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ESG Focus: ASX300, Eye On Energy Revenue

ESG Focus | Nov 16 2022

This story features WOODSIDE ENERGY GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WDS

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: ASX300, Eye On Energy Revenue (1)

The Ukraine invasion fired a focus on the energy revenue opportunity in the June half, and we examine ESG developments affecting gas and nuclear energy demand for this year and the next decade.

-Gas and nuclear benefit from Ukraine invasion
-Gas clear-cut, nuclear a bit more complicated
-Globally governments jump on board
-Litigation threats for gas and nuclear grows
-Appetite strong for green nuclear-energy bonds

By Sarah Mills

It was all about energy in the ASX300 August reporting season. 

The Ukraine invasion and lockdowns conspired to generate energy and supply chain inflation, leaving consumers and businesses to absorb the hit through higher interest rates during the June half.

Energy stocks rallied sharply (including coal companies) in response to Russia’s invasion of the Ukraine.

Carbon-free energy sources and renewables were overshadowed by the gas and coal boom but developments ticked along there as well, with $10bn of investment proposals in Australia being logged alone, which we discuss in our second instalment in this series on green energy.

Meanwhile, the Ukraine invasion conveniently gave the European Parliament just the push it needed to get the inclusion of gas and nuclear energy across the line for temporary inclusion in the European green taxonomy. 

Gas and nuclear energy will be designated “sustainable” as of January 1, 2023, but risks abound.

Europe specified the inclusion of both in the taxonomy would be for a “limited time” and has set a deadline for construction permits of 2030 for gas and 2045 for nuclear energy plants.

Products produced with gas and nuclear energy will only be considered sustainable if they replace coal generation (gas producers will also need to prove they can switch to low-carbon gases from 2035) and “do no significant harm”, which opens the doorway to a bevy of legal challenges.

The fuels can only be used in instances where economically feasible low-carbon alternatives are not available.

Large EU listed non-financial and financial companies must disclose the proportion of their activities linked to natural gas and nuclear energy, paving the way for potential tariffs when deadlines pass (or laws change).

Gas And Nuclear Energy Gain A Short Second Life

Gas and nuclear stocks, while both hardly green, technically count as green for tariff purposes after their inclusion in the green taxonomy, leaving coal as the only global fossil fuel pariah.

Big capital let the funds flow into these sectors in the June half as markets moved to redirect energy shipments to Europe, and capital expenditure plans progressed on the assumption of continued returns.

For now, demand for gas is expected to continue to be supported as the favoured transition fuel over uranium, given Europe placed taxonomy limits on the latter’s waste disposal, but this preference will likely be short-lived.

Natural gas is a relatively low-carbon fuel, producing about -60% less carbon emissions than coal. It is the cleanest burning of all fossil fuels, hence its inclusion.

Nuclear energy, while not a carbon-based fuel, produces hazardous waste, and it is likely to experience less support than gas in the short-term pending lobbying and technological developments, (more on that below) and its poor economics.

Gas projects must emit no more than 270grams of CO2 equivalent per kilowatt hour to receive the temporary green label; or annual emissions can’t exceed an average of 550kg p/kw over 20 years.

The ruling will affect EU sustainable finance legislation, including its green bond standard, which is expected to include both gas and nuclear energy.

Gas revenues stream in 

On the ASX, Woodside Energy’s ((WDS)) share price soared in the June half, well ahead of the Ukraine invasion, after the merger with BHP Group's ((BHP)) Petroleum division was announced in November, and as markets possibly punted on gas’s inclusion in the taxonomy and the likelihood of an invasion.

Santos ((STO)) fared less well, its share price also rocketing heading into the Ukraine War before beating a hasty retreat as the June half drew to a close. 

Santos announced a partnership with SKE&S and others to develop carbon capture technology, a dubious investment but, with sufficient lobbying, it may well attract large government subsidies given Labor has a majority in Parliament. 

It was a similar story for Beach Energy ((BPT)), which managed to connect the first two wells of its offshore Otway Basin to the Otway gas plant and started delivering to market. The same for Karoon Energy ((KAR)).

Strike Energy ((STX)) experienced a similar trading pattern (although it recovered) and plans to target the industrial market. The company is interesting from a zero-carbon energy perspective in that it also operates geothermal plants (more on that in our next article on non-gas revenue streams).

Meanwhile, Europe’s inclusion of gas for a limited time appears to have been increasingly unnecessary.

The International Energy Agency reports the Ukraine conflict has turbo-charged the green transition, and predicts fossil-fuel use will peak within five years, a date the IEA executive director describes as a “pivotal moment in history”.

In its World Energy Outlook 2022, the agency says global energy demand growth to 2030 will ‘almost entirely’ be met by renewables, suggesting the growth prospects for gas to be diminished post that date.

The Institute for Energy Economics and Financial Analysis reminds investors the recent military intervention behind gas-price rises is unsustainable and advises:

“Market fundamentals for oil and gas are weak because disarray within the industry and competition threatens the industry’s growth plans. For investors seeking a steady, stable investment, fossil fuels are unreliable.”

IEEFA says the investment case for divestment remains strong as a defensive move to prevent the loss of shareholder value.

Nuclear not so straight forward

According to Reuters, nuclear energy’s inclusion in the European taxonomy, while welcome, was accompanied by too many clauses to be useful to long-term nuclear investors and reflects more of a capitulation to France and other lobbyists.

While the 2045 deadline for construction permits appears to be carte-blanche for the fuel, other clauses provided serious industry challenges.

They included the necessity to use Accident Tolerant Fuel (ACT) in existing plants and Generation III new builds by 2025; and each country using nuclear energy must dispose of their low-level waste in their own countries in approved operating facilities and have a plan for high-level waste by 2050 (no rush on the latter it seems).

The former (ACT) is in the testing phase and will not be commercially available, nor certified and approved by 2024, leading observers to opine this makes it impossible for nuclear energy to meet Europe’s criteria in the near term.

The latter (own-country waste disposal) is bound to meet grass roots political opposition and could (along with the gas inclusion) dislodge green support for ESG, particularly if environmentalists perceive the net-zero narrative to be merely a whitewash to push through previously untenable green positions on gas and nuclear energy.

To be approved, the new technologies must be much more fuel efficient, designed to make accidents impossible in the event of an earthquake and other externals; must not release radioactive material into the external environment; and must never separate uranium and plutonium (to reduce the potential to create nuclear weapons). 

Nuclear activity under the European taxonomy includes research, reactor construction, and life extensions, while mining and milling, which mostly takes place outside of the EU, is excluded.

Globally Governments Up The Nuclear Ante

Britain, meanwhile, displayed great confidence in nuclear energy as a future fuel heading into Europe’s approval, co-investing in a GBP450m joint government-private sector venture to develop a Rolls-Royce small-scale nuclear modular reactor last year and asking its nuclear regulator to start approving the reactors. Approval is expected by mid-2024. 

Hence, former British Prime Minister Boris Johnson was ready and rearing after the Ukraine invasion to commit to bringing eight new reactors online within eight years so as to end its dependence on foreign energy. The Rolls-Royce-led consortium plans 16 reactors in the UK.

Johnson wanted nuclear to contribute 25% of the country’s energy power.

France has plans for 14 new nuclear plants and is restarting plants closed for maintenance. 

India has committed to build new reactors in joint ventures with companies (few companies are prepared to brave the poor economics of nuclear energy alone).

Notably, Indian energy giant Adani, which has committed to spend US$70bn within the decade to sustainable energy, has demonstrated little interest in the fuel.

Poland has selected Westinghouse Electric to build the country’s first nuclear energy reactor.

Romania is set to buy a modular reactor from the US, which could well be the first in Europe.

China plans to build 150 reactors over 15 years at a cost of US$440bn – suggesting a doubling in demand. In line with EU stipulations, it will enable China to retire its coal-fired power stations and that appears to be the deal.

What type of nuclear reactors will be built remains to be seen. The country is likely to adopt small modular reactors in the near term but has other irons in the fire.

China started its Generation IV reactor in late December 2021.

Criteria for Generation IV reactors are yet to receive regulatory approval. There are six Gen IV technologies in total, four of which (fast-neutron reactors) with closed-fuel cycles are designated for hydrogen production. 

In August, the Shanghai Institute of Applied Physics received approval to commission an experimental thorium-powered molten-salt reactor after a three-year plant construction in Wuwei City and, if successful, plans to assert intellectual property rights on the technology. 

The Wuwei reactor is the first molten-salt reactor to operate since 1969 and its success would be a triumph for China, given the West was unable (or unwilling) to successfully develop the technology.

China hopes to have its first plant running by 2030.

Under the project, all fuel salt would be discharged after five to eight years and proceed to a continuous recycling of salt, uranium and thorium, working on 20% to 80% thorium fission. If successful, it will not require water for cooling and will be operable in deserts.

Canada’s CANDU reactors can run on thorium, and a 2012 report to the United States Secretary of Energy states a molten-salt reactor using thorium has been proposed.

This year, a bill was introduced in the US Senate on May 18 to provide for the preservation and storage of uranium-233 to foster development of thorium molten-salt reactors – the Thorium Energy Security Act.

Thorium is weakly radioactive, abundant, widely available, and its adoption would seriously affect the prospects for uranium. Thorium fission is relatively safe and cheap, and its waste much shorter-lived. Its products also have less chance of being weaponised than those of uranium. 

While taking less time to build than large uranium-based reactors, the reactors still take a long time and one assumes blow-outs would be par for the course, so an immediate threat thorium is not, although some existing nuclear reactors can be adapted to run on thorium.

Meanwhile, the Ukraine War has also raised security concerns and is jeopardising critical systems at Ukraine’s Zaporizhzhia site that are intended to prevent a radiological release.

This is a first and has led some security experts to suggest countries such as the United States should reconsider selling nuclear reactors to countries that may experience a ground war or to those with a decent chance of being in an air war. 

For now, all of these concerns are falling on deaf ears. Perhaps the uranium industry is merely making hay while the geopolitical sun is shining.

To Finance Or Not To Finance Gas and Nuclear Energy

The EU ruling will flow down to the sustainable finance market.

Already, Nomura expects gas companies will use green bonds instead of sustainability-linked debt for their financing, reports Bloomberg.

While some banks, such as the European Investment Bank, are not including nuclear power in their investment policy, overall investors, including banks, appear to be champing at the bit.

The International Capital Markets Association says nuclear energy could account for more than 10% of green energy bonds going forward.

Responsible Investor quotes the CEO of ICMA Nick Pfaff: “Many investors to our knowledge are saying this [the European green taxonomy inclusion] isn’t going to change much because they have their own in-house views; they have their own exclusions list.”

Pfaff said some other investors also take a conditional view dependent on jurisdictions such as Canada and France, where nuclear energy is considered important.

Canada’s Bruce Powers recent CA$500m green bond, backed by nuclear power generation, was six times oversubscribed so at this stage, investor appetite appears solid.

This was followed by 10-year CA$300m green bond from Ontario Power Generation to refinance the refurbishment of the Darlington Power Station. 

RI says Sustainalytics views the maintenance and refurbishment of existing nuclear power plants as eligible for transition finance in areas with strong regulation and safety track record, but says new plants are not, given the time and capital intensity of projects, which carry strong opportunity cost.

But financing will be an area investors will need to keep a keen eye to as banks move to manage their own environmental risks.

Meanwhile, the uranium price rallied sharply heading into the Ukraine invasion but retreated sharply in June, partly because of monetary tightening and European speculation, before regaining most of its losses.

Back home in the June half, profitable uranium producers were well received, and August proved an excellent month.

Paladin Energy ((PDN)) jumped sharply in response to the Ukraine invasion and has been volatile since but is trading not too far from its earlier highs. 

Macquarie has raised its uranium-price forecasts for 2024 and 2025.

This suggests the sector is faring similarly to the rest of the market in a rising-rate environment. Successful producers are attracting the bulk of capital, poor performers face an unforgiving market, and start-ups and juniors are starving for capital.

For example, a recent IPO for Basin Energy bombed, and Orpheus Minerals, a spin-off from Argonaut Resources ((ARE)), is in the middle of an IPO but Argonaut has faired poorly. Relative newcomer Aurora Energy ((1AE)) also tanked this year. Terra Uranium ((T92)) was an outlier, offering a decent stag.

Unlike flagging battery-metals start-ups, uranium juniors should be less likely to benefit from a second capital tide, when interest rates stabilise. 

Legal Issues With Nuclear and Gas

There are other problems with the nuclear and gas inclusion in the European Commission’s green taxonomy, which have yet to be resolved.

Not only do they clash with other taxonomy clauses, they clash with several existing laws in various bloc countries, leaving the commission open to lawsuits. 

According to Greenpeace, several governments and organisations are reportedly planning legal challenges. 

Given Greenpeace has traded in its ships for lawyers, and given Greenpeace has publicly opposed the European Commission’s inclusion of gas and nuclear, at least one litigant already exists.

Greenpeace describes the inclusions as robbery, taking billions of dollars from renewables to be sunk into other fuels.

“This anti-science plan represents the biggest greenwashing exercise of all time,” says Greenpeace. "The inclusion of gas and nuclear in the taxonomy is increasingly difficult to explain as anything other than a giveaway to two desperate industries with powerful political friends.” 

Many climate advocates are particularly chafed over the inclusion of gas (gas is most likely to be Greenpeace's main target), which it says violates existing laws, and believe the gas inclusion was merely a concession to get nuclear energy through.

Nuclear And Gas Risks Remain

Even if nuclear and gas are included in the EU’s green taxonomy, it does not mean investors will be let off the hook.

Readership numbers for FNArena’s ESG Focus demonstrate a much greater investor interest in stories focusing on risk-management over revenue opportunities (nearly 2:1), suggesting the prospect of new gas and uranium revenue may not appear as enticing as one might expect at the headline level.

Again, investors are focusing heavily on value and risk-aversion over opportunity, thanks to higher interest rates. 

Natixis Corporate and Investment Banking reports some investors have dissociated themselves from the delegated act, creating a de facto multi-speed taxonomy.

The investment bank notes there is less common ground between gas inclusions in various global taxonomies, and that nuclear costs remain exorbitant at a time when renewable costs are plummeting.

Director of Climate Energy Finance Tim Buckley describes nuclear energy costs as crippling and says a poor track record on budget and time-blowouts make nuclear uneconomic.

“The cost of nuclear is almost always double whatever anyone estimates,” Buckley told the ABC.

“There’s not a nuclear power plant in the world, that I’m aware of, that’s been built without massive government subsidies.”

Even Britain’s smaller modular reactors (which are large by SMR standards) have required the government to stump up more than 50% of capital.

The Economist, which is pro-nuclear energy, recognises this to be the case, even for smaller reactors, and acknowledges the risk of overruns with smaller reactors remains.

Combine this with Europe's determination that gas and nuclear energy can only be used where there are no other economically feasible "green options" and both industries have an intractable problem.

Weak economics represents perhaps the greatest obstacle to nuclear energy, and may make taxonomies largely irrelevant and the longer-term future for nuclear energy in an environment of plummeting renewables prices a moot point.

But until renewables can supply reliable energy, nuclear and gas supply provide energy security and stability to the grid, so whether a disguised subsidy or not, both are likely to gain government support for at least the next five years.

Even Buckley agrees existing nuclear plants should run as long as possible, so the refurbishment market appears alive and well for now – but it is a market of diminishing returns.

Solar costs are plummeting and green hydrogen is just around the corner, all of which we discuss in our next article on ASX green energy prospects.

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