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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Big Oil Cannot Afford To Ignore Climate Change

Shale rig sunset

Investors have begun to take climate change more seriously now that the Paris climate agreement of December 2015 has created a new set of initials to watch, NDC for “nationally determined contribution”. A study sponsored by the biggest investors in the world claims that only 94 of the more than 1000 companies that answered the sponsored survey have developed coherent strategies to meet their goals and the fossil fuel companies had the most disappointing responses. That should not be a big surprise. And considering that so many of those investors have a policy of buying just about every large capitalization stock (they are index fund or closet index investors), it is not clear what most of them will do with the information until they make some serious investment policy decisions. But the heat is on, at least at the margins, and likely to grow hotter for those investment funds, especially if the regulatory agencies force corporations to discuss climate risk in their reports. Investment committees don’t want to have to explain, afterwards, why they ignored warnings.

That brings us to the energy marketplace. Moody’s Investors Services just issued a bond rating report explaining how and why it considers climate change risk in rating energy companies. Among the G20 economies, electricity production and central heating account for 45 percent of the country’s carbon emissions. This is, of course, the economic sector that can utilize renewables right now. The firms in the electric business are capital intensive and issue bonds often. If the rating agencies become negative on the sector and lower the bond ratings, companies will pay more to raise money and a few will not be able to raise money.

Moody’s argument could be boiled down to this. The cost of renewable energy is falling, and lower renewable prices will put pressure on wholesale energy prices just as carbon pricing adds to the costs of the carbon-fueled generators. Thus, margins will fall the most for the least efficient carbon-fueled facilities. Unregulated, inefficient and inflexible carbon fuel generators will suffer the most because they will lose market share, face falling margins and they have no regulatory protection. On the plus side, for them, the unregulated markets have had to create capacity payments to keep generators from closing down and leaving the system with insufficient capacity and capacity payments now make up 40 percent of generating gross margin in regions that have such a scheme to pay generators to keep open to prevent emergencies. Related: Will Electric Cars Be Cost Competitive By 2020?

Unfortunately, the impact of the new policies go beyond dirty generators. First, more renewable output may reduce the market for gas-fired electric generation. (If electricity sales were growing, there might be enough market for everyone, but sales are not growing. And gas as a fuel for generation has been the fastest growing segment of the gas market, so a slowdown will hurt.) Second, new technology enables local and on-site generation and storage, and that makes the transmission and distribution grid less valuable.

Moody’s entitled its report, “Carbon Transition Brings Risks and Opportunities” but makes clear that the opportunities go to the most efficient and flexible firms, regulated firms have some protection and the risks accumulate for those with old, inefficient and unregulated assets. We suspect that Moody’s has got it right, but consider this: if all the ratings agencies begin to think the same way, they will set ratings that affect the flow of capital and they could accelerate the trends that they foresee.

In sum, it appears that big money is beginning to speak, and it says, “Carbon emissions count and if you don’t believe that, you’ll pay dearly if you need money and you might not get our money at all.”

By Leonard Hyman and William Tilles for Oilprice.com

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Leave a comment
  • MarkG on November 11 2016 said:
    ....and just follow the money trail.
    The climate has been changing for thousands of years before the human race on this planet, and it will be changing after the life on this planet is extinct due to wars or natural catastrophe.
    However this time in the 21st century, someone, somewhere decided to make a business out of this UNKNOWN climate changes. Because of this, lots of so called climate scientist on both sides of the debate, have got a field job with all kinds of computer modelling of climate change. Actually, just few years ago, it was a debate on GLOBAL Warming, but because they (climate scientists) could not develop a consistent computer model for that, they have decided to take a safer approach, and steer the agenda towards CLIMATE Change.
    From then on, everything they say is like a GOSPEL. And how can ,anybody be against it, when all the "smart" people, rich people like Leo DiCaprio, Al Gore are preaching this GOSPEL.
    Even Pope Francis lent his authority to the debate about UNKOWN.
    When a LIE is repeated by these "experts", with such an UNRELENTLESS media campaign (day in and day out), it will become the ONLY TRUTH we know it.
    Will the people like Al Gore, DiCaprio or Suzuki ever be held accountable for their outrages predictions 30, or 50 years from now? The corporate world does not really care about it. They will fit into the agenda to make a profit by adding few dollars for trading "HOT AIR", but the rest of us will be driven to the poor house. The socialist agenda will prevail, share the wealth, everyone must be the same poor. Only few will be laughing all the way to the bank. Follow the money trail......
    I guess Russian leaders like Stalin, Khrushchev, or Brezhnev were right. Socialists will prevail with New World Order.

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