Warren Buffett (the crafty, veteran right-hander) likes to remind investors that when it comes to investment pitches nobody is calling balls and strikes. In other words, you can ‘take’ as many pitches as you want without striking out. Institutional investors sitting on their fossil fuel trillions are under no obligation to swing for the Renewable fences.
Even if they thought that getting out of oil and gas shares was a smart thing to do, because they observe that the risks are rising along with the sea level, investing that capital in New Energy companies (a term that has become synonymous with clean tech companies) does not necessarily follow. So why would they? Institutional investors are not going to commit to these companies just because “it’s the right thing to do.”
The start-up phase of renewable energy companies and projects may be over but New Energy companies are not going to prosper just because they show up. The long term winners from all sources are going to be those that pass these key tests, the Four Noble Truths of Energy Investing:
4) Producing few hazardous side-effects
(For the purposes of this discussion, the term New Energy will also refer to conventional sources, and include the next barrel of oil, the next cubic foot of natural gas, the next ton of coal and the next megawatt-hour of electricity. Fossil fuels are, after all, still the source of over 80 percent of the world’s primary energy).
The first item on the list would seem to go without saying; if something costs too much, how many people are going to buy it? To be sure, some very important developments have massively shaped the world without being cost-effective. Getting the bomb before Hitler and getting to the moon before the Russians were both extraordinarily complex science projects that highly motivated and well-financed engineers were able to solve when backed by a national consensus; cost was not a concern. However, an energy source that is still in its science project phase today is not likely to contribute much in the way of climate change mitigation, nor is it likely to become a threat to fossil fuels. Related: This Is Why Californians Pay More For Their Gasoline?
Any source or technology that is going to make a difference must pass from the science project phase through the next one -- the Formula One racecar phase, and ‘cross the chasm’ to become affordable to mainstream customers. At the Formula One stage, a product is available but it is prohibitively expensive for mainstream consumers (the Tesla Model S, for example), and/or it is designed for enthusiasts who can afford not to care about the cost; they tend to be labors of love. Though race cars will probably always be too expensive for the mass market, Tesla is working to produce a $35,000 machine that can go 200 miles on a single charge. (With batteries now costing $250 per kWh and falling, this moment is not far off.)
At that point, Tesla moves into the category that matters; their output will scale for the mass market, and rather than competing with Ferraris and Porsches, the company will have to take on EVs coming from the low end, such as lightweight vehicles from Asia and Europe. It remains to be seen if Tesla can do that and make money. When it comes to investing for the long haul, earnings matter (unless you are Amazon.)
The second condition, bankability, is highly correlated to the first, but there is more to the game than cost.
A reasonable definition of bankable is that a product or process is likely to attract investment, and likely to make money. Simply put, can it be financed? And if it is going to matter, can it be financed by the markets, not by a temporary bout of enthusiasm or ideology force fed by the government?
Indeed, renewable energy has received its share of subsidies, but so have oil & gas. Coal may be included on this list because the lack of a price for carbon is, in effect, the largest subsidy in the world and it benefits fossil fuels. Subsidies, however, belong in the discussion of side-effects even though many sources would not be ‘bankable’ without them. Nuclear energy would not exist without them, for example. Related: Can U.S. Nuclear Plants Operate For 80 Years?
With condition #4 – no hazardous side-effects – already a win for renewables, the main focus should be on conditions #2 and #3. Renewables continue to make headway finance and scale. At the same time, fossil fuel projects are suddenly losing their attractiveness as investment opportunities.
Until the price of oil collapsed last year, there was no problem getting financing to drill holes and flush out oil & gas in the U.S. That has changed, especially for tight oil producers. Cheap oil may seem like a good thing for drivers, but too much of a good thing is not in the interest of the suppliers. On June 29, Bloomberg reported that “Crude oil’s plunge is leaving drilling rigs idle from Africa to Latin America as the world’s biggest energy companies curtail spending and stall projects. . . . Rig costs typically react to oil with a lag of about six months, so today’s contracts reflect prices that sank to almost a seven-year low in January, forcing major producers to defer almost $200 billion of ‘megaprojects’.”
The price pullback is also beginning to impact shale gas, which has continued to flow in abundance even though the price fell further than oil in percentage terms. Bloomberg, on July 16, reported that “After four years of record supply, America’s natural gas output is shrinking as producers retreat from shale amid tumbling oil prices.” The focus of the article was on BHP’s (the Australian resource giant) writedown of $2.8 billion for its U.S. shale assets.
BHP is the largest overseas investor in U.S. shale, and the new writedown brings the total for its U.S. venture to $5.9 billion. “BHP said it will cut spending on its U.S. onshore unit to $1.5 billion in the year through June 2016, supporting a development program of 10 operated rigs. The producer spent $3.4 billion on drilling and development in the previous year.” Related: Toxic Waste Sullies Solar’s Squeaky Clean Image
Things have also taken a turn for the worse for King Coal. Another Bloomberg headline points to a new problem for the beleaguered industry: “The Latest Sign That Coal Is Getting Killed: Coal is a sick dragon, and the bond market wields a heavy sword.” The bond market takes no prisoners and the newest problem for some coal producers has reared its head, affecting even the strongest.
“Coal companies are allowed to avoid costly insurance premiums by showing they have the capital to clean up after themselves. It's called self-bonding. This year the federal government has started taking a closer look at whether the struggling coal companies still qualify. In May, the Wyoming Department of Environmental Quality told Alpha Natural Resources it no longer qualifies for self-bonding in the state, and the company has until Aug. 24 to post collateral or cash against $411 million of reclamation liabilities.” Alpha’s bonds fell by an astonishing 70 percent in the second quarter. Peabody’s bonds fell by 40 percent even though they may continue to self-bond. (They are currently the largest U.S. producer of coal).
Hopes are flickering that someday carbon capture and storage (CCS) technology will ride to coal’s rescue. The cost is too high, the technology involved reduces the efficiency of the plants and the infrastructure involved to carry out the process is massive (which means it costs too much). The Department of Energy (DOE) has just decided to stop funding a CCS project in California. “The agency says the project has failed to meet benchmarks such as failing to sign on customers to use its product for advanced oil recovery.” This comes on the heels of the decision earlier this year to pull the plug on FutureGen 2.0. It is past time to realize that ‘clean coal’ will never be clean.
For years Big Finance has favored fossil fuels over renewable energy. But with the collapse in commodity prices of all kinds, renewables are looking more and more “bankable” relative to their dirtier rivals.
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