Two powerful forces are currently driving energy markets and climate outcomes.
Carl Pope | July 28, 2015 9:31 am | Comments
Advocates of “market-based” climate solutions paint pastel pictures reflecting smoothly adjusting macro-economic models. Competitive markets gradually nudged by carbon pricing glide into a low carbon future in a modestly disruptive fashion, much as sulfur pollution from power plants was scaled back in the 1990’s.
But commodity markets for oil and gas don’t work that way. These real markets are poised to savagely strand assets, upset expectations, overturn long established livelihoods and leave a trail of wreckage behind them—unless climate advocates start owning the fruits of their own success and preparing for the transition. Schumpeter’s destructive engine of capitalism is about to show its ugly side.
Fossil fuel prices are indeed opening the door to climate solutions, but not through the gradual carbon pricing mechanisms so favored by economists (and recently, reluctantly beginning to be explored by conservative thinkers). Instead, the divergence between clean energy price curves, which fall rapidly with market share and fossil fuel prices, which rise with consumption, are about to collide explosively.
Second, Investors are indeed, moving away from fossil fuel stocks and bonds, but not out of ethical concern over climate risk, or even an expectation of global regulation of carbon combustion. They are racing to the exit as bloated coal and oil stock values collapse on the other side of the “Commodity Super-Cycle” which until early 2014 was the dominant paradigm.
Two weeks ago I wrote two pieces in Bloomberg Views suggesting that the fossil divestment movement was arguably behind market trends in arguing that coal and oil were bad investments. The following week witnessed a cascade of commentary making my pieces look milquetoast and timid. Markets are abandoning carbon companies—even if society continues to burn far too much of it.
Look at the numbers:
U.S. coal consumption has fallen, in the face of competition from performance (efficiency), alternatives (natural gas) and disrupters (solar and wind.) Five years ago we burned a billion tons of coal; now we burn 850 million tons. Solid progress. But still 850 million tons.
What happened to coal company share values? In the last five years, a coal company has gone bankrupt on the average every month. The second largest U.S. coal company, Alpha, after one bankruptcy and reorganization, was just dumped from the NY Stock Exchange because its price fell below $1.00. Even a coal producer (Walter)
whose output, metallurgical coal, still enjoys a strong market had to file for bankruptcy. The biggest U.S. coal company, Peabody, which traded in 2011 at $73, is now selling at $1.29. The bond markets have abandoned coal. All coal company debt is now graded “junk.” In the last quarter the three worst performing major U.S. bonds were all coal:
Alpha Natural Resources: -70 percent
Peabody: -40 percent
Arch: -30 percent
Coal, as an investment class, is effectively finished—coal companies will go through a series of reorganizations. After each one only those with the best balance sheets and cheapest mines will remain. The reclamation bonds which the U.S. government and the State of Wyoming allowed these companies to self-insure against their balance sheets are about to go south, creating sequential calls on capital that will push even more companies first into Chapter 11 and then into Chapter 7. Outside the U.S., 1/6th of Australia’s coal mines now operate at a loss. Companies in the sector are in liquidation, even though the world will use a lot of coal for quite a while to come. Eventually slumping demand will be overtaken by declining production and more mines will become cash flow positive, but existing stakeholders will be liquidated first. That’s the dynamic of shrinking commodity markets—investors, communities and workers lose fast even as markets shrink slowly.