussed whether engagement or divestment is the best approach for institutional investors to deal with this risk.
Participants
Peter Cripps: Looking at it from an investor’s point of view, how do you deal with the risk of stranded assets? Kate Brett: One of the biggest issues is the dislocation between the timeframe the investors are looking at and the impact of climate change. Even when you have long‑term investors, usually their assets are managed by asset managers who, typically, think in a shorter timeframe. Some ‘pioneers’ are looking at stranded assets as a risk; however the majority of investors are not yet aware of it. It tends to be the ones that have been the focus of the fossil fuel divestment campaigns; so the charities, universities, faith-based investors, foundations, etc. James Cameron: Not mainstream investors at all? Kate Brett: Very few in the UK; perhaps slightly more so in the US where the divestment campaign started. Victoria Barron Victoria Barron Victoria Barron: We represent a large number of international institutional investors, mainly corporate and public pension funds. We undertake engagement on their behalf and frequently speak to companies on the topic of stranded assets. We were recently having a conversation with a client who is concerned about the long term sustainability of oil and gas companies, and we touched upon the role of investors, i.e. do they wait for the companies to make the capex allocation decisions and change their business model, if they can, or is it up to investors to encourage them to change or just simply divest? Peter Cripps: Is it a question of rebalancing your portfolio, or using your power as an investor in that company, or both? Victoria Barron: Each of our clients will have their own policies on the question of rebalancing, but we, obviously, believe there is a crucial role for engagement in assessing the risks in their business models. James Cameron: The idea that you would use your influence to make an incumbent do what you want it to do might work at the margins, but it will not lead a complete shift in direction, to an alternative technology. Victoria Barron: One question which we ask quite a lot of the companies is: ‘What proportion of your investor base is asking you questions about this topic?’ Conversations [about stranded assets] are happening with some asset managers but at the moment I could not say it is a majority - Geof Stapledon Geof Stapledon: I would say it is certainly increasing. Very much so among the UK, Dutch and Australian investors. The conversations are happening with some asset managers but at the moment I could not say it is a majority. Victoria Barron: With the asset owners, we start to get into the complications of mandates. Unless you, the asset manager, have a very specific mandate from the asset owner saying, ‘No, this is the sort of risk that I would not want you to take,’ then it is really up to the asset managers. So I am really wondering if the conversation is occurring at that level. Cathrine de Coninck-Lopez Cathrine de Coninck-Lopez Cathrine de Coninck-Lopez: We can engage and we can ask questions about risks but, if the company is in the indices, then, from a fiduciary perspective, if we are not mandated to divest on ethical or moral grounds we have to have a really strong conviction that these assets will become stranded. So engagement is possibly the easier approach. Peter Cripps: But is it actually working? Cathrine de Coninck-Lopez: Well, to some extent. I think some of the oil majors are getting the message. James Cameron: Sure, they are smart people but that is not where the transformation is going to come from. You have to reinvest somewhere else to find the kind of yields that will allow our fiduciary responsibility to be adhered to. At the moment the closest you get is one or two companies emerging in the US out of the ‘yieldcos’ but, in the end, there have to be pure clean energy companies. Victoria Barron: We are seeing quite a lot of investor interest in low‑carbon indices, but they are still in development. Miguel Santisteve: But how many asset managers are asking these questions? The presence of asset managers that integrate environmental, social and governance issues in the oil and gas sector has actually grown in the last four years. What I am seeing more and more … is investor engagement with companies on this topic. Even though the headlines make us think that everyone is divesting, actually it is so far having a tiny impact in relative terms. Kate Brett: It is very early days, so people are saying, ‘We will divest from fossil fuels,’ but they have not yet done the analysis to understand the full impact on their portfolio. Some ‘pioneers’ are looking at stranded assets as a risk - however the majority of investors are not yet aware of it - Kate Brett James Cameron: That is where we are. What does it mean when the insurance industry, for the first time, steps up at the Climate Summit and says, ‘We accept the connection between our investment and risk?’ In the past they always kept these absolutely separate; ‘We have people who do investment, and we have people who do risk.’ However, now they say they want to deploy their capital in ways that they say is ‘climate smart’. But what does that mean? What asset classes would be beneficiaries of that? Is this fresh capital? Is this a big allocation away from something? James Leaton: I think if you talk to Storebrand, for example, they would say, ‘Well, the reason we are doing this is we think there is a financial case in the long term that these high‑carbon activities will underperform. It is not a moral decision for them. They will also say, ‘We find it very easy to find other things to invest in.’ Peter Cripps Peter Cripps Peter Cripps: I think most big investors feel that they would miss the fossil fuel industry from their portfolios; they do not feel that divestment is an option for them. I therefore wonder what use engagement has if, ultimately, the bottom line is: you cannot divest? James Leaton: We are not actually saying: ‘Divest from everything.’ We are not saying we are going to stop using oil or coal tomorrow. The oil majors have a range of options, a lot of it at the low end of the cost curve that fits within even lower demand projections. You would not actually miss the small percentage of pure coal companies; that are probably worth less than 1% of the market. Cathrine de Coninck-Lopez: We should not underestimate the power of investors. We have certainly seen companies change their investment model and change their dividend policy in response to investors. They do listen, but it cannot just be the sustainability voice; it has to be the investor’s whole voice. I think that is the real challenge. Peter Cripps: Do asset managers feel they get good information when they speak to the extractive companies about break‑even points etc? James Leaton: Some of the companies we have spoken to are saying, ‘A year ago we did not have to talk about break‑even prices and capex allocation; that was a private debate we had with a few analysts. Now it is a public debate; we have to publish long reports, discuss it in the media or discuss it with shareholders.’ So, I think it has driven a new debate, which we welcome. Solange Le Jeune: One of the key things I like about Carbon Tracker is its break‑even products analysis. This is an area where we find engagement can be useful. We push for the companies to give us this information on oil production cost per project type and then to make it more public. Now we have estimates but they (the companies) will have much more accurate information, so we can ask: Is it the right capex? Is that the right asset allocation here? Do we need to invest that much in this asset? Miguel Santisteve: I think they are definitely open to these messages and remain focused on profitability. We know some oil and gas companies are actively shrinking their balance sheets, selling assets and therefore reducing the size of the company because, at the end of the day, if the focus is on earnings per share and it takes a smaller company to do that, then that is what it takes. Cathrine de Coninck-Lopez: Yes, the big oil majors are important dividend‑paying stocks and they would be massively slated if they suddenly said, ‘No, we are not going to pay dividends, we are going to invest in solar.’ I think, perhaps, that is the right thing to do in the long term. However, I am not sure the market would like that. We should not underestimate the power of investors - Cathrine de Coninck-Lopez James Cameron: I do not believe the answer is going to lie with the incumbents, ‘You show us the way to the future; you do solar.’ No, you want solar companies out there that will absolutely cream them in the market. Cathrine de Coninck-Lopez: But they have so much money. Who else has that amount of money? James Cameron: Indeed. Who has the money? Who knows how to make it deliver technological innovation and who is used to disruption? The real problem is the power of the incumbents. They dominate our psychology, they make us think there is no future without them, they make us think we will have to wait ten years, 20 years when we cannot; it is a fantasy, we cannot. It is a standard innovation problem; it is combining different types of capital to get to scale to deliver basic needs at lower cost or at lower risk. Victoria Barron, James Cameron, Miguel Santisteve, James Leaton, Graham Cooper Victoria Barron, James Cameron, Miguel Santisteve, James Leaton, Graham Cooper Victoria Barron: If those technologies do take off … what will be the impact on companies like the utilities, the miners and the oil and gas companies? That is when investors, I think, are really going to be saying … ‘Hold on a second.’ James Cameron: Yes, then people start to move as well as money. They go to where they feel their best opportunities lie. However, it is all a question of timing and how much disruption will take place in the meantime. Peter Cripps: So, is there a first‑mover advantage for people who want to put their money into this? Is it a leading edge or a bleeding edge? James Cameron: But exactly the same thing happened in the Industrial Revolution. Even in the big infrastructure developments that we all think were tremendous, most of the early bond holders all lost their money. Geof Stapledon: It is just a question of getting the timing right. Solange Le Jeune: That is why research is so important. The threads need to be tied together; we need to talk more to each other and there is a need for more information and research to come through to make people more aware. Improved awareness is key to drive the sustainable investment and funding decisions Tomas Gärdfors Tomas Gärdfors Tomas Gärdfors: We have a wide range of clients and we see a large number of investors looking for new yield opportunities. The situation can change rapidly, however. In the case of solar power in the UK, for example, we continue to see a real ‘run for the sun’ given the Renewables Obligation Certificate deadline next March. New rules were introduced in the spring to manage the scale of solar investment and we now see a more mature market responding to the changing regulatory environment. Zoe Knight: Can I ask the group, how much time have you spent talking to oil and gas analysts and sell‑side houses on this issue and what sort of responses are you getting? James Leaton: We have spent some time doing that. I think there is an overlap with mainstream business risk analysis in terms of: should they be reducing capex, for example. But it is still the tragedy of horizons that Mark Carney mentioned. If their model only runs for five to ten years and they put in high demand and price assumptions, the answer they get at the end is perfectly valid, but represents a short-term view at one end of the spectrum. James Cameron: I used to use different techniques for valuing companies. I would ask probably more of a lawyer’s question; I would say, ‘But surely you would have factored in the possibility of a rule change,’ a price on carbon in China, for example? ‘No, that does not feature.’ ‘What about access to water – a critical factor in almost all fossil fuel production?’ ‘That is not part of it.’ ‘Okay, well, what about public protest and acceptability on the client side?’ ‘No that does not feature either.’ So there is a whole list of real‑world phenomena that clearly affect markets and they do not feature at all in the way the company’s value is calculated by analysts. I do not understand that. Victoria Barron: The auditors are now looking at proven and unproven reserves; it is on their radar. So we have asked analysts, ‘What happens if, in the future, investors turn around and say, ‘You gave us incorrect information, incorrect valuations?’ Solange Le Jeune: I would like to see a new way of modelling and valuing the oil and gas sector. Not talking specifically about this sector, but I do see some people who have just become fund managers and they want to tweak their model with a range of different things, such as social and qualitative indicators. I mean that a new generation of analysts and investors is starting to look at valuation models differently. But I find fund managers and analysts in the oil and gas sector tend to be more conservative. It is a risky exercise to change the way you model the sector but I think the response can come from the new generation James Cameron: So you are saying another generation will come through and they say, ‘We will do this.’ Solange Le Jeune: Hopefully, yes. Zoe Knight Zoe Knight Zoe Knight: I do not think there is a lack of desire to do it; I just think that the day job takes over, in the sense that it takes time to think through new modelling approaches and techniques which means they can be put at the bottom of the list of daily priorities. Solange Le Jeune: However, that is why I think it could work with a new generation of analysts. They might find developing a new model takes a year or two and then perhaps it has to be tweaked, but their career is just starting and they will have many years ahead of them to demonstrate the new way of analysing and valuing is relevant Miguel Santisteve: I agree. I think there are not enough people thinking outside of the box. I think, being part of the financial sector, you have so many cognitive biases. So you tend to think that the economy is always going to grow, the market is always right. Even though there are so many facts out there telling you otherwise, in terms of human population, arable land, access to water, scarcity of resources. It is obvious and in front of you: we need to change the economic model. EF Carbon Market Platform Carbon Market Platform 1,061 members Member Joost Kanen Follow Joost Stranded assets because of oil tumble Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Investors face up to a future of stranded assets :: Environmental Finance environmental-finance.com Recent studies have warned that a range of fossil fuel assets could become ‘stranded’ because of high extraction costs or regulations to curb climate change. In this round table, organised by Environmental Finance, with support from HSBC, the... Like Comment (20) Follow Reply Privately5 days ago Comments 20 comments Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com One reason for stranded assets is likely to be difficulty with borrowing. Even if prices bounce back up, lenders will not be willing to assume that prices will stay at the high levels. Also, interest rates will be higher, because of the greater default risk. The combination of these factors mean that lending limits will drop, and cost will be higher on funds borrowed. Because of this, it is likely to be very difficult to get oil production back on line, if oil production drops in response to a serious price drop--even apart from rising extraction costs and climate change regulations. Like Reply privately Flag as inappropriate 3 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Is it me or has the shift to a new era begun now... I did research on North Sea oil in 1998 and 1999 and we then already foresaw that between 2010 and 2015 would be the start of the end As you wrote in your article Gail, this might trigger new junk bond defaults by lenders to shale gas firms as well as small North see oil producers..but when and how significant will this be.. So the oil price and oil production will become much more unstable and risky.., and this might benefit renewables, depending on the impact of the oil price has on gas prices here, especially in Europe Like Reply privately Flag as inappropriate 3 days ago Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com While it is easy to focus on our oil problems, and oil-related junk bond debt defaults, we are really operating in world with many simultaneous problems. This is not entirely a coincidence; the issues that are leading to problems in oil are leading to problems elsewhere as well. Prices of nearly all commodities are down, raising the risk of default on loans for both (a) companies extracting these commodities and (b) countries exporting these commodities. Also, the drop in prices of commodities adds to deflationary pressures. Debt of all kind is harder to repay in a deflationary environment. The issue gets to be, 'How much will total default losses be?' and 'How much will derivative and other financial security losses add to 'regular' default losses?' I think a strong case can be made that the situation will be much worse than in 2008. To make matters worse, governments have fewer tools for fixing bank problems now. Interest rates are already very low, removing one tool. Also, sovereign debt levels are already very high compared to historical norms, removing the bail-out tool as well. The 'new' approach planned by the G-20 seems to be 'bail-ins'. (There are also plans to raise equity requirements and otherwise try to reduce the chance of problems, but these appear to be too little, too late--not sufficiently helpful 2015-2016.) The nature of bank 'bail-ins' is that funds by depositors may be 'haircut,' to make certain that all of the obligations of banks on derivatives and on other types of financial products will be handled according to the terms of the agreements. Part of the reason for this approach seems to be timing and availability--depositors funds are easy for a bank to access, whereas derivatives and other financial products may take years to settle. The concern I have is that a bail in approach will be very disruptive to the economy. Suppose an electric utility has funds in a bank account for a variety of purposes: to pay employee wages, to pay for upcoming fuel deliveries, and to pay debt obligations coming due. It could find itself unable to pay any of these obligations, if a 'bail-in' takes a substantial part of the utility's bank deposit. Because of the nature of the problem, having more renewables does not help the situation. The electric utility would become unable to pay for renewable energy, just as it becomes unable to pay employees and other suppliers. Like Reply privately Flag as inappropriate 3 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Well it's difficult to estimate these default losses, and bail-in costs. Still I can't believe these defaults will be the size of the bank bail outs in 2008. especially in Europe these were massive Like Reply privately Flag as inappropriate 3 days ago Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com Pricing of derivatives and other financial products tends to be done using the Black-Scholes pricing model. This model works fairly well, when oil extraction and other processes that approach limits are quite far away from limits. This model works increasingly poorly as limits are reached, because it is no longer true that adverse events are independent and normally distributed. Thus, a person would expect a series of financial catastrophes similar to 2008, getting worse over time. It looks to me like we are approaching the next one, in 2015 or 2016. I mention the deficiencies of the Black-Sholes Model in my 2008 Oil Drum post in which I correctly forecast the financial problems of 2008. www.theoildrum.com/node/3382 Like Reply privately Flag as inappropriate 3 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. I know option theory and you are right, but I can't imagine the hedging with options by energy and shake firms to be of the same massive size as was the case with the bank defaults in 2008. Also you assume that the utilities generate electricity from renewables as well as from fossil fuels. So the fossil fuel problems would drag renewables down with it. But that might not be the case, eg E.On from recently announced that it will spin off its fossil fuel generation from its renewable generation. So renewable only generators might survive Like Reply privately Flag as inappropriate 3 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. I meant shale oil firms...typo Like Reply privately Flag as inappropriate 3 days ago Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com The issue with energy firms is that they all depend on the financial system. It is the financial system that can be expected to drag everyone down at the same time. It doesn't particularly favor so-called renewables. The only renewable that is really independent of the financial system is the tree that someone has in his or her yard (or in a local public forest), that can be cut down with an ax. There is no need for the financial system to finance this 'extraction of energy.' Otherwise, the name renewable is a misnomer. Renewables require a large amount of front-end financing, so they are very much affected by problems of the financial system. They basically use a lot of front end energy to produce dribble of energy over the years, as wind or solar are passes over them. (One reader suggested that they be compared to batteries.) Below is a chart that researcher Graham Parker put together, showing how long it takes to get back the energy inputs for solar. http://gailtheactuary.files.wordpress.com/2014/04/solar-pv-eroei-graham-palmer.png When solar panels are used, somehow energy balancing must be done. Graham as done this with batteries. He has left out other required energy inputs, including the use of an inverter to provide alternating current. This omission makes the result less bad than it really is. Looking simply the energy that can be easily counted of the solar panel and the energy required for batteries and replacement batteries, it takes about 25 years (out of a 30 year lifetime) of the solar panel to get the energy that is put in at the beginning (often mostly coal) to be gotten back out again. If the solar panel had not been built, our coal usage would have been that much lower. Like Reply privately Flag as inappropriate 3 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Indeed but the forward projections are highly unstable, as you yourself pointed out. Personally I see carbon markets and renewable energy as a knowledge product, and the learning curve is more important than the panel or the wind rotor... When you lead the road to the future is often unclear.. Like Reply privately Flag as inappropriate 3 days ago Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com We have two estimates of future energy production: 1. The one underlying promises about the future of various types--bonds, debt, stock prices, and promises such as Social Security and Medicare. These assume that the output of goods and services will rise at a fairly rapid rate for the indefinite future, allowing business as usual to continue, and an ever-larger population to be fed, clothed, and transported. 2. One based on the diminishing resources that are available. There are plenty of resources theoretically available (fossil fuels, metals, fresh water), but the cost of extraction keeps rising. This happens because we extracted the easiest to access resources first, leaving lower quality ores, minerals in deeper mines, and water requiring desalination. There are also more pollution issues to handle, adding to resource costs. The higher cost of extraction means that more and more of our resources must be concentrated on the extraction of resources. Thus, in this sector of the economy, real returns are falling--workers are producing less oil or coal or fresh water per hour of labor, and using more resources to produce these resources. This means that wages should be lower, if wages reflect true productivity. It also means that fewer resources are available for purposes other than fossil fuel, metals, and water extraction--in particular to do the things that might 'grow' the rest of society. Economists have hypothesized that we can somehow produce more services and fewer goods, and somehow continue to grow as in the past, despite the problem of diminishing returns. If economists are wrong, and the amount of goods and services can no longer rise rapidly, then we have a huge mismatch between what has been promised in the financial markets and what will really be available. Our financial system becomes, in effect, a Ponzi scheme. Repayment of debt with interest becomes impossible because, at some point, economic growth becomes negative. I believe that this is where we are headed, as diminishing returns take a bigger and bigger 'cut' out of economic growth. Losses on derivatives and other financial products are likely to point out this financial mismatch before the problem becomes apparent otherwise. Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Did you know that political parties in the Netherlands are planning to shift taxes from labour ( now most important source of government revenue as workers are sitting ducks) to goods, which would make hiring workers much cheaper and buying and consuming goods much more expensive? What do you think of this strategy? Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. It's called Circular Economy See link http://www.government.nl/documents-and-publications/reports/2013/10/04/opportunities-for-a-circular-economy-in-the-netherlands.html Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. In the USA this might be more difficult as taxes on labor are already low Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. http://www.usatoday.com/story/money/2015/01/15/crude-oils-collapse-will-cost-9000-jobs-at-schlumberger/21826189/ Like Reply privately Flag as inappropriate 2 days ago Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com I am not sure I understand the issues involved here well enough to comment on the taxation approach. In selecting any approach for fixing the problems of Netherlands, one big issue is being competitive with other countries. This means that costs of businesses are low in total, including cost of energy, cost of labor, and taxes. Another issue is getting more spending power into the hands of individuals in a country. This happens when businesses are 'productive' -- can produce more goods with fewer inputs, or at least less expensive inputs per unit of output (but not lower wages in total). It also happens when debt increases, so that individuals, businesses, and governments can afford to buy more 'stuff' (whether or not they can pay back this debt later). This approach obviously is only a temporary one, if they cannot repay this debt. I don't think the circular economy is a viable option. The paper talks about transforming waste to goods that can be used. Unfortunately, the critical question is, 'Can this be done more cheaply than other approaches?' For example, 'Are biofuels produced in this way less expensive than fuels imported from other countries?' If not, it means that salaries of Netherlands' workers will go less far. More workers will be absorbed into this inefficient sector of the economy, leaving fewer workers for more efficient sectors of the economy. On average, each worker will produce less, and the economy will contract, because of lower output per worker. Many debts will go unpaid. While it is true that the wages will (at least partly) stay in Netherlands for this process, what will happen is that you will still indirectly use a lot of imported products, like oil, in this process. There will tend to be many indirect costs that will be overlooked--the need to keep roads still in reasonable repair for example, which is one of the oil uses. Also, the workers will use their salaries to buy food grown elsewhere, and clothes made with cotton and wool produced elsewhere. So the effect of the local salaries will be tend to be quickly lost, as these wages are spent on imports. The overall impact will be much less beneficial than planned, unless the new recycled goods are truly inexpensive compared to other options. It also would help if most of the effort involved in recycling is labor, not energy and capital goods purchased outside the country. Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. All foreign goods will also fall under the increased taxes, eg doubling of VAT (to 42%)....so local goods will become price competitive, as well as labor costs will become more competitive vis a vis other countries Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Worker's net incomes will not decline but stay the same, the only thing that is reduced are the income tax rates and the taxes employer pay for employees. So spending power doesn't have have to decline too much, depending of the price increases of the goods. Basically the argument is that now labour is too expensive and goods too cheap in the light of a constrained resources/energy future Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Income tax rates are now between 30 and 52% here Like Reply privately Flag as inappropriate 2 days ago Gail Tverberg Gail Gail Tverberg Researcher writing at OurFiniteWorld.com Making local goods more competitive compared to foreign goods is definitely a plus for the local economy. Adding carbon taxes (when carbon taxes were not charged on imported goods, made with coal and cheap labor) had exactly the opposite effect. It tended to make imported goods relatively cheaper. Like Reply privately Flag as inappropriate 2 days ago Joost Kanen Joost Joost Kanen Author & Founder Gryphon Carbon Consultancy B.V. Yes but the European Commission was actually quite stupid and made many expensive errors in the design of the ETS... carbon leakage could have been made irrelevant by placing the carbon caps further down the value chain, at distributor level (as I believe is the case in california) Like Reply privately Flag as inappropriate 2 days ago |
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02 December 2014 |
| The text being discussed is available at https://www.environmental-finance.com/content/analysis/roundtable-investors-face-up-to-a-future-of-stranded-assets.html |