The Australian Coal Association recently hired some consultants (ITS Global) to review the carbon bubble thesis. For clarification, here are our corrections and responses to their output.
The two degree commitment
Our reports use this as a reference point, as it is indeed the stated objective of the international community. We respect the right of companies, investors and other parties to take a view on how likely this outcome may be. However if the market is currently assuming that the only possible outcome is that the world will go to the other extreme (ie six degrees of warming), then it is not giving sufficient consideration to any lower temperature scenario.
The implications of not achieving the two degree target
As has been widely documented by a range of institutions from the World Bank to PricewaterhouseCoopers, the social, economic and environmental impacts of global warming will have far wider and more serious consequences than tackling emissions. This would impact investments across all sectors. The Climate Institute provided their expert analysis of the current status of policies in key markets for Australian coal. The Climate Institute has also responded to the ACA’s report here.
Other factors reducing coal use, eg air quality
We are always careful to note that, whilst negotiations continue, there are already a number of measures in place that are not explicitly linked to carbon or climate change. In key markets, it is air quality that is a political issue, with health concerns over the particulates and toxins released from burning coal. The United States introduced Mercury emissions regulations in 2012, which in combination with cheap gas supplies, saw many utilities shut down coal plants, rather than pay for expensive retrofits. China is also dealing with air quality and carbon. The Deutsche Bank – Big bang measures to fight air pollution in China March 13 analysis of the winners and losers from China putting particulates standards in place demonstrates that the capital markets are starting to consider these issues. It also shows how the energy transition will produce new opportunities for those who adapt to the new context. Water availability is also a concern for power generation, which has already demonstrated its significance in Australia and India.
ITS claims that our ‘model’ ignores CCS, although do acknowledge in a footnote that our recent global report conducted with Lord Stern’s team at the Grantham Institute does address it comprehensively. Given the uncertainties around CCS, we are not going to impose a view on people as to the likelihood of coming to pass, but have provided the numbers for anyone to factor its contribution in as they see fit. Our analysis indicated that if the IEA’s idealised scenario is achieved, then CCS could extend the carbon budget by 12-14% up to 2050. This would require around 3800 projects to be delivered globally, and the finance in place to support this, compared to the 8 pilot projects currently underway. For more details see the Unburnable Carbon 2013 report.
Business models dependent on CCS
ITS feels it would be excessive for companies to explain their business model in a range of emissions scenarios. Yet they indicate that coal’s future will be secured by CCS. We believe this is surely of interest to investors, if an industry is relying upon a technology that is still far from commercially proven and widely deployable. Do companies explicitly state that their business model is dependent upon CCS or are they assuming that everything can be burnt unmitigated? We do not believe it is unreasonable for investors to have that information. It is no different to stress-testing plans against different commodity prices or inflation rates.
Misquoting the IEA
In our opinion ITS misreads the IEA’s work. For example they indicate that: “the IEA has been lead to conclude that the risk of “stranded assets” for the coal industry as a whole is limited”. Actual quotes from the IEA’ s Redrawing the Energy Climate map report indicate there is a clear impact on coal related assets, even using the IEA’s narrow definition of stranded assets:
“In our 450 Scenario, more than two-thirds of current proven fossil-fuel reserves are not commercialised before 2050, unless carbon capture and storage (CCS) is widely deployed.6 More than 50% of the oil and gas reserves are developed and consumed, but only 20% of today’s coal reserves, which are much larger (Figure 3.5). Of the total coal- and gas-related carbon reserves, 3% are consumed in CCS applications where the CO2 emissions are stored underground.”
“In our less stringent New Policies Scenario, there is higher consumption of fossil fuels but at the price of failing to achieve the 2 °C trajectory. Even in the absence of any further action on climate change, not even those allowed for in the New Policies Scenario, around 60% of world coal reserves would remain underground in 2050.”
“An additional 2 300 GW of fossil-fuel plants are either retired before the end of their technical lifetime (37%), idled (47%) or retrofitted with CCS (16%) in the 450 Scenario, compared with the New Policies Scenario (Figure 3.10).”
The IEA are only classifying assets as stranded if they don’t recoup expenditure. However for investors that may not be enough – they are expecting high returns, not just breaking even. Also this doesn’t capture the reserves which never get developed, but may currently be on the companies’ books as reserves. The Australian Climate Commission supported the view that up to 80% of reserves may need to be left in the ground.
ITS criticises Carbon Tracker for not dealing with the economics of coal. We highlight the importance of fundamentals such as the relative prices of thermal coal, where Australia is not that competitive. However, we are providing our analysis to stimulate new thinking by those who advise investors – hence the work by HSBC, Citi, Deutsche Bank and Standard and Poor’s which builds on our work. We do not presume to tell those people how to do their jobs – merely to give them questions to think about and interpret as they see fit. We agree that work needs to be done to identify the winners and losers, and that there will be different views on that. But we believe the highly paid experts in the financial community should be doing this for investors, and indeed those mentioned above already are. Directors of companies also have a duty to shareholders to explain how and why they are allocating capital on their behalf under their fiduciary duty.
Coal industry withdrawal
The largest Australian mining companies have already seen the writing is on the wall for coal – they know the maths doesn’t add up. BHP Billiton has indicated its CAPEX will decline post-2014 as no new coal projects are planned in Australia beyond those that are already underway. Meanwhile Rio Tinto has put around $3billion of Australian thermal coal assets up for sale. This is not exactly a vote of confidence for the future growth of an industry.
We have never accused the markets nor the actors in them of being irrational. We challenge some of the assumptions underlying the models, but believe the analysts come to perfectly logical conclusions based on the data and parameters they are applying. This reflects on the structural issues of the market, such as promoting a short-term approach, and defining risk as deviation from the benchmark which contributes to the market’s inability to deal with longer term risks like climate change.
Preventing a bubble
It is our recognition of how the capital markets work – prioritising short-term returns and following the benchmarks – that leads us to conclude that action needs to be taken to align the markets with climate change objectives and prevent a carbon bubble. The recent financial crisis demonstrated the market’s inability to spot these kind of risks, and the herd mentality which drew in the whole system. This is our opportunity to prevent a bubble by halting the divergence between capital markets and climate change policy. Denying that there are growing constraints on coal use around the world is exactly the kind of mentality that will create wasted capital and stranded assets.
To divest or not to divest
Contrary to the ITS report Carbon Tracker has never backed divestment as a viable strategy for the majority of investors – it is one of a number of options we discuss in our recent Unburnable Carbon 2013 report. There is a growing campaign led by 350.org which makes the moral campaign for divestment which has put the issue on the agenda of many pension funds. The detail of 350.org’s asks is actually a phased sell-down rather than an overnight sale, which is often overlooked. Industry commentators such as Jeremy Grantham have already indicated they are reducing exposure to the most carbon intensive activities of coal and oilsands. Carbon Tracker has always been focused on the financial issues relevant for investors. For example, the largest US coal mining companies lost 50% of their share value in the first 6 months of 2012. It is sensible for investors to consider whether that could be repeated elsewhere in the world.
Make up your own mind
Our global analysis and australian piece are both available on our website – we suggest you read them and make up your own mind whether coal is still a sound investment which will provide “solid long-term returns”, as claimed by the CEO of the Australian Coal Association.
Or see some other views, including from Australian investors, in this ABC news piece.
The former chair of the ACA has a very different view to the current chair: Why Coal has to go by Ian Dunlop