The global energy market’s moment of truth

If you want to know what addressing climate change will really be like for business and investors, then take a look at today’s electricity and energy markets.

Driven by climate policy, technology development, business innovation, NGO campaigns and investment risk analysis, creative destruction is inflicting itself upon the sector with a vengeance – and the process has just begun.

Value is being destroyed at an incredible scale with just one example being European utilities losing $750 billion in market cap in recent years. Another is the huge losses in value for coal companies and the cancellation of a large number of new coal mining projects around the world as the forecast growth in China and India evaporates. As I argued in my last Chronicle, Carbon Crash Solar Dawn, this is not a temporary market blip but a fundamental shift. Company strategies and business models that have been working for generations are collapsing. In parallel we see the creative side of the process, with new industries being built, entrepreneurs flourishing and massive wealth being created. Now the market is working, as it should, allocating capital to the places where risk and return are best aligned. It is at once a beautiful and brutal process to observe.

This is an important inflection point to acknowledge, with significant implications that should reframe our thinking about these issues.

For a start it means, climate policy and its economic consequences have now shifted from future forecasts to present reality. This reality, with all its brutality for existing businesses, give us important insights into what to expect as the world wakes up to climate change. Business is already waking up to what that means in a market economy – creative destruction unleashed to destroy slow responders.

This suggests that traditional corporate responsibility, which argued sustainability was good for all businesses, is outmoded and not helpful. We have moved into an era of win/lose rather than win/win, and with that, sustainability is shifting from ‘environmentalists vs business’ to ‘business vs business’ as I covered in this earlier Chronicle. 

Taken together this means we need to change the way we talk and think about climate change and business. Sustainability is not good for many businesses – in fact it means they’ll have to go out of business. This is what sustainability at its core is all about – things that are unsustainable will stop.

While on the one hand this is blindingly obvious, it is a conversation many in business and politics don’t want to acknowledge. So when the previous Australian government brought in its carbon pricing scheme, it went to great lengths to argue that Australia would still have a healthy coal industry. And President Obama’s new regulations on CO2 emissions in the US power industry are likewise being positioned as being as much about health and air pollution as climate policy.

But as Michael Grunwald argues in this Time Magazine piece on “Obama’s War on Coal” – a phrase used by the coal industry to suggest this is unfair and unreasonable – it’s time to face up to the reality of climate action. It is a war on coal, pure and simple. Grunwald calls it the “just but undeclared war ”. But rather than “just” with its moral overtones, we could simply argue it is “necessary” based on any objective analysis of what’s good for the economy and for society. What is necessary is to move a range of companies out of the economy and replace them.

Coal is first in the firing line. As a major cause of CO2 emissions and with the lack of market support for Carbon Capture and Storage suggesting “clean coal” is either a delusion or at best an expensive PR campaign, coal simply has to go. That means coal companies will go out of business, and then oil companies and gas companies will follow them.

This is not a problem at all for the economy, as they will be replaced with new companies and new industries, which will create new jobs, new wealth and new innovations. But it is a major problem for the incumbents who will cease to exist and for their owners who will lose their money. Unless we have that conversation honestly and openly, we are setting ourselves up for pain and suffering we can easily avoid or at least minimise by thinking through the consequences and being better prepared for their departure.

Of course the best way to minimise the pain would be for fossil fuel companies to transition to new areas of business, to use the great wealth they have created to diversify into sustainable sources of profit. But most of them won’t. It’s not that they couldn’t – it’s just that they won’t. And it’s not just coal but also oil and gas who are, for the most part, in strong denial about what’s coming and so won’t be prepared, as well explained in this article by Giles Parkinson at RenewEconomy.

We shouldn’t be surprised. History shows how rare it is for companies to transform and survive major market and technology shifts. That’s why the average life expectancy of a successful multinational is only 40-50 years. And that’s why the financial markets – who act without ideology based on looking at the data – are rapidly responding.

They are stripping value from fossil fuel exposed utilities and the resource companies that provide their fuel. They are also downgrading credit risk, with Barclays recently issuing a warning the investors should no longer see utilities as a “sturdy and defensive subset of the investment grade universe”. The report concluded: “We see near-term risks to credit from regulators and utilities falling behind the solar plus storage adoption curve.” No doubt Deutche Bank considered these risks when they recently announced they wouldn’t consider funding a major new coal port next to Australia’s Great Barrier Reef.

So while the idea of “war on coal” is in some ways an accurate summary of the momentous threats the industry faces from a range of forces that are consciously and deliberately coming after them, we could also just see this as how markets work.

Fossil fuels provide us with energy, but they also destroy value across the economy – by driving climate change, damaging health and increasing costs for taxpayers while imposing unmanageable risks on other companies who rely on a stable climate for their business success. So the market is simply doing its job, pricing in some of these costs using the proxies of regulatory, credit and technology risk.

The market is working …. and fossil fuels are losing.