article 3 months old

ESG Focus: Energy Shock Lifts Subsidies & Taxes

ESG Focus | Jun 23 2022


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:

ESG Focus: Energy Shock Lifts Subsidies & Taxes

A senior US sustainability adviser says the Ukraine War will hasten energy production and this will require metals and materials, despite ESG mandates.

-Net-zero transition to be rethought in light of Ukraine
-Likelihood of government intervention rising
-Tax breaks for gas producers
-Expect demand for metals and materials to rise
-Nuclear is back in the mix

By Sarah Mills

US Executive Vice President for Calvert (recently purchased by Morgan Stanley) John Wilson led a roundtable as part of his trip down-under this week.

Wilson’s main message to Australian investors is that the Ukraine War has sparked a rethink of the net-zero transition amongst owners of big-capital driving the sustainability movement.

From now on better energy security will be paired with carbon reduction when it comes to determining investment decisions, explains Wilson.

“Because of the difficulty of simultaneously trying to balance the Ukraine and the transition, the impacts are obviously to the price of energy, and the costs of energy are up and are going to stay up,” he predicts.

This will have several consequences: it will hasten energy production and will require metals and materials, and possibly nuclear energy.

The potential to add nuclear back in has risen but the focus will be on cost and regulation. We envisage smaller, more modular reactors with on-site fuel storage.

While Wilson's comments appear to suggest that ESG investors are likely to support gas in the medium term, it is a bit of a moot point.

S&P Global, at its Asia-Pacific Commodities: The Short-Term Boom Versus the Long-Term Transition webinar, notes rising prices fired up by the Ukraine War (not to mention the covid recovery) means that gas producers, particularly large-scale producers such as Woodside Energy ((WDS)), will be generating sufficient cash flow to internally fund their own projects and will be less reliant on external funds going forward.

This has been accentuated by the industry's deleveraging in the past two years as producers moved to repair or reinforce balance sheets in the wake of covid.

In the Asia-Pacific region, S&P estimates producers are budgeting between 5% and 10% of capital expenditure to new projects, including traditional and green infrastructure.

The panellists believe hydrogen and nuclear investment will accelerate and that gas capex will outpace other fossil fuels.

Even coal is looking well supported given the weak net zero commitments from China and India.

As an aside, a quick survey of attendees shows 50% do not expect peak emissions to occur until after 2040. About 27.3% expect the world will reach peak emissions by 2040 and 27.8% by 2035. Only 12.3% expect peak emissions to hit by 2030.

The International Energy Agency meanwhile predicts energy investment this year will total US$2.4trn (an 8% year on year rise), including renewables, but it falls well short of what's needed to plug the supply gap as the spat with Russia continues. 

Meanwhile, the Chinese General Administration of Customs reports that China's crude oil imports from Russia have risen 55% year on year to May, toppling Saudi Arabia from its No.1 energy-supply position, as Russia discounted its prices.

Outlook For Gas Taxes

Calvert's Wilson adds the possibility of governments globally entering the energy market has increased and predicts governments will relieve gas taxes to ease prices.

This whole area is hard to pin down given transparency around taxes and subsidies is abysmal, but it appears energy producers and shareholders are likely to be the main beneficiaries of this trend at taxpayers' and non-resources corporations' expense.

For example, the UK’s Boris Johnson has already imposed a temporary 25% windfall tax on gas companies but this has been paired with extremely generous tax incentives to producers (91p for every GBP1 invested). 

All up about GBP5m in consumer savings compared to an estimated GBP15m in subsidies to oil and gas producers.

The Australian tax situation

In Australia, Wilson's reference may possibly relate to the Petroleum Rent Resource Tax of $2.4bn, which the new Labor government is currently debating increasing. (The old Liberal government recently provided a fuel excise holiday). 

Net, however, the energy sector is subsidised by the Australian taxpayer, so the only takeout from any easing in gas taxes appears to be that taxpayers will be increasing their subsidies to the sector at a time the economy can ill afford it – the nation will be paying substantially more for its energy unless the Labor government opposes global trends, the chances of which are slim.

What is stranger still is why would an easing of gas taxes be needed to fund new projects when, according to S&P, high gas prices are enabling energy producers to fully fund such projects internally?

Such Statements From The ESG Fraternity Are Telling

To anyone who has been watching developments in global markets for the past year, Wilson's statements appear self-evident, but it is good to have them confirmed by someone of Wilson’s stature within the sustainability community.

Wilson is a senior figure in the responsible investing sphere. He is a member of the US Sustainability Accounting Standards Board, which is establishing reporting guidelines for US companies, a member of the Leadership Impact Weighted Initiative Council and Calvert’s Chief Officer Responsible Investment.

Calvert has been a long-term responsible investor. The fund’s assets under management have quadrupled since 2017.

Pros And Cons for Australia

Wilsons' and S&Ps comments are at least reasonably good news for the Australian resources sector.

Even should Chinese demand slow, and a recession hit the West, demand should continue apace for energy derived from secure countries for multiple years.

Even were the Ukraine War to end, the message appears to be that energy security will remain a priority for big capital, and this will result in a significant reshuffle and re-investment.

On the one hand, the Australian economy should benefit from a potential influx of capital into its economy, with both brown energy producers and green commodities producers likely to benefit if, as Wilson predicts, the net-zero theme and the energy security theme continue to run in tandem for the next few years.

On the other hand, for the broader Australian tax-payer base and corporations and businesses outside of the resources sector, the outlook is less rosy, as government tax breaks to producers would mean Australians and Australian businesses are essentially funding the Ukraine War, not to mention the transition.

The prospect of a gas-tax holiday for producers, while good for resources companies, is disappointing for other sectors, businesses and consumers, who might have been hoping for the implementation of a national reservation scheme with significantly lower capped prices. (Although it is possible Wilson’s prediction of easing global taxes may play out differently in Australia – certainly Queensland's shock imposition of coal tax provides hope).

Tax breaks, which would drain funds from other government investment, are likely to place further downward pressure on the economy just as interest rates are rising, money supply is tightening through the repo market as covid stimulus unwinds, and as companies transition their energy requirements.

If tax breaks were issued in return for a share in the company via a placement, it might be a different question (although the wisdom of building an exposure to potentially stranded assets is questionable).

Right now many voters might be looking back at former Prime Minister Gough Whitlam's bid to nationalise Australia's resources and be ruing his dismissal.

Also it is difficult to justify tax cuts to encourage investment when S&P Global is predicting the oil price will fall to US$85 a barrel in 2023 and US$65 a barrel by 2024. Gas prices are likely to be a bit more intractable but how long is the Ukraine War expected to last?

Meanwhile, higher gas prices would surely expedite investment in greener alternatives. And as now noted thrice – S&P expects the energy producers will have sufficient cash flow to fund their own projects, so why cut taxes?

Transition – What Transition?

ESG isn't just about jobs and economic growth. It's supposed to be about the environment.

To an extent, the Ukraine War has made a farce of the ESG movement.

That big capital was not prepared for the chance of war (which one assumes all governments and owners of capital should include when planning a transition of this scale) beggars belief. 

To many, it's starting to look pretty much like business as usual and ESG is shaping up as a resource-predators' ball – a ruse to allow more gas and coal mining and other polluting forms of mining such as lithium (under the cloak of climate change) that would otherwise have struggled to have gained approval. 

There is a growing schism between environmentalists that support the push to renewables at any cost to the environment, and those that urge more environmental solutions over growth-driven business-as-usual solutions.

The latter would find the suggestion of easing taxes on fossil fuel companies to fund yet more fossil fuel investment an impossible pill to swallow. They may yet find agreement from many in the former category, potentially causing the two camps to reunite.

Meanwhile, the Queensland government is having none of it and has just proposed a shock sliding-scale royalty tax of up to 40% tax on coal exports. 

This will be a real test for the Labor government's green credentials, not to mention its independence from big capital. 

Given the newly elected Labor Party conveniently holds a Federal majority, one suspects supplication to global edicts may well be a fait accompli.

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:

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms