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Dig, baby, Dig! Citi says coal investments at risk

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Australian based analysts at Citigroup says fossil fuel reserves in Australia face significant value destruction in a carbon constrained world, with the value of thermal coal reserves likely to be slashed dramatically if governments get serious about climate action. It says fossil fuel asset owners could be best advised to dig the resource up as quickly as they can.

In a further sign that the idea of carbon budgets is gripping mainstream investment and business discussion, Citi recognises the potential impact of “unburnable carbon” – where decisive climate policies will force the bulk of the world’s fossil fuels to be left in the ground. It says the declining cost of renewables could have the same impact.

The Citi report – lead authored by Elaine Prior – downplays any immediate threat to these fossil fuel investments, and is warning its clients not to bail out of fossil fuel investments too early. But it concedes that half  of the value ascribed to the thermal coal assets of BHP Billiton and Rio Tinto and specialist coal miners could be lost if the world took decisive action on climate change by 2020.

Citi judges that it is unlikely the world would act in such a decisive nature that would force the world’s biggest fossil fuel companies to leave their cherished assets in the ground, but is “monitoring” developments. Ironically, it suggests investments may be equally threatened by the fact that these fossil fuels could be exploited and more warming is created.

“Unburnable carbon is clearly a risk. However, at the other extreme of the spectrum, there is the risk that the world does not successfully embark on coordinated carbon constraints,” the Citi analysts write. “In this case, key risks would be those resulting from physical climate change (eg droughts, floods, cyclones, sea level rise, melting icecaps, etc), rather than from devaluation of fossil fuel reserves. “

The conclusions of the Citi report may reflect some of the thinking going on in the boardrooms of the biggest fossil fuel companies in the world, and their strategies at influencing national and global policy development.

Citi suggests that the concept of unburnable carbon is no longer an “if”, but a “when” – so fossil fuel companies may be best advised to develop, produce and sell a significant portion of their reserves before markets are significantly impacted.

This is revealing, and underlines why the biggest policy battle going on in energy and resource markets across the world is about “delay” – the fossil fuel companies working hard to push back the development of renewables, and the environmental organisations ramping up their opposition to fossil fuel projects, knowing that they may soon be priced out of the market, even if policies do not deliver – a possibility recognised by Citi analysts (and in a previous report by Citi’s global energy team, which underlined why even cheap shale gas would not push back wind and solar).

Other organisations have written extensively about this “carbon bubble”, and there is a huge amount at stake – some $1 trillion a year in revenues by 2050 if the world diverts from what the International Energy Agency describes as business as usual to a carbon constrained world that aims to limit global warming to 2C.

Indeed, in one section of this latest report, titled “Should fossil fuel companies build windmills?”, the Citi analysts questioned the idea that fossil fuel companies should diversify into sectors such as renewable energy.

“… From the perspective of (asset owners), it is not clear to us that this is a logical strategy,” the analysts write. “Instead, it may be more sensible for fossil fuel companies to exhaust their reserves as fast as possible, and pay out the proceeds as dividends, ultimately to (asset owners).”

The analysts say the asset owners could then reinvest that cash themselves. It notes that the fall in costs in renewable technologies, particularly solar, are likely to have an impact on fossil fuel developments as well, as are unilateral national policy decisions from big importers such as China.

“In our view, technical progress might lead to renewables such as solar becoming cheaper and more economically viable than fossil fuels. If alternatives to fossil fuels are financially viable without regulatory support, this would seem to offer the best prospect of moving away from fossil fuels,” it writes. “Otherwise, regulatory measures such as global carbon constraints would seem harder for major governments around the world to establish and maintain when faced with plentiful cheap energy resources in the form of fossil fuels.”

The Citi report is significant because it is not produced just by the “carbon” specialists within the group, but draws on the input of those specialising in mining and energy industries, illustrating that the concept of unburnable carbon is seeping through to the people making recommendations about investments. Even if you agree with the Citi conclusions or not, the significance lies in the fact that fossil fuel risk is now a mainstream issue.

Citi seeks to downplay the broader impact of a severe carbon budget on the Australian Stock Market. It says that around 14.1 per cent of the ASX200 market capitalisation relates to fossil fuels, but only about 1.5 per cent relates to thermal coal production. A further 2.0 per cent is ascribed to coking coal, 7.7 per cent to oil and gas, and the remaining 2.8 per cent to other related businesses.

Specifically on Australian companies, Citi underlines the value of policy “delay” to asset owners, saying that if coal demand holds up until 2025, about 70-80 per cent of the value attributed today to BHP’s and Rio’s coal assets would have been realised.

But if the change happens as soon as 2020, only about half of the value would have been realised. If it occurs after 2030, there would be minimal loss of value.

However, for companies the size of BHP and Rio, thermal coal contributes only around 5-10 per cent of global value, so even if half the value of each company’s thermal coal was at risk under an “unburnable carbon” scenario, this would be roughly 3-4 per cent of its valuation of each company.

The impact would be more significant for “pure play” coal miners such as Whitehaven Coal. It says one third of the value of that company could be at risk.

It says those companies most at risk will be those heavily leveraged to new, long life thermal coal projects, which has interesting implications for those companies seeking to develop green-fields projects such as the massive Galilee Basin in Queensland with its multi-billion dollar infrastructure requirements (railroads, electricity and ports).

So what should asset owners and asset managers do? Apart from digging up fossil fuels as quickly as they can (see above), Citi says investors who strongly believe in “unburnable carbon” would find it more productive to actively tilt their portfolios, while accepting that this strategy also poses risks if fossil fuels are stronger for longer than they expect.

 

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  • keith williams

    OK time to publicise exactly what Citi is recommending here. If fossil fuel exploitation increases dramatically then there will be no chance of avoiding 2C or even 4C temperature rise. So basically they are advising the end of the world so that investors can make a short term killing.

    Fortunately there there may be sufficient action already to block a suicidal fossil fuel exploitation rush. China pushing renewables and capping coal use, the US shutting down 100 coal power plants and Europe and the Middle East aggressively pushing renewable energy might just make financing tricky.

    … and we need more community action to shine a light on what is being proposed here. It is working for coal seam gas.

    Scrolling through the ASX300 suggests to me that Australia is much more exposed to fossil fuel exploitation shutdown than the Citi report suggests, which is presumably why the major political parties are in denial.

  • JHM

    If your investment advisor has to warn you not to bail out of fossil fuels too fast, it’s time to get out.

    • Roger

      YES , Don’t get out yet, wait till I unload my shares first. Now we have Woodside getting out of the Kimberly Gas project ? Solar and wind are making fossil fuels look dearer for new power stations.

  • Graham Palmer

    I Hope you are right Keith Williams for what a diabolical coincidence of forces! A conservative government with an unhealthy majority will no doubt claim a mandate to do as little to combat climate change as it possibly can, while the fossil fuel industry continues its suicidal course to dig up and burn as much of their resource before having to stop.
    If history is anything to go by, humans rarely take action on signs of ecological collapse so is it likely to be different this time?
    I certainly cannot see the Liberals or Labor, for that matter, taking charge and taking action to avoid this fate since sadly both will have already held focus groups and found peoples’ concerns more likely to be ‘growing’ the economy, keeping living costs down etc and politicians will concentrate on delivering these.

    With all the knowledge at our finger tips will we be the richest, fattest, most sophisticated civilisation in history to end up voluntarily going into oblivion?

    • keith williams

      Graham,

      The Romans, the Mayans disappeared, so probably it’s our turn next.

      Perhaps the difference is that unlike the way we approach much of the technology-rich society (where we make use of knowledge of engineering to make sure buildings, bridges etc are constructed safely) in the case of burning fossil fuels and climate change those in charge of running the show just ignore the facts. (I suspect that the Romans and Mayans might have been less knowledgeable about what it was that led to their breakups.)

      Strangely it seems that most citizens accept that there is a problem, but this acceptance isn’t strong enough to lead to action to make the politicians do something about it.

      My theory is that with tea party/Tony Abbott style politics there is a complete breakdown of politics being basically about common good. The Abbott lens says that any action by the government is an opportunity to demonise and use the lowest logic to scare people from acting rationally…. maybe the end of it really is complete breakdown of society??

  • http://FacebookTwitter Ron Barnes

    TO SIMPLE.
    Don’t give up on fossil fuels yet.
    Their will always be a need for them .

    Especially in the Steel Industry, Blast furnace,s .

    Why not filter all flue gasses through lime water.
    Made from lime out of Crushed burnt limestone.
    This would remove Co2 Converting it to calcium carbonate.

  • http://FacebookTwitter Ron Barnes

    The same thing could Apply to Methane, From Garbage waste used to run Generator,s for Electric power at nigh time When no Sun is Available.

  • http://FacebookTwitter Ron Barnes

    This process is Millions of years old it in nature is What formes Stalactite And Stalagmites in caves.

    • Mr Mauricio

      Limestone

      • http://FacebookTwitter Ron Barnes

        TOO SIMPLE
        Yes Limestone.

  • Pedro Schwindt

    God knows how much of our superannuation is tied up in the fossil economy. When the carbon bubble finally bursts, how much of a hit will super take? Investing in insurance companies does not seem like a good idea either.

    I tried to find out what my super was invested in and it is pretty hard to untangle who owns what or the level of investment in companies with large carbon pollution footprints. Even reputable ethical investment super products are entangled in the fossil power industry.

    • Sam Nelson

      I have an ethical super and returns have been higher that the normal one that includes coal.
      Shift today and make a killing killing coal!

    • http://Allthingssustainable.wordpress.com Jo Lewis

      Move to Australian Ethical

  • http://www.450ppm.com.au Terry Mc

    I agree with Keith. Citi is saying look you have few choice’s lobby government and delay action while you get it out of the ground ASAP or lobby government and delay, delay, delay while you get it out of the ground ASAP. 2C or 4C would you like sugar with that? When are these people going to wake up they live here with us. They seamed to think that it will happen to someone else, thats not the way its going to pan out. CC will affect everybody equally including the people who write these reports. Would they be better off in the long term investing in renewables or killing off their current investor’s. Hmmm Have to think about that one? There are solutions this election Repower Port Augusta is on table we just have to vote for it and start a new industry and phase out an old industry before it’s to late. (About now).

  • Bob Wallace

    US coal mining companies are pushing to get a coal port on the Pacific. Their domestic markets are shrinking.

    The world is only going to burn so much coal. It takes years to build a new coal plant and many countries have decided to phase out coal, not increase use.

    The market will flood with supply and prices will plummet.

    If I had any money in coal it would have come out before I took time to write this comment.

  • Milton Catelin

    Where is there any evidence that “the fossil fuel companies working hard to push back the development of renewables”?

    Rio Tinto, Anglo American and others are Investors in renewables as well as coal and nuclear.

  • Milton Catelin

    Is poverty eradication also an issue or is global warming the ONLY challenge facing the planet?

    The IEA estimates that half the on-grid electricity needed to address extreme poverty needs to come from coal.

    Surely there needs to be a balance between the challenges we face?

    • Louise

      “Where is there any evidence that “the fossil fuel companies working hard to push back the development of renewables”?”

      Perhaps their massive PR budgets to deceive the general public.

      I for instance am not part of the fossil fuel lobby, I am not paid by anyone to write anti-fossil-fuel comments.
      I am part a the growing number of people who object to being milked for every penny and having our lungs damaged with micro particle of fossil fuel soot.

      The grass roots support for ethical and socially responsible energy management is only just starting to increase at a rapid rate.

      • Milton Catelin

        So you have no evidence?

  • Louise

    “Is poverty eradication also an issue or is global warming the ONLY challenge facing the planet?”

    If you want to eradicate poverty, then look at Bangladesh and it becomes clear that by staying with fossil fuels you are virtually ensuring continued poverty. In Bangladesh, their path to freedom is via renewables (energies). They have more than a million solar powered homes.

    “The IEA estimates that half the on-grid electricity needed to address extreme poverty needs to come from coal.”

    That is as incorrect an assumption as can be!

    I believe that the likelihood is very high that you know that the IEA is mainly funded by the fossil fuel industry.
    Therefore, it is not difficult to figure out that the IEA works for the interests of its commercial members.

    The IEA aims to promote the use of fossil fuel.
    A decrease is exactly what they want to avoid.

    “Surely there needs to be a balance between the challenges we face?”

    That is a completely false hypothesis! Could not be more wrong.

    The reason why Australia is not already 100% renewables powered is purely a political one.
    There is no other reason.

    My house produces more than 100% of its own energy.
    When my car lease expires in 18 month I will get a Plug-in-Hybrid-Electric-Vehicle, (PHEV) and that will reduce my consumption of petrol by 99% as I travel only 37km a day and a PHEV can go twice that on a single charge.

    I would not need to wait for the car to charge as the car could charge overnight while I sleep.
    By using a wireless third party charger in my garage, charging would be automatic and thus it would be more convenient to drive a PHEV than it would be driving a petrol car, as I would only need to use a petrol station once a year to fill up the petrol tank.

    In case you do not know, petrol has an expiry date of about one year, then the chemical bond starts to break down, hence you would need to empty / drive on petrol once a year to empty the tank.

    • Milton Catelin

      The IEA routinely warns against coal, has one person working full time on coal, and more than a dozen working full time on renewables. It is incorrect to say they promote either fossil fuels and particularly misleading to say they promote coal.

    • Concerned

      Louise, like you, if you are who you say, could afford to outlay the capital to achieve what you aspire to. However at this stage, it does not make economic sense.

      In the real world, very few people have the capital an opportunity to do what you aspire to.

      Therefore, your suggestions at this stage do not make sense, or are affordable.

      Inevitably, unless you have some type of giant storage facility for your generated power, you will need an outside source to backup your system.

      If you live on the coast as you say you do, the insolation is not ideal, and there are weeks of less than ideal conditions.