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Fossil fuels put on notice – the party is about to end

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The Australian and the global fossil fuel industry have been given stark warnings by two heavyweights of the international finance sector that their future will not just be constrained by political decisions to limit emissions, but by the lack of, or the high cost, of finance.

The first warning comes from Deutsche Bank, which says that China’s use of thermal coal is likely to peak within a few years, and by 2017 it could become a net exporter of thermal coal rather than a large importer.  This, says Deutsche Bank, is likely to have a significant impact on coal prices.

The implications for the Australian coal sector, and its massive expansion plans in ports, mines and rail infrastructure in Queensland and NSW – led by the likes of Gina Rinehart and Clive Palmer – is that the long term price of thermal coal will not be sufficient to make these investments profitable. They could, in fact, become the acts of the greatest futility if they go ahead.

The second warning comes from leading credit ratings agency Standard & Poor’s, which in a report released on Monday predicts credit downgrades and negative outlooks in the oil sector because of the potential carbon constraints driven by global climate change policies.

S&P says future carbon constraints need to be factored into credit assessments for the oil sector – along with uncertain future oil prices and rising operational costs – and financial models that rely on past financial performance are no longer adequate.

“By analysing the potential impact of future carbon constraints driven by global climate change policies, our study shows a deterioration in the financial risk profiles for smaller oil companies that could lead to negative outlooks and downgrades,” said Michael Wilkins, head of environmental finance at Standard & Poor’s. He says these downgrades could occur in the next three years.

S&P focuses in particular on three operators of the controversial oil sand mining industry in North America, and questions the business model of investing more capital in tar sands, noting that the companies analysed need to refinance nearly half of their $13.6 billion in corporate bonds in coming years, and may have trouble doing so.

“This research shows that credit ratings need to start looking at alternative futures, as a carbon constrained world will not see past performance of this sector be repeated,” it says.

Ironically, both the S&P and the Deutsche Bank reports came as one of the biggest oil producers in the world, Shell, delivered its own in-depth report that predicted that solar would emerge as the dominant energy provider in the world by the turn of the century.

Shell, which ironically quit the solar business a few years ago – although its Japanese offshoot Showa Shell owns Solar Frontier –  says that solar could provide between 37 per cent and 70 per cent of the world’s energy by 2100.

But even these scenarios are predicated on a world in which politicians and financiers respond poorly to the science and a world that fails to reduce emissions until the 2050s. Independent organizations such as the International Energy Agency suggest that needs to occur by 2020, however, but Shell’s optimistic view appears to be characterised by its reading (or lack of reading) of the science. It confidently predicts that emissions will not fall until the 2050s – when the link between Co2 emissions and changing climate will finally be proven.

Deutsche Bank, on the other hand, says action is quite likely, and much, much earlier. It points to the case of China where the new administration is under huge pressure to reduce air pollution levels, which have soared in the past 12 months to 40 times acceptable levels, and put the government under enormous pressure to take action.

In one scenario painted by the Deutsche Bank team led by chief economist Jun Ma, China’s imports of thermal coal would cease by 2017, nearly a decade earlier than most forecasts, and coal consumption would fall from 68 per cent of total energy consumption to 32 per cent by 2030. Clean energy consumption would grow by 12 per cent annually over 2013-2020. as more incentives were put behind solar, wind, gas and nuclear.

China, the second biggest coal importer in the world after the EU, would become a net exporter, tipping the balance in the global coal market. Deutsche Bank coal analysts say in a separate report that this would blow a hole in the global seaborne coal market and send thermal coal prices towards $70/tonne. Australia would be the hardest hit of any coal exporters because it has the highest marginal cost.

Indeed, Deutsche Bank says that even at $87/tonne, some 43 million tonnes of export production from Australia would be forced offline, and investments in Queensland’s Galilee Basin, such as the massive GVK Alpha coal mine part owned by Gina Rinehart, would be delayed. At such prices, these projects would not be profitable, and could not attract finance. It would also have significant profit impacts on current operations for Anglo American, BHP Billiton and Rio Tinto.

While Shell relies on a future scenario based on past experience, when fossil fuel giants have been able to influence global and individual country policy, the report by S&P, in conjunction with The Carbon Tracker Initiative, says that this view of the world may be no longer valid.

“Global energy use and the resulting emissions may have to change or we will have to adapt to a warmer world; arguably, it’s likely we will need to do both,” S&P notes. “As a consequence, financial models that are based on past performance and creditworthiness may not be relevant in the future.”

Carbon Tracker’s research director James Leaton  said emissions ceilings have clear implications for the future fundamentals of the oil sector, both in demand and price.  “The uncertainty around the future of carbon intensive fuels needs to be translated across credit analysis of business models going forward.”

Simon Redmond, a director in S&P’s oil and gas team, said even in the IEA’s 450pppm scenario, the outlook in the very near term for ratings changes in unlikely to be much different.

“However, as the price declines persist in our stress scenario of weaker oil demand, meaningful pressure could build on ratings,” he says. “First the relatively focused, higher cost producers, and then also more diversified integrated players, as operating cash flows decline, weakening free cash flow and credit measures, and returns on investment become less certain and reserve replacement less robust.”

The S&P report should not be seen is isolation. In January, HSBC said in its “unburnable carbon” report the market value of oil majors such as Shell, BP and Statoil were at risk because they could be forced to leave much of their resources in the ground. This message of risk, and its effect on financing, was taken up by Bloomberg New Energy Finance, whose recent conclusions that wind farms and solar farms were already cheaper than new build coal and gas-fired generation  in Australia were largely based around the rising cost of finance for fossil fuel generators, influenced primarily by carbon risk.

And in the past few weeks, investment banks such as UBS, along with Macquarie Group and Deutsche Bank have all noted how the solar industry is reframing energy markets in Europe, and beyond, and turning once profitable coal and gas fired generators into marginal businesses, and forcing many to close or to embrace a more rapid change to renewables and distributed generation.

Just last week, Duke Energy, the largest utility in the US, said the plunging cost of solar would redefine the traditional utility business. The second biggest, NRG, has already stated that solar will cause a revolution in the energy industry.

And to those miners who believe that India will remain a beacon in the fog, CLP Holdings, the Hong Kong based company that is one of the largest power companies in Asia, said it wouldn’t invest any more money in coal-fired generation in India following the disastrous results of its latest 1,200MW investment, which is losing money from lack of access to coal and poor quality supplies. It will focus entirely, it says, on renewables such as wind and solar from now on in India.

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  • Graham Palmer

    Governments don’t lead they follow and the fossil fuel industry will pump and dig till we fry. The only way change is going to happen is through the actions of banks and people acting individually then collectively in what will be seen as in their best interests.
    Bankers are at last realising there are no returns to be made in a world that goes past a point where climate is unpredictable or worse out of control. Individuals too are quickly beginning to realise that being captive to the oil and coal industries is not in their best interests either.
    Resources that the fossil fuel industry has in the ground are more than likely to become ‘stranded assets’, so why they aren’t investing heavily in renewables, which must be the only way for them to survive beyond this decade, remains a mystery.

  • John Bowman

    Happy days ‘ll be here again. The skies above ‘ll clear again. Happy days will be here again.

  • John

    At last some good news from the banks…

    • concerned

      My goodness thought no one trusted the Banks, what has happened? A sell-out?

  • http://www.dudawills.com.au Ray Wills

    Even the utilities operating the market won’t highlight the wins – Perth has had its hottest summer on record, enduring the longest streak of temperatures above 37C in its history.

    But despite the heat, power usage is down on previous years.

    Western Power have said the downturn in electricity use from increased awareness of energy efficiency and increased use of solar power. This summer’s peak demand of 3984 megawatts on 12 February 13 was well down on last year’s high of 4068MW. There were also no power outages this summer as a result of overloading.

    In fact it a lot down given in the last few years WA have opened two desalination plants – yet overall consumption in WA is stable or falling. What wasn’t said is that there are now 127000 homes with 275 MW of solar on roof tops in WA.

  • Scott

    I wish the “renewable” industry would “put up or shut up”. Yes, we all daydream of having endless energy from the sun. The problem is the renewable industry has yet to deliver sustainable energy in a cost effective manner. I suggest you stop sledging an energy source you currently cannot beat, and focus on technologies that beat it. Your fear campaign is losing as more and more data shows no global warming for the past 17 years, and that the global warming the earth is encountering is a normal cycle that occurs every 100,000 years.

    • Richard Koser

      “Scott” is wrong. 2010 was hotter than 1997/8. Anyone with a solar system should be getting a higher return on their investment than any other asset. As for the Milankovitch cycles, we should be in a gentle cooling phase of the cycle, not a rapid warming phase.

      • dmb

        scott is also wrong about the comparative cost matter. renewables are rapidly approaching parity with conventional energy sources. not to mention they’re doing so while being given mere table scraps in comparison to the subsidies that we (in the u.s.) extend to the oil giants, no matter that they’re sustaining record profit levels.

  • Observing the fossil fuel lobbyist

    I can always spot the fossil fuel lobbyists, from a mile away, or should we say form kilometer away. We changed over in 1968 and I still can’t get used to it.

  • Chris Sanderson

    Thanks Giles, bloody good and well researched article. May it all gather pace asap.

    I’m just reading Jeremy Rifkin’s new book:’The Third Industrial Revolution’ (TIR).

    What you’re saying fits in very well with the plans for TIR that his organisation has sold to the EUR.

    It’s based on a network of smart grids connected to distributed private roof top solar and wind installations.

    Thae are linked through what sounds like an internet based ‘trading system’ that takes unused capacity and sells it to the highest bidder.

    Currently, distributed excess solar capacity can only be sold to one’s existing electricity supplier. This monoloply sucks as they offer a pittance.

    I would have considered such a plan as fanciful if Australia had not already installed solar in 1.5mil homes.

    As Paul Gilding suggests in his book: ‘The Great Disruption’, once things start to move in the right direction things will move quickly……./Chris

  • Frank Zappa

    and yet:

    Maria van der Hoeven, the IEA’s executive director, said: ‘‘Coal’s share of the global energy mix continues to grow each year, and if no changes are made to current policies, coal will catch oil within a decade.’’
    The report, which predicts trends in the coal market to 2017, suggests coal demand will reach the energy equivalent of 4.32 billion tonnes of oil by that year – narrowly below 4.4 billion tonnes of demand for oil itself.
    Global coal consumption, which is measured in in tonnes of coal equivalent – the industry standard to reflect energy content rather than physical weight – will reach 6.2 billion tonnes in 2017, up from 5.3 billion in 2011.
    China’s share will rise to more than half of that, while India will become the world’s second-largest coal user.

    http://www.smh.com.au/business/world-business/coal-set-to-overtake-oil-as-biggest-energy-source-20121219-2bmau.html#ixzz2MZaD4HTq

  • Ron Horgan

    Pardon my immature sense of responsibility.

    I am composing a musical piece about world energy and trying for a harmonic picture.Coins of various denominations are falling onto a sounding board with the following results.

    The sound of money is a working title.

    The elements are as follows:

    Deutsch Clink
    S+P Clink
    HBSC Clink
    Macquarie Clink
    Duke Energy Clink
    NRG Clink
    CLP HK Clink
    Shell Plunk
    Galillee Clank
    Chinese coalImpts Clank
    Indian coal Impts Clank
    Chinese CoalExpts Ping

    Thus while there is some order its all a bit post modern Some seem to be in tune and some cracked.
    Best Wishes Ron

  • Ron Horgan

    A late addition

    IEA vavaboom!