ESG Focus: Climate Change Megatrend 3 – Fossil Fuels Part 1

ESG Focus | Dec 02 2020

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The International Energy Agency has switched its allegiance from fossil fuels to renewables post-covid painting a bleak picture; battery storage has hit the US$100KWH tipping point and the market can expect a rollout in 2021.

-A tale of diminishing returns
-Covid accelerates the demise
-Geopolitics favour the renewables arms race

By Sarah Mills

The momentum towards renewables is relentless. Even fossil fuels’ stalwart ally, the International Energy Agency (IEA) has switched camps post covid and long-term prospects for carbon producers seem to become bleaker by the minute.

More than 450 investors managing a collective $40trn in assets have now signed up to Climate Action 100 Plus. 

That’s $40trn in ESG funds being funnelled to the most efficient fossil fuel users and adopters of renewables to drive the transition to electrification.

Governments are also mobilising trillions of “green aid” as part of their stimulus packages.

Fossil fuel producers globally are converting to a “sustainable mantra”, with the likes of BP recently capitulating to a renewable future.

This two-part series examines the latest ratcheting up in the war on fossil fuels before drilling down to the specific fates of the coal, oil and gas dominoes in part 2.

IEA urges governments to favour renewables

The International Energy Agency (IEA) reports that covid has catalysed a structural fall in global fossil fuel demand, and coal in particular.

The IEA, traditionally a strong supporter of the fossil fuel sector, plumped heavily on the side of renewables during the crisis, and has urged governments globally to favour renewable conversion to help refire the world economy.

“The economic downturn has temporarily suppressed emissions, but low economic growth is not a low-emissions strategy – it is a strategy that would only serve to further impoverish the world’s most vulnerable populations,” says IEA executive director Dr Fatih Birol.

Only faster structural changes to the way we produce and consume energy can break the emissions trend for good.

“Governments have the capacity and the responsibility to take decisive actions to accelerate clean energy transitions and put the world on a path to reaching our climate goals, including net-zero emissions.” 

The agency also notes increased investment in renewable energy will be needed to refire the economy, just to support the oil price.

The IEA forecasts energy demand between 2019 and 2030 will decline on pre-covid forecasts of a 15% rise. 

Instead, it estimates a rise in energy consumption of only 9% or 4%; the former figure being based on a faster-than-expected shift to renewables, which it says is needed to fire economic growth. 

2020 forecasts as year draws to a close

The IEA’s World Energy Outlook 2020 report expects world energy demand will have fallen -5% in 2020; emissions -7% and energy investment -18%. Coal consumption is expected to close the year down -7% down, gas -3.3%, oil -8.5% and nuclear energy -4.6%.

Global electricity demand is only forecast to have fallen -2% on the year and renewable energy consumption is forecast to have risen 1%.

The latter trends are tipped to accelerate as the renewable energy market grows and electronic vehicles roll out. 

Electricity demand is forecast to remain strong, buoyed by renewable investment. Solar and the nuclear industry followed by wind are expected to be the main drivers.

Producers write down reserves and cut investment

Fossil fuel prices are forecast to remain under pressure, while posting intermittent spikes in volatility as a result of the recent plunge in upstream investment.

“The slower pace of energy demand growth puts downward pressure on oil and gas prices compared with pre-crisis trajectories, although the large falls in investment in 2020 also increase the possibility of future market volatility,” says the IEA.

Lower prices and downward revisions to demand, resulting from the pandemic, have cut about one quarter off the value of future oil and gas production. 

“So far in 2020, leading oil and gas companies have reduced the reported worth of their assets by more than $50 billion, a palpable expression of a shift in perceptions about the future,” says the IEA.

“Investment in oil and gas supply has fallen by one-third compared with 2019, and the extent and timing of any pick-up in spending is unclear.”

Fossil investors globally have bowed to ESG investor pressure. The likes of BHP Group ((BHP)), Woodside Petroleum ((WPL)), and BP have all communicated their acceptance of the fate of fossil fuels

Woodside Petroleum’s chief executive Peter Coleman has acknowledged that the oil and gas price slump won’t quickly reverse.

BHP has announced that it will invest $400m in sustainability initiatives, and BP has announced a pivot to renewables. 

When even oil and gas companies are adopting the mantra of sustainability: low-cost resources, low emission and diversification as key strategic pillars to woo the “best-in-class” ESG dollar, the outlook must be poor. 

Most major companies across all industries are now issuing sustainability updates in their annual reports, a sign of increased pressure upon all sectors to cut emissions.

Investors are becoming increasingly sceptical about the viability of upstream projects, increasing the risk of a squeeze in fossil fuel prices.

“Declines from existing fields create a need for new upstream projects, even in rapid energy transitions,” says the IEA.

Fossil fuel producers are banking on this, and appear to have accepted their demotion to second-port of call for the renewables revolution, their fate reduced to picking up the scraps from their rivals.

Fossil fuel competitors ramp up

The IEA World Energy 2020 report models scenarios of renewable investment and none are particularly favourable for fossil fuels.

It argues that, depending on the level of structural change, investment in renewables could propel the world out of recession much faster.

Renewables grow rapidly in all IEA scenarios. Hydropower remains the largest renewable source of electricity but solar remains the central pivot for new technology, thanks in part to access to cheap capital (via green stimulus). 

Solar is forecast to set new records for deployment each year after 2022 followed by onshore and offshore wind.

Solar PV is consistently cheaper than new coal or gas-fired power plants in most countries.

Solar plays to robust grids, which should attract an additional premium as well as supplies of resources necessary for transformation. 

India, the last great hope for thermal coal, is now the largest market for utility-scale battery storage – the writing is on the wall.

Renewables on the rise

FNArena discusses renewables in greater depth in Part 4 of this climate change series, but we provide a quick overview here of its competitive position to fossil fuels.

In contrast to fossil fuel, Kane Thornton of the Clean Energy Council points out that renewables no longer need subsidies.

IEEFA’s Buckley points to the rapid fall in the price of renewables.

“With the cost of renewable energy falling 10% to 20% each year, and given most of the costs are upfront, it appears hard to imagine a future in which fossil fuels will thrive,” he says.

And the efficiency of renewables, and solar energy in particular, is rising dramatically. 

According to Dr Philip Green, one of the fathers of modern solar cell technology, solar cells, which are already cheaper than rivals, will at least double in their efficiency. 

Add to that a forecast -20% annual decline in battery costs, increased range, and a -50% reduction in the weight of vehicles with the introduction of carbon-fibre, then oil barely appears competitive.

Batteries storage at the magic price of US$100KWH (cost-competitive with oil) is already a reality, and these batteries could hit the market in strength within a year, accelerating the rollout of electronic vehicles.

Investors are betting on not if, but when, the tipping point hits.

Buckley is not alone. Others, even from within the industry, have forecast that the renewable energy revolution could end the world’s rising demand for oil and coal this decade.  

The one wildcard in fossil fuel’s favour is the pace of the rollout of the fourth industrial revolution (4IR). 

4IR is meant to be built on a circular economy and renewable energy, however, should its demands outpace renewable supply, fossil fuels are the first port of call.

Meanwhile, the United Nations’ Sustainable Development Goals (SDGs) demand greater energy access and this should work against fossil fuels. 

Renewables offer more democratic access to energy (an SDG goal), and renewables are also the UN’s preferred supplier given its climate goals. 

Governments aligning against fossil fuels

Most of the world’s governments have committed to reducing carbon emissions. The industry had one powerful friend in Donald Trump’s United States, but the Democrat victory is expected to change that.

President Joe Biden signalled his commitment to the environment in his victory speech, and is forecast to oversee the channelling of US$5trn in subsidies to the renewables industry over the term of his presidency.

Credit Suisse points to growing evidence favouring the channeling of US$10trn in global economic stimulus towards green investment; evidence suggesting that investments in renewable and energy efficiency could be roughly three times as effective in creating jobs in the construction phase than would be the case if the funds were diverted to fossil fuels.

IRENA projects that the global renewables industry could provide 42m jobs by 2050 – nearly four times the present level.

Decarbonisation and the social investment nexus

As noted in previous articles, the climate change trend is generating an increased focus on social investing.

Rising poverty in 2020 may have made basic electricity services unaffordable for more than 100m people who already had electricity connections, and may force them back to more polluting, inefficient energy sources. 

Attempts to connect new people have already regressed since covid, notes the IEA.

This could lead to strong flows of ESG funds into green infrastructure to developing countries.

Clean air can save 12 million lives by 2030. This means renewables also qualify for the social investment dollar.

Uncertain demand estimates

The IEA is circumspect in its forecasts for energy demand this year given the covid shock, and has modelled four scenarios, which largely hinge on the rate of transition to renewables, and the speed of economic recovery, and the timing of the ends of lockdowns.

None of them bode well for fossil fuels, given the boost to the economy from investment in renewables would be necessary to underpin demand growth for fossil fuels.  

The IEA notes that a prolonged economic downturn could knock more than -4m barrels per day off oil demand.

The agency also predicts global carbon emissions from the power sector will fall more than -70% by 2040 despite a 46% jump in electricity generation over the period.

The electronic vehicle market is expected to surpass the motor vehicle market by 2030, if not beforehand.

Regardless of ESG flows, the fossil fuel industry has very little to recommend it short of government subsidies and a diminishing coterie of friends – making its prospects as an investment against cheaper renewables increasingly bleak.

Geopolitics

Fossil fuels are becoming less relevant in determining the world’s pecking order and the chess pieces are moving,

Most savvy investors are aware that an abundance of supply is being met with ever-diminishing demand as the global transition to electrification to support the fourth industrial revolution gathers pace.

Not to mention climate change fears and geopolitics.

The rise of coal seam gas globally, its relative ubiquity, and its enormous reserves have already shifted global relations in the past decade – even before renewables found their footing.

It allowed the United States to become the world’s top producer of gas and oil and bask in self-reliance (not to mention flex its muscles against petrostates Iran and Venezuela) for the first time in more than half a century.

Now it appears to be carbon-deprived China’s turn.

Analysts forecast that most devices using carbon will shift to electricity within 15 years, empowering renewable manufacturing nations, an arena in which China dominates.

“Unable to be a petrostate, it is becoming what one might call an electrostate, investing all along the chain from mine to meter,” says The Economist

“It gained this dominance through authoritarian regulation and subsidies, which enabled it to produce solar panels to feed Europe’s early demand and creating domestic incentives for locally produced batteries.

Research for China’s 12th and 13th five-year plans emphasises the need for a more flexible, reliable energy system. They directly focus on investments in advanced technologies, particularly clean energy.

While short on carbon, China houses large reserves of the resources necessary for renewable production.

The country produces about 60% of the world’s rare earths and refines more than twice as much lithium and eight times as much cobalt as any other country.

Bloomberg analysts estimate China is about 10 years ahead of the West in developing its renewable manufacturing base and technology and is heavily focused on the renewables supply chain, buying critical renewables input such as copper around the globe.

“Politicians in America, Europe and Australia have expressed concern at Chinese control of minerals critical to not just energy but defence,” says The Economist. 

The US Development Finance Corporation is, for the first time, taking equity stakes in mining companies.”

Some analysts are betting that ESG investors may prefer mines independent of Chinese control – again alluding to the potential for ESG to extend its reach into geopolitics.

Joe Biden has promised to get back into the energy arms race. Europe is also pushing ahead with renewable technology, and has two decades of solid investment in the sector behind it.

Sovereign nations are rebuffing Chinese bids to build stakes in their electricity companies.

It is in China’s interest to invest in solar companies abroad and at home, given the potential to boost demand for Chinese renewable manufacturing inputs. 

The nation is expected to invest more than US$6trn in low-carbon power generation and clean energy over the next two decades, according to Brookings, and is forecast to generate 80% of its energy from renewables by 2050.

China issued about US$25bn in green bonds for infrastructure investment in 2016. 

The Climate Bond Initiative expects this to rise to roughly US$500bn by 2030.

This is only a fraction of the US$100trn in funds expected to flow into the market. 

And all roads lead to China.

But the renewables arms race is just beginning, ungracefully shoving fossil fuels off the global geopolitical centre stage. Once the unchallenged champion of geopolitics, fossil fuels are starting to look like an also-ran.

Renewables aside, China also boasts an ambitious nuclear program, which should also reduce the world’s largest oil and coal importer’s dependence on carbon. 

The nation has been building plants faster than any country and intends to continue. China and France are in a state of constant exchange, and sometimes partnership, on nuclear technology, including fusion projects.

China is also developing a molten salt nuclear reactor that uses thorium as fuel and the Chinese Academy of Sciences says the technology is environmentally safe and cost-effective.

But it is the reliance on imports that is the death warrant for fossil fuels. 

Very few countries wish to be beholden to exporters. The world is still banging on about the oil shock from the 1970s.

In The Last Oil Shock, author David Strahan reports that Britain’s Blair Labour government was brought to its knees soon after assumption of power, as an oil shortage threatened to send the country into a state of emergency in as few as three days. The message to the government was loud and clear. 

China, notes The Economist, imports US$215bn a year and is heavily reliant on the flow of oil through the straits of Hormuz and Malacca. The nation is acutely aware of its dependence on those cargo lanes.

India, the third largest crude oil importer in the world in 2018-19 with a spend of US$120bn is equally vulnerable. 

A major consideration is simply the cost. A country like India can ill afford the bill and, despite corruption, will be doing its best behind the scenes to end the carbon impost on its economy. 

India also boasts the world’s largest thorium reserves, which it can use for nuclear energy. Thorium waste is only slightly radioactive and its toxicity ends in a few decades (unlike uranium nuclear waste which is radioactive for 1,000 to 10,000 years). It is also abundant.

China too, would not only benefit from cost savings from a shift to renewables, but given the power of its manufacturing base, could quickly dominate the renewables market, shifting the geopolitical balance firmly in its favour.

China continues to avow its demand for coal and oil imports, but if this were to change swiftly a-la the National Sword Policy on plastic, things could get ugly fast. 

No-one, not even fossil fuel producers, denies that the outlook for fossil fuels is poor. The big questions are: how poor, and which will fare better than others? We will examine this in Part 2 of the Climate Change article on fossil fuels.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

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