Ten Economic Risks of Fossil Fuels

Garvin Jabusch

A train, loaded with coal, crashed into the back of a passenger train in Czechloslovakia in 1868.

Securities of fossil fuels firms, as an economic sector, may soon
be on the decline. Predictions as to when oil, gas and coal will
become a smaller part of the investment society makes into its
total energy mix in favor of renewables (such as solar, wind and
ocean energies) vary, ranging from 2060 on the long side (this

prediction from oil industry powerhouse Shell) to 2030 or
even sooner on the shorter side (as reported
by Bloomberg). But so far, markets appear to be mispricing the
risk this presents to fossil fuels companies, and their share
prices for now remain stable. In our opinion, it’s not too soon to
consider divesting from fossil fuels while one might still recover
significant value.

Coal, oil, and natural gas, though, are the main sources of
energy that have gotten civilization this far (at least since the
late 1700s, or the entire industrial revolution), so why are many
expecting them to so quickly diminish in importance? 

Mostly because of recent innovation and renewable energies’
efficiency and cost gains. Our ‘next economy’ thesis asserts that
the energy and material resources we need to host an indefinitely
thriving economy exist in more than sufficient quantities
(particularly energy), if we would only collect and use them in
smart and efficient ways. The innovations required to put world
economies on a long term sustainable path largely exist today. For
example, the various forms of solar energy collection have become
so efficient over the last 20 years that all of civilization’s
energy requirements could presently be met by covering
0.3%

of the earth’s land surface with solar panels and
concentrated solar thermal systems. Our models insist that through
promoting true sustainability solutions in materials and energy,
we can indeed maintain a healthy, thriving biosphere, all while
growing our economies and improving standards of living
potentially everywhere, for everyone.

This in mind, we put together 10 primary reasons why fossil fuels
investments, in next economy terms and indeed in general economic
terms, no longer appear to be the attractive source of
risk-adjusted returns they have historically been.

Fossil fuels are economically becoming subprime because:

1. Fossil fuels have the capacity to threaten basic
systems.

Warming and its sequelae such as severe weather, droughts,
floods, more frequent and intense storms and attendant
uncertainties all undermine our basic economic foundations. A
recent World Bank report conceded that “There is … no certainty
that adaptation to a 4° C world is possible,” referring to a
global average temperature increase of 7.2 degrees Fahrenheit from
pre-industrial times that is considered likely by scientists over
the next few decades if fossil fuels’ use is not soon severely
limited. To rephrase what this means, the traditionally
conservative World Bank believes that human economies may not be
able to adapt to a world that has on average warmed four degrees
Celsius or more. Note that the global temperature has risen
nearly

one degree Fahrenheit since 1975.

Millions of pages have been written on the underlying reason for
the unsustainability of fossil fuels. Their power to disrupt basic
climate and therefore world societies is vast, complicated and is
a topic best left to our best specialists. I suggest to the
interested reader the works of more qualified practitioners
including Dr. James
Hansen, Lester
Brown and Bill
McKibben.

2. Fossil fuel assets present abandonment risk.

Fossil fuels companies are now confronted by the risk that many
of the still-in-the-ground assets they count on their balance
sheets and/or in their future revenue projections may never be
recovered or realized. As this becomes the apparent, their asset
valuations and revenue guidance may be revealed as currently far
too high, and the values of their companies and stocks overvalued.
Citing abandonment risk, Bloomberg recently reported
that “Investors in carbon-intensive business could see $6 trillion
wasted as policies limiting global warming stop them from
exploiting their coal, oil and gas reserves.”  Carbon Tracker
reports that
“Between 60-80% of coal, oil and gas reserves of publicly listed
companies are ‘unburnable’ if the world is to have a chance of not
exceeding global warming of 2°C.”

The press down under is reporting
that “Australian based analysts at Citigroup say fossil fuel
reserves in Australia face significant value destruction in a
carbon constrained world, with the value of thermal coal reserves
likely to be slashed dramatically if governments get serious about
climate action…Fossil fuel asset owners could be best advised to
dig the resource up as quickly as they can.”

Over at HSBC they recently pushed up a similar report,
encompassing a global scale, essentially saying we can’t count all
the fossil fuel reserves on firms’ balance sheets because we
cannot burn them all and therefore “Oil and gas majors,
including, BP, Shell and Statoil, could face a loss in market
value of up to 60 percent should the international community stick
to its agreed emission reduction targets.” (As reported
by GreenBiz.com.) (I don’t believe most policymakers in
governments around the world currently have the wherewithal to
honor their various carbon reduction treaties, but I also don’t
believe that matters. Peak oil demand is upon us because the
alternatives are simply becoming far more competitive and because
awareness of fossil fuels’ dangers is rapidly advancing.)

What Bloomberg, Citi and HSBC are saying, in sum, is that
infinite growth of a known harmful asset – in this case an asset
with the ability to disrupt climate and civilization – must come
to an end, and soon.  And shares of the firms exploiting this
asset are at risk.

3. Renewables are becoming too competitive for fossil
fuels.

Forbes has

quoted Rick Needham, director of energy and sustainability
at Google saying, “While fossil-based prices are on a cost curve
that goes up, renewable prices are on this march downward.” That
pretty much sums it up. In just the last five years, solar
photovoltaic module prices

have fallen 80 percent and wind turbines have become 29
percent less expensive. Moreover, after the initial investment,
renewables such as wind and solar, having no cost of fuel, will
prove far too competitive for fossil fuels no matter how cheap
those may appear to be. Cheap fuel is still more than free fuel.

One of the first major investors to recognize this was Warren
Buffett. Via his MidAmerican Energy subsidiary, he has quietly
made Berkshire-Hathaway America’s single largest owner of both
solar and wind electrical power generation capacity. Patrick
Goodman, Buffett’s CFO of MidAmerican said

simply “we believe renewables is the better investment right
now.” Warren Buffet, who believes that once a good investment has
been identified it’s time to “back up the truck,” is showing no
signs of giving up his leader status on solar, having just begun
construction on the “largest

solar plant in the world.”

All this is happening now, today, with today’s technologies and
today’s economics. That the smart money already sees renewable
energies as more competitive long term than fossil fuels is
obvious. The ‘smart money,’ by the way means individuals as well
as institutions. Solar crowdfunding pioneer Mosaic in April of
this year sold

out the first tranche of $100 million in solar project
investments to Californians in just hours.

Further technological advances aren’t required to make renewables
competitive, but advances are occurring. Fossil fuels will
represent only a small percentage of all energy investments in
just a few years for a simple reason: few will want to invest in
the less profitable technologies of the past.

4. Fossil fuels firms are beginning to have to pay for
their externalities.

Fossil fuels companies have never had to pay for their economic
externalities such as pollution, warming, health effects and
contaminated water and farmland. There are signs that this is
beginning to change, and firms will increasingly be liable for
damages in the tens if not hundreds of billions. The highest
profile example is BP’s Deepwater Horizon spill, the worst oil
spill in U.S. history. BP has already been required to set up a
US$20 billion fund to cover cleanup and damage costs, and perhaps
far more significantly, is facing potentially “tens of billions”
in additional damage payments pending the outcome of what the Financial
Times is (in a dedicated section)
calling the “trial of the century,” now underway in Louisiana. The
FT is also reporting
that BP is facing an additional 2,200 lawsuits related to the
spill. Even if BP should prevail in most or even all of these
suits, the massive costs of these litigations will start to become
a drag on the firms’ traditionally easy profitability. Newsweek
has a longform

piece covering many details including additional BP
liabilities such as: “that BP lied about the amount of oil it
discharged into the gulf is already established. Lying to Congress
about that was one of 14 felonies to which BP pleaded guilty last
year in a legal settlement with the Justice Department that
included a $4.5 billion fine, the largest fine ever levied against
a corporation in the U.S.” BP’s continuing
potential

liabilities from this one incident, including “uncapped
class-action settlements with private plaintiffs” and “civil
charges brought by the Justice Department” and “a gross negligence
finding [that] could nearly quadruple the civil damages owed by BP
under the Clean Water Act to $21 billion,” show the danger to
shareholders. Any representative of an asset class carrying this
kind of risk can justifiably be labeled a subprime investment.

Other firms facing liability issues surrounding the dangerous
nature of their products include Chevron, which has had to abandon
Ecuador altogether to avoid paying a $US19 billion settlement
there in a “nightmare

case” that threatens to drag on around the world as Ecuador
seeks payment via Chevron’s assets in other nations.

5. Fossil fuels are likely to have to face carbon taxes.

There will be carbon taxes in many if not most countries that
will directly impact the profit margins of fossil fuels firms. The

New York Times Op-Ed framed the argument like

this:

“Substituting a carbon tax for some of our current taxes — on
payroll, on investment, on businesses and on workers — is a
no-brainer. Why tax good things when you can tax bad things, like
emissions? The idea has support from economists across the
political spectrum, from Arthur B. Laffer and N. Gregory Mankiw
on the right to Peter Orszag and Joseph E.
Stiglitz on the left. That’s because economists know
that a carbon tax swap can reduce the economic drag created by our
current tax system and increase long-run growth by nudging the
economy away from consumption and borrowing and toward saving and
investment.”

A carbon tax is good for everyone but fossil fuels companies, who
will see their profits reduced (or attempt to pass the costs on to
consumers, reducing demand for their products further). So far,
several nations, provinces and individual municipalities have
implemented a carbon tax, and many others have carbon trading
schemes (the Carbon

Tax Center is a good resource for keeping up with these).
Carbon taxes can raise revenues, shrink deficits, and move tax
burden away from citizens, all while slowing the worst effects of
warming. Look for their implementations to continue to spread.

6. Fossil fuels will soon face diminishing governmental
subsidies and benefits.

Fossil fuels have received as much as half

a trillion dollars per year in subsidies from the U.S.
alone. To the extent that austerity or desires to balance budgets,
combined with legislation to limit greenhouse gas emissions,
reduce the scale of this windfall, the seemingly easy
profitability of these companies will be undermined. This point,
as well as point five above, is more fully developed in point
seven.

7. There is growing global institutional belief that
transition to renewables solves climate AND economy.

We’ve already seen the dire warnings about warming coming from
the World Bank, and discussed the positions of Bloomberg, Citi and
HSBC. These institutions are far from alone. The International
Monetary Fund, in calling for “Energy

Subsidy Reform,” recently calculated that between directly
lowered prices, tax breaks, and the failure to properly price
carbon, the world subsidized fossil fuel use by over $1.9 trillion
in 2011 — or eight percent of global government revenues,
representing a huge drag on economies. The United States taxpayer
is fossil fuels’ largest benefactor at $502 billion in 2011. China
came in second at $279 billion, and Russia was third at $116
billion. For perspective, that $502 billion is just over 3% of the
US economy, currently being given away to big fossil fuels
companies.

The IMF concluded that the “link between subsidies, consumption
of energy, and climate change has added a new dimension to the
debate on energy subsidies.”  The IMF’s solution to both
economic and climate risk (as reported

by The Hill) is in two simple parts: “end fossil
fuel subsidies and tax carbon.”  The solution to both climate
and economy is worldwide conversion from fossil fuels to
renewables.

8. Fossil fuels are the ultimate non-circular: they’re
completely consumed upon first use, so more primary source
extraction is required.

As I mentioned above, to get global economies on an indefinitely
sustainable foundation, we need to make far more efficient use not
only of energies but also of raw materials. Fossil fuels represent
both raw resources and energy sources, and they represent the
worst of both. Smart, efficient use of materials means reusing
nearly everything at the end of its lifecycle to repurpose into
something else we need. For a thriving, sustainable long-term
economy, we need to get close to perfect recycling of resources of
all kinds so we can minimize our depletist impacts on earth and
avoid the basic environmental degradations that go along with
those.

This approach of course excludes fossil fuels and other resources
that are consumed entirely on their first use. Raw materials can
keep economies growing for a long time if we preferentially mine
our huge stockpiles of already extracted resources and minimize
extraction from primary, geological sources. But fossil fuels,
unlike materials used to make solar panels and wind turbines,
don’t work like that. Since they are consumed entirely on their
first use, reuse is impossible and we have to literally go back to
the well for more. This means ever more greenhouse gasses in the
atmosphere, ever more degrading of the local environments where
extraction takes place, ever more risk of accidents, and the
possibility of eventually exhausting the resource completely
(although on this last point I personally believe we will – for
the reasons presented here – reach peak demand far before we fully
exhaust fossil fuel reserves).

9. Distributed renewable energy grid is more secure than
traditional hub and spoke systems, even those powered by
domestic fossil fuels.

FERC Chairman Jon Wellinghoff has recently

said, “It wouldn’t take that much to take the bulk of the
power system down. If you took down the transformers and the
substations so they’re out permanently, we could be out for a
long, long time,” and “A more distributed system is much more
resilient…Millions of distributed generators can’t be taken down
at once.”

This is common sense. And short of equipping every home and
business with its own diesel or natural gas generator – which of
course would be disastrous for local areas’ air quality – fossil
fuels can never offer anything like the kind of security and
resilience that distributed renewables like rooftop solar can.

10. Renewables will counter fossil fuels’ endless ‘boom
and bust’ economic cycles.

As I’ve posted

before, the price of oil and other fossil fuels has, at
least since World War II, been the main control knob permitting
expansion and causing contraction of world economies. It’s widely
known that 10 of the last 11 major recessions were preceded by
peaks in oil prices. Rising oil prices are inflationary, adding to
the costs of almost everything from transportation to fertilizers
to plastics, and they therefore cause demand for all these
affected items to become depressed, slowing economic production.
 Renewables, relying as they do on free fuels like sunlight,
present no such economic pressures, and as they become an ever
larger percentage of our energy mix, fossil fuels’ huge GDP drag
will begin to disappear.

Conclusion                                                              

What then is the future for fossil fuels versus renewables?
Fossil fuels have already begun to rapidly lose market share. In
2012, most
new

electricity generating capacity brought online in the
United States was from renewables, and in January and now March
2013, all
new

U.S. electrical generating capacity was provided by
renewables. So where is this headed?

Image courtesy BNEF

Bloomberg New energy Finance (BNEF) has calculated

that “70% of new power generation capacity added between
2012 and 2030 will be from renewable technologies (including large
hydro). Only 25% will be in the form of coal, gas or oil.” BNEF
CEO Michael Liebreich has

said “I believe we’re in a phase of change where renewables
are going to take the sting out of growth in energy demand,” which
goes to our thesis that we can both lighten our ecological
footprint and increase our standards of living.

So add Bloomberg to the growing group of financial analysts warning that fossil fuel investments are poised
to become a bad bet. 

Citi bank, in its note about the Australian coal industry, went
as far as to warn investors that it will be difficult to extract
value from their still-in-the-ground resources as action on
climate change advances, stating, “If the unburnable carbon
scenario does occur, it is difficult to see how the value of
fossil fuel reserves can be maintained, so we see few options
for risk mitigation.” (Italics added; Source.)

Well, with all due respect to Citi, I can think of one option:
we, like Buffett and Google, can instead invest in civilization’s
non-carbon sources of power. As the IMF pointed out, the solution
to both climate and economy is worldwide conversion from fossil
fuels to renewables. This massive conversion program will lead to
powerful economic growth, less economic drag from energy costs,
higher revenue for treasuries, and strong employment drivers.

If we fear for the future, it is paradoxical to attempt to
mitigate risks by remaining invested in fossil fuels. What we do
now will bring about the future for better or worse. If we’re to
emerge from our 19^th century energy system, it must be
us, now, today, who set that emergence in motion. Leave fossil
fuels for those who prefer to look backwards.

Garvin Jabusch is cofounder and chief investment officer
of Green

Alpha ® Advisors, LLC. He is co-manager of the Shelton

Green Alpha Fund (NEXTX), of the Green
Alpha ® Next Economy Index, and of the Sierra
Club Green Alpha Portfolio. He also authors the
Sierra Club’s green economics blog, ”Green Alpha’s Next
Economy.”