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Trading Lessons

The Coming Carbon Asset Meltdown

Politics / Climate Change Oct 30, 2013 - 05:01 PM GMT

By: Andrew_McKillop

Politics

YOU CAN BELIEVE AL GORE
For Al Gore and his investor fund partner David Bloodai, writing in 'Wall St Journal' October 29, what they define as “carbon assets” are headed for a bust. Gore does not say in his article that he had plenty to do with the present and growing crash of intrinsically – not basically but intrinsically - worthless assets, which I define as the motley crew of carbon finance and its related and downstream assets.


 For Gore and Bloodai, the growth of “carbon assets” - they mean all fossil fuel assets - can in several pertinent ways be compared with “investing” in subprime mortgages. They say that after the 2008 credit crisis and Great Recession, it is with hindsight ridiculous to have thought that subprime mortgages could work. The risk of giving around 7.5 million mortgages to people who couldn't possibly pay them off was somehow “not on the radar screen” of most investors at the time. Imagining that CO2 emissions would somehow cause planetary disaster by 2099, and tailpipe or smokestack emissions must be taxed to extinction, with hindsight is equally ridiculous.

Their argument for a coming carbon asset meltdown hinges on the claim that all fossil fuels will have to be abandoned by at latest 2050. They say investors have made a fundamental error by not understanding there is not a risk of global fossil fuel reserves becoming worthless – but a certainty.

Classically, risk can be priced but uncertainty cannot. When the investor “community” and their friends in government confuse the two, crisis will ensue. Gore and Bloodai make a giant stride – for their fund, we imagine – by repeating the theoretical claim of Lord Stern, made earlier this year, that “at least two-thirds” of all global fossil fuel reserves are “stranded assets”.

Stern was certainly not talking about carbon finance, CO2 emissions credits trading, tree-planting in the Gobi desert to absorb CO2, or a proposed French tax on goods transport vehicles, called the “ecological tax” in France, that supposedly would be partly used to build city center electric car charging points. Stern's theory of “stranded assets” is here: http://www.carbontracker.org/wastedcapital

Gore and Bloodai go on to offer a 4-point program for “wise investors” who want to avoid disaster.

CONSENSUS SCIENCE AND POLICY                                                                                                                      Gore won a Nobel peace prize for global warming advocacy, so we can't be surprised to hear, yet again, that increasing the world's average temperature by more than 2 degC will “likely cause devastating and irreversible damage” to the planet. Gore and Bloodai believe that the IPCC of Gore's prizewinning partner Rajendra Pachauri is on the button with its “reliable measurement” of CO2 emissions and forecasts of when we will “so easily” cross the threshold of +2 degC. We can note that if we took any notice at all of IPCC reports, their latest says decadal (10-year) warming is now set, by them, at 0.09 degC, meaning that warming of 2 degC will need well over 200 years.

For Gore and Bloodai this is “the near term”, and they cite the IEA's carbon-consicious-calculator which purports to show that two-thirds of all global fossil fuel reserves will never be used – they mean must never be used – due to warming of 2 degC being possible by or before 2045 or 2050. The logic and time gap between the IPCC and IEA is evident and massive – and is nothing to do with me.

Continuing with Gore & Bloodai's logic, they say the subprime carbon asset bubble is growing dangerously because most market participants are mistakenly treating carbon risk as an uncertainty, and are failing to incorporate it in their investment analyses. They are ignoring the crucial difference between a stranded asset, and a normally depreciating asset.

A stranded asset is one that loses economic value well ahead of its anticipated useful life. Stranded carbon assets, Gore, Bloodai and Lord Stern say, include all the fossil fuel, as well as those assets which, given their dependence on fossil fuels, are CO2-emissions intensive. This for instance means any fossil fuel-power plant or any vehicle needing fossil fuels. Gore & Bloodai also say that energy projects with the highest break-even costs and emissions profiles will be stranded first, and give their claimed two most vulnerable cases, of tar sands and coal, which in fact makes a mockery of the EROI (energy returned on energy invested) of coal projects compared to tarsand oil projects.

They also argue that government policy is either soon going to make carbon assets vulnerable to stranding, directly by way of an international carbon price, or by way of increased pollution and environment controls, water usage limits and charges, public health regulations, renewable energy mandates, and energy efficiency regulations. Investors must therefore not delay on the misinformed belief that carbon assets will only be vulnerable to stranding when a global carbon price is enforced. They claim that this decision “is unwise and increasingly reckless”.

MARKET STRANDING

Gore and Bloodai also claim that “free market forces” are already stranding the fossil fuels and their downstream and related assets. To be sure, renewable energy technologies can be economically competitive with fossil fuels in a number of countries without subsidies, but this is a very small part of the global energy system. Believing like they do that long-term pricing for electricity might intensify or at least maintain the current rate of “backing out” fossil fuels for power generation ignores the critical problems faced by power producers in almost all developed countries (see my articles on this subject). The power sector crisis in Europe is only partly due to growing renewable-source power production, but key results of this real crisis will include a cutback in long-term power contracts, increased power market price volatility, and reduced feed-in tariff subsides and support to renewable-source power.

Due to European energy transition being ahead of other world regions, the real world effect of cutting renewable energy subsidies – as in Spain – can be seen and studied by Messrs Gore & Bloodai. Renewables-intensive businesses have lost their "license to operate," thereby stranding their assets.

They of course argue that delaying action to mitigate climate change will not delay climate change itself. The relation of that decision (or non-decision) to stranding fossil fuel and fossil energy assets is not clear, but Gore & Bloodai claim there is a relation. They say that delaying the abandonment of all fossil fuels will cause a much larger stranding across all industries and all asset classes in the future.

Carbon tracking now has a stronger and somber meaning. All portfolios must be scrutinized, as Lord Stern has proposed, including equity and debt valuations, from the short-term, giving a new meaning for the term “prudent risk management”.

THE PRUDENT INVESTOR

There are four principal ways investors can handle the coming carbon asset collapse:

First, Gore & Bloodai say, investors should determine the extent to which carbon risk is embedded in their current and future investments. They say that around 10%-30% of most major stock exchange capitalizations are exposed to the coming rout. As a result, index-tracking funds are exposed and must restructure their portfolios before it is too late.

Second, corporate directors and executives must disclose their plans to mitigate carbon asset risks. Investors should ask if companies have a shadow price on carbon, and if not, why not? Investors need to know what amount of carbon the company plans to burn, and how it relates to the long-term strategic plan. Cash flow must be diverted away from developing fossil fuels, and toward more productive non-carbon uses in the context of a transition to a low carbon economy.

Third, diversify investment to opportunities positioned to succeed in a low-carbon economy. Investors should tilt portfolios away from assets with embedded carbon risks and toward assets with low or no carbon emissions. Gore & Bloodai identify “emerging solutions” such as: energy generation (solar, wind, geothermal); buildings (insulating materials, lighting, smart metering); and transport (electric vehicles, goods vehicle fleet logistics).

Fourth, although they admit it “can be complicated”, investors and companies must divest their fossil fuel assets, the surest way to reduce carbon risk. Supposedly, somebody will be there to buy the divested and soon-to-be-worthless assets, but Gore & Bloodai do not say who. Presumably Big Government will be there, to buy the useless assets, TARP-style.

They end with a quote from John F. Kennedy to the effect that the risks and costs of an audacious plan can be less than the long run costs of “comfortable inaction”. As history tells us, we can be glad Kennedy's rash and reckless action in the Bay of Pigs invasion of Cuba was followed by his inaction in the 1963 missile crisis with Russia. Otherwise we might not even be here, today, to talk about it.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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