Like it or not, the market is pricing carbon. When UK Bank of England governor Mark Carney warned last month that “there have already been a few high profile examples of jump-to-distress pricing because of shifts in environmental policy or performance” he was not just hysterically echoing the drumbeat of famous environmental thought leaders. He was reflecting the increasing reality of a disorderly capital flight from coal firms in the United States.
Bond holders for Alpha Natural Resources and Arch Coal Inc. had already learned the hard way that carbon risk can transform a risky, but high yield transaction into an illiquid loss of value. But there are signal that markets are overly willing to distress coal burning assets. The problem with this disorderly de-capitalization of coal is that in the physical world, electricity generated by coal is still needed in the immediate term.
Earlier this autumn, Citibank published an essay entitled “Time to Price Carbon: Obama’s Clean Power Plan Alters Energy Landscape” in which the firm’s commodity analysts argued that financial markets “should start factoring in ‘shadow carbon prices’ into investment decisions starting today. I would argue that the market already has done so, and in fact may be overcorrecting on time scale as investors retreat en masse from assets that could potentially get stranded in the future.
In the early days of the Clean Power Plan, the marginal cost of abatement will likely be determined by the costs of switching from coal generation to natural gas. Citibank says in the near term, assuming a $3.50 MMBtu price at Henry Hub which could prove high, the shadow price for carbon in the United States would be roughly $14 a ton, in line with California’s cap and trade prices which have fluctuated between $11 a ton to $23 a ton. The high in the European Union’s cap and trade market was 30 Euros a ton.
The tragedy of coal’s illiquid bonds is a warning for the rest of the energy world. Giving long winded speeches about the long time horizon for an energy transition will not eliminate the risk to the oil business from a disorderly decapitalization over time. Even oil producing countries may some day find it harder to identify takers for national debt. While it is true that there are easy substitutes for generating electricity from coal and not for oil use in transportation, the transition time away from the coal industry is still years away. But the last year or two are demonstrating clearly that markets will begin discounting a future loss of value rapidly.
Some companies such as ConocoPhillips and Statoil are pro-actively adding carbon scenarios to corporate planning activities to ensure their company is properly positioned to adapt to regulatory and market changes. In the case of Statoil, this exercise has resulted in the creation of a new energy division. In the case of ConocoPhillips, the firm has been shedding high cost, far flung assets in Kazakhstan, Alaska, Western Canada and even deep water assets in Nigeria and elsewhere. This summer the company announced it was shifting away from deep water exploration to cut costs and increase capital flexibility.
Clearly, it is hard to project a transition away from oil in transportation use in real terms. But it is not hard to craft a realistic scenario where accelerated interventions by government, automotive technology breakthroughs and cultural shifts in attitudes towards mobility might put a larger than expected dent in the level of demand growth needed to support current stock valuation of long asset companies. Our recent study shows that concerns about unburnable carbon have led to an aggregated loss of over $23 billion to oil and gas stocks since the first stranded assets science was published in 2009.
As the industry reassesses its lobbying strategies ahead of the Climate meeting in Paris later this year, it might want to rethink its approach. Denial and lawsuits against regulation have not served the coal industry and their shareholders well. Given that a shadow price for carbon is already upon us, a new approach is clearly needed.