2019 was a bit of a shock to many directors of financial services firms. For many in banking, pensions, fund management and insurance, climate change action largely used to be restricted to writing lengthy reports about distant future effects along with delivering abstract long term platitudes.
In the last few months however, things have moved on from just making the last person to leave the office turn out the lights & switching to reusable coffee cups. Its been a bit like the difference between seeing storm Ciara on a weather map heading towards the UK on Saturday versus trees being buffeted, widespread flooding and roof-tiles flying around on Sunday.
There are 2 big factors at play in why of this changing the financial services landscape
1 Climate Change
Firstly the Climate change or Climate crisis/ Emergency has become much more visible and urgent. We’ve seen extinction rebellion, the extraordinary Greta and others demanding action and widespread warnings that now really is the last chance to limit the temperatures increase. Then just on queue we’ve seen Australia, with its coal loving climate change denying Prime Minister, on fire with air so full of smoke that it was hazardous to breathe along with the most extraordinary apocalyptic imagery. Followed by torrential floods.
Don’t think this is reserved only for far away Australia. The Climate impacts will be global & Europe is very much included.
Fires and floods: maps of Europe predict scale of climate catastrophe
Secondly we have cleantech. A friend of mine summarised the action we need on climate change as..
“we have to stop burning stuff”
Cleantech is the whole eco system from renewables like wind, solar, hydro, tidal powering all our energy needs including Electric vehicles, industry & heating.
Of these 2 twin factors Cleantech is key. Some people are still under the misapprehension that renewable power can’t be done, it’s more expensive, uncompetitive without enormous extra cost and subsidy, it’s flakey, it can’t cope with times when its not windy or when it’s dark. You’ll still need coal or gas power to fill the gaps. All of that is now wrong..and it’s been a bit of a shock to some.
The fundamental difference with cleantech is that once you’ve spent a capital outlay to build it, the energy for solar or wind farms is free, with maintenance being the low production cost – and that capital cost is falling rapidly. This makes renewables massive disrupters. Why? Because after many years of investment and heavy subsidy cleantech is cheaper than burning coal, gas and oil.
Even in deepest Trump-land coal mines are closing. The reason -Existing coal power stations that the mines supplied are closing, well before the end of their operational lives, because even existing coal generation is more expensive than wind and solar. Even voters in states where calling someone green is an insult don’t want to pay more for their power than they need to. In Texas in 2020 Natural gas retains market-leading position with 45% share on ERCOT, followed by wind, with 23%(about 7% in 2010), coal, with 18% (40% in 2010), nuclear, with 11%, and PV, with 2.3%. In the FT 11th Jan 2021 report in “Wind power overtakes coal in Texas electricity generation” this is charted out.
If you want to see which way the world is heading.. look at new US generating capacity being added in 2021
In the US Solar leads the 2021 pack with 39% of total new US electricity generating capacity. It’s followed by wind (31%, or 12.2 GW), natural gas (16%, or 6.6 GW), battery storage (11%, or 4.3 GW), nuclear (3%, or 1.1 GW), and Other, at 0.2 GW. So that’s 39% + 31% + 11% or 81% renewable with zero new coal plants and just 16% gas in the fossil corner.
“It no longer matters whether you believe in climate change or not. Decisions are now being made in governments and boardrooms around the world, the economic shift is happening, the market cap of the big fossil fuel companies is collapsing while the market cap of cleantech companies is soaring as is the shift in investment and jobs. Elon Musk’s personal net worth is now greater than the market cap of Exxon”
And wind and solar are benefitting from falling capital cost & higher efficiency every year. UK offshore wind is a case in point.
Hornsea One that went online in 2019 powering 1m UK homes
UK Offshore wind production right now
Ok so the power supply is shifting to renewables..why does that matter to financial services firms? Well its about $$$$$$
Mark Carney, the outgoing Governor of the Bank of England provided some fairly clear clues..
Mark Carney suggested the financial sector had not yet woken up to the looming crisis and was “not moving fast enough” to divest from fossil fuels.
Climate breakdown could render investments held by millions of people “worthless”, the outgoing governor of the Bank of England has warned.
England’s central bank has previously suggested that while £16tn of assets could be wiped out by climate change, companies at the forefront of efforts to curb emissions could be handsomely rewarded.
Financial Services firms trade in, lend to, insure and invest in assets that have a value in the fossil fuel era but will have a value of zero in future. The first quartile of firms has already begun to head for the exits or begun to lay off the risk – the firms that exit too late along with their investors face colossal losses.
An August 2019 report by BNP Paribas looked at the useful energy delivered today by investing in renewable energy compared to oil.
“Oil will have to fall to $9-$10 a barrel in the long-term in order for gasoline cars to remain competitive with clean-powered electric vehicles, and to $17-$19 a barrel for diesel, Mark Lewis, global head of sustainability research at BNP’s asset management unit, said in a research report. U.S. benchmark crude was trading at about $55 in New York on Monday”
Video interview with Mark Lewis on the shift away from fossil fuel to renewables 5:08Mein Geld TV: One-on-One mit Mark Lewis von BNP Paribas
Bloomberg Mark Lewis interview 2019 on Management, Sustainable Investing
Let’s imagine the effect of oil even at the highest price mentioned, $19 a barrel. Forget climate change for a moment, just look at disruptive effect of renewable energy & electric vehicles competing with fossil fuels at this price point. In the energy sector wind and solar are rapidly driving coal power stations out of business and the same is beginning to happen to Natural gas. Not because of the climate emergency- simply because coal, oil and gas can no longer compete.
What if the price of oil and gas falls in order to compete. This is where it gets interesting. Fossil fuels require capital spend as well as substantial costs of production. There’s drilling, crude transportation by pipeline and ship, refining and then transport to a petrol station. These vary enormously by the type of production. Once the oil price falls below its production cost, the oil in the ground becomes a stranded asset that would cost more to extract than its economic value. It becomes worthless.
These fossil fuel assets have a running order of being stranded as renewables & EVs cut demand. The order is likely to be..
- tar sands of the type that dominate in Alberta Canada.
- Next out will be fracking largely in the US along with deep offshore oil.
- Then Shallow offshore follows.
- In the end at $19 a barrel only onshore wells in places like Saudi will still be profitable.
All other higher cost oil will be stranded & have zero value, not because of a ban, but because it’s uneconomic to extract it and it can’t compete. Along side this will be industries that have not adapted or decoupled from the fossil fuel age. If you invest in companies whose assets are invested in petrol or diesel engine plants or gearboxes or fuel or exhaust systems their sun is setting fast.
We wrote this article in February 2020 but held off releasing it while the pandemic was at its height.
In a way the effect of lockdowns has been similar to pressing a fast forward button on the subject of the article. The oil price dropped massively to around $20 a barrel (and briefly went negative on some futures). Oil production from Canada & Alberta was cut sharply and many producers may go bust.
For now as at June 2020 an OPEC/ Russian deal combined with the North American cuts has helped oil recover to $40 a barrel. At this price some existing US production is coming back online but is only covering costs & it seems unlikely new production will be worth investing in. It seems likely OPEC will try to prevent oil going much over $40 specifically to avoid a US shale resurgence.
The stranding of coal assets has been accelerated by lockdown, essentially knocked out by a one two bunch of cheaper renewables & the fall in gas prices for power generators. Its got so bad even Warren Buffet is investing in solar. Coal is the biggest confirmed loser and won’t recover.
US shale has probably peaked (its debt levels are massive) but a further rise in the oil price over $50 could provide a stay of execution.
This 28th May article from oil price.com illustrates the scale of the challenge “Global investment in energy will fall by $400 billion in 2020, the largest single-year decline in history. U.S. shale will be hit particularly hard, with capex set to fall in half, according to a new report from the International Energy Agency (IEA)”
Big Oil update 22nd December 2020
in the week Tesla finally entered the S&P 500 with a market cap of $616B (7th biggest), the market cap of Exxon (the biggest of big oil) had fallen to $177.4B (43rd) while Chevron the last other US big oil company was in 47th place with $165.7B. In 2013 Exxon was the number 1, the most valuable company on the planet with a market cap peaking at $446B in 2014.
When we say these fossil fuel assets will be worth zero, that’s guilding the lilly somewhat. In the US closing coal mines have not just had an economic impact from lost revenue. There are redundancy costs when jobs are terminated. It also turns out that many had for years run big shortfalls on their pension plans and had failed to reserve for cleanup and restoring land to safe use.
2019 Numbers from Alberta “oilpatch” suggest the industry has set aside C$1.6B for cleanup but regulators estimate the cleanup cost to be between C$58B to C$250B.
Alberta officials warned oilpatch faced ‘landslide’ of failures. Then coronavirus struck Article contains video of a farm with wells now out of service and the original news report revealing the Alberta oil patch clean up estimates
To put that in perspective the entire Federal tax revenue of Canada was C$280B in 2018/19. Already 1/3rd of wells are not actively producing but are not being decommissioned because of the massive costs that would be incurred. Instead the industry has allegedly been transferring ownership of wells where production has been “paused”, to shell companies with no assets to pay for the enormous clean-up liabilities. Courts may in future take a dim view of a large scale scheme to shift liabilities from big oil companies to future generations of Canadian taxpayers.
These new economics are now making themselves clearer in the market. Tesla, a company that only makes electric cars is now worth more than BMW, more than Mercedes and more than Volkswagen. While VW is inching closer to delivering on its switch to EVs. BMW and Mercedes are so attached to old diesel and petrol technology that there are growing doubts they will survive the next 10 years. A single electric car, the Tesla Model 3 already outsells all German premium saloons combined in the US, Norway and the Netherlands. Much of the legacy car industry is denial despite their sales falling year on year in major global markets.
So what are the specific risks to Financial services firms
Well the risks manifest themselves on a quite a wide spectrum starting with the risk of being seen as accessories & enablers to fossil fuel industries
- publicity – as activists increasingly identify companies abetting harmful projects or industries. In some high profile cases individual Banks, Insurers and engineering firms are now the subject of global campaigning
- disclosure – companies who directly or indirectly work in fossil industries will face increasingly onerous disclosure requirements to investors and regulators.
- share value. Fossil fuel divestment is moving from the ethical fund space to the mainstream and the Climate action 100+ group now represents $35 trillion in funds under management . Individual investors are increasingly demanding their funds are divested and that investment funds do not assist fossil fuel development. Someone who avoided taking a flight on holiday or switched to a vegan diet is hardly going to be delighted to find a fund manager has sunk their pension pot into coal mines & oil rigs.
- Ability to attract talent. Young people committed to action on climate change will also not choose to work for companies associated with fossil fuels
- Economic and investment loss. 80% of energy related investment over the next 3 decades is predicted to go into Cleantech. This leaves investors not decoupling exposed to a declining market, losses on investments that may become less liquid for sellers and risks associated with liabilities of closing fossil fuel production without going forward revenue.
Is it too late?
No but with the smart money already heading out the warning signs are there. Big money is shifting its capital to companies that are smart enough to figure out how to mitigate risks related to sustainability and climate crises, and still turn a profit.