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Research firm Corporate Knights revealed that the pension fund would be $22 billion richer had it divested from fossil fuel stocks in 2008. That’s almost $20,000 for of each of the pension fund’s 1.1 million members & retirees.

A new in-depth analysis by the research firm Corporate Knights, shows that New York State pension fund would be $22 billion richer had it divested from fossil fuel stocks 10 years ago. That works out to almost $20,000 for of each of the pension fund’s 1.1 million members and retirees. To perform their analysis, Corporate Knights looked at the stock holdings of the pension fund in every year between 2008 and 2018.

These shocking numbers come on the heels of recent WNYC which revealed that the top pension official, Chief Investment Officer Vicki Fuller, took a $275,000+ job with the Williams (NYSE:WMB) pipeline company just one day after she quit working for the state. She did this after advocating against divestment by the state pension fund for years and while doubling the fund’s investments in the Williams pipeline company to $160 million. Williams is trying to get two fracked gas pipelines built in New York State. More than 30 organizations have asked the New York State Ethics watchdog to investigate this conflict of interest.

It’s abundantly clear we need to get fossil fuels out of politics in New York and also out of the state pension fund.

By refusing to divest from fossil fuels, the New York state comptroller Thomas DiNapoli, who has ultimate authority over the pension fund, has chosen to be on the wrong side of history, and it’s costing New Yorkers billions in foregone profits. The money the state could have earned by divesting a decade ago would have covered more than 25 percent of the costs from 2012’s climate change fueled Superstorm Sandy.

Fossil fuel companies are driving the climate crisis. And investing public funds in them is not only morally wrong, it doesn’t make financial sense. For years, experts have been ringing the alarm bell on the growing financial risks of coal, oil and gas companies.

While Comptroller DiNapoli has chosen to spend his time ‘talking’ to fossil fuel companies like Exxon, other jurisdictions, recognizing the risks and their fiduciary duties, are moving forward with real climate actions like divesting. New York City, for example, announced in January, its commitment to divest its $200 billion pension funds from fossil fuels and more recently promised to invest $4 billion in climate solutions like renewables. That’s real, financially sound, climate action and much better than talking to and investing in Big Oil companies.

If New York City can do it, New York State can too.

As we face down the next storm and as sea levels rise, our state needs to do more to protect the futures of New Yorkers. It’s important that the state take action on climate at all levels, including getting fossil fuels out of the state pension fund.

This article was first published on the Fossil Free NY Blog.

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by Helena Tavares Kennedy

The seasons are changing in many parts of the world right now, but what really is changing this autumn is how the world is looking at renewable diesel. Phillips 66 and REG’s announcement about a new renewable diesel plant on the U.S. West Coast planned for 2021 comes after a notable increase in refineries that are being converted and changed over to renewable diesel. Change is good, especially in this case.

As Bob Dylan sang, “For the loser now, Will be later to win, For the times they are a-changin’.” And who knew he was singing about the RFS and biofuel economy before it even existed with “There’s a battle outside, And it is ragin’. It’ll soon shake your windows, And rattle your walls, For the times they are a-changin’.”

Maybe Dylan’s song is playing in the corporate offices of Texas-based Phillips 66 (PSX), a former petroleum focused energy company, as they see the value of change by partnering up with one of the largest producers of advanced biofuels – Iowa-based Renewable Energy Group (REGI, a.k.a. REG). While it was over a year in the making, they announced last week that planning is underway for the construction of a large-scale renewable diesel plant that will utilize REG’s proprietary BioSynfining technology for the production of renewable diesel fuel.

Planned feedstocks include a mix of waste fats, oils and greases, including regionally-sourced vegetable oils, animal fats and used cooking oil. If approved, production at the new facility is currently premised to start in 2021.

Location, location, location

The new facility would be constructed adjacent to the Phillips 66 Ferndale Refinery in Washington state. The Ferndale Refinery is a perfect spot with existing infrastructure, including tank storage, a dock, and rail and truck rack access and happens to be a hot spot for this type of project with a Mercurius biorefinery nearby.

“The proposed facility’s strategic location in Washington state would enable us to move renewable fuels more efficiently to support West Coast and international fuel market demand,” said Brian Mandell, senior vice president, Marketing and Commercial, Phillips 66.

“REG is excited to be working with a leading refiner, Phillips 66, on a project that has the potential to significantly expand biofuel production in Washington state and provide low carbon fuel markets with products that are in significant demand on the West Coast,” said Randy Howard, CEO of REG. “We look forward to working with state and local stakeholders to facilitate development of this important project and increase the supply of low carbon fuels in the region.”

Transformations abound

Phillips 66 isn’t the only one converting from petro-based diesel into biodiesel. Several others are keeping up with the changing times and moving towards more sustainable diesel.

In fact, World Energy announced a $350 million investment over the next two years to complete the conversion of its Paramount, California facility into one of the cleanest fuel refineries in the world, as reported by The Digest in October. The project will enable World Energy Paramount to process 306 million gallons annually. The conversion to renewable jet, diesel, gasoline and propane will reduce both refinery and fuel emissions while supporting more than 100 advanced, green economy jobs.

“This project will transform the Paramount facility into California’s most important hub for the production and blending of advanced renewable fuels,” said Bryan Sherbacow, Chief Commercial Officer of World Energy. “This investment will better enable us to deliver much needed low-carbon solutions to our customers. Importantly, with 150 million gallons of annual renewable jet production capacity, World Energy will be able to help the commercial aviation industry combat its greenhouse gas emissions.”

Another conversion is underway by Andeavor (now joined with Marathon as of October 1^st and known as Marathon Petroleum Corporation (MPC)). As reported by The Digest in August, Andeavor is converting the North Dakota Dickinson Refinery to process 12,000 barrels per day of renewable feedstocks, including soybean oil and distillers corn oil, into renewable diesel fuel. The project is expected to be completed in late 2020 and is subject to permitting and regulatory approval.

ENI (ENI.MI) is another petroleum company that switched to renewable diesel. While it still is an oil and gas company, Eni expanded into renewables with its Venice biorefinery in Italy a few years ago which was renovated by UOP to produce renewable diesel. Eni is even supplying the city of Venice and their waterbuses with its E15 Eni Diesel+ which is part produced from UCO collected in the city.

Eni must be doing something right in the renewable diesel space since the Indonesian government is now collaborating with ENI to see if it’s feasible convert Pertamina’s Plaju and Dumai refineries into biodiesel production facilities, as reported in The Digest in October. Both refineries were built in the 1930s with refining capacity of 133,700 bpd and 170,000 bpd respectively. Conversion of refining production capacity into biodiesel production is becoming more common in Europe with both ENI and Total having done it or are currently in the process of doing it, such as Total’s La Mede refinery in France.

Neste (NEF.F, NTOIF) is expected to decide by December as to whether or not it is sticking to an internal deadline of December to make its investment decision about the potential new aviation biofuel production facility in Singapore. As reported in The Digest in October, the company already produces biofuel in Singapore but increased demand for renewables spurred by the most recent IPCC report and Norway’s 0.5% aviation biofuel mandate has given further impetus to the project that the company has already spent “tens of millions” developing.

In November 2017, the Digest reported that Valero (VLO) and Darling Ingredients (DAR) were looking at doubling Diamond Green Diesel production from 275 million gallons to 550 million gallons at the DGD facility in Norco, Louisiana. Why? They are looking into the future through their crystal ball…in anticipation of growing demand for renewable diesel due to the RFS and global low carbon markets. This comes on the tail end of their most recent expansion where they went from 160 million gallons of renewable diesel to 275 million gallons in annual production capacity. Though they had to replace a catalyst that was damaged recently which will lower 3^rd quarter projections, they expect to go back to 275 million gallons rated capacity very soon.

LCA of renewable diesel

Renewable diesel is a low carbon and low sulfur fuel, making it an attractive investment for any company looking to lower their carbon footprint, whether it’s because shareholders are pushing for it, local or state mandates are demanding it, or consumers are requesting it.

If you aren’t convinced about renewable diesel’s environmental benefit, a recent LCA study showed that biodiesel reduces GHG emissions by 72% including ILUC. As reported in the Digest in January, the Argonne National Laboratory, Purdue University, and the U.S. Department of Agriculture (USDA) study represents the most up-to-date and comprehensive lifecycle analysis of biodiesel ever produced. This study represents the first time Argonne National Laboratory has published a lifecycle assessment of biodiesel including indirect land use change (ILUC).

The more the models reflect real world data, biodiesel’s benefits become even clearer. The improved model reduces ILUC emissions by more than 30 percent relative to the score adopted by CARB in 2015. Those are some impressive stats that can tempt any petroleum-based company to switch at least some of their facilities over to biodiesel. Add the fact that it is a drop-in fuel and you’ve got a win-win situation.

What does this all mean?

By our estimates, we are talking about more than 1 billion gallons being converted recently from traditional diesel to drop-in renewable diesel out there, and with California’s mandate as well as others internationally, the demand alone for road transport, not counting jet fuel or marine and shipping fuel is significant. The demand is there and now it looks like the production is starting to catch up to meet that demand. More renewable diesel is still needed, however, so we anticipate seeing more announcements for renewable diesel expansions, new constructions, or conversions from petro-based diesel to biodiesel. After all, the times are a changin’.

Helena Tavares Kennedy is a writer for Biofuels Digest, where this article was first published.  Biofuels Digest is the most widely read  Biofuels daily read by 14,000+ organizations. Subscribe here.

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“The global economy likely faces an economic crash of horrible proportions in 2020, not for want of a nail but want of low-sulfur diesel fuel,” writes renowned energy analyst Phil Verleger in a note this month titled “$200 Crude, the Economic Crisis of 2020, and Policies to Prevent Catastrophe”. Not good timing for a White House re-election effort if, as expected, the blame falls on lack of preparedness in the 2017-2020 run-up to the projected crisis..

It’s a dire scenario but there’s hard data behind it, and though few go as far as Verleger, almost every expert is warning of a low-sulfur diesel; refining capacity crunch. You can read the Verleger note in full here.

The root cause? A rule agreed by the  International Maritime Organization in 2008 and confirmed in 2016 to reduce sulphur content in marine fuels from 3.5 percent to 0.5 percent beginning in January 2020.

The proximate cause? Neither shipping owners nor oil refiners found a way to comply either through fuel-switching, crude-switching to bring in less sulphur-laden “sour” crudes, or to add enough refinery equipment to remove sulphur.

As the National Biodiesel Board’s Technical Director Scott Fenwick told The Digest:

The IMO (International Maritime Organization) has set new sulfur specifications for all marine fuels to not exceed 0.50% sulfur by the year 2020.  Right now, vessels are able to use high sulfur fuels in international waters but must use the same fuels within coastal waters (up to 200 mile radius) in what are called ECA (Emission Control Areas).  Typically, marine vessels use the dirtiest fuels available.  In order for ships to meet these new criteria, significant amounts of ULSD (ultra-low sulfur diesel fuel) will be need to be used for blending or in place of typical marine fuels.  Biodiesel is another option for blending.

NEXANT’s Ron Cascone added:

Instead of “playing checkers” with refinery modifications or scrubbers for a short term fix, we should be “playing chess” with low-sulfur, low NOx, and low-carbon solutions like biofuels or  methanol, LNG,  or DME, which can be bio-based. The stakeholders needing to examine strategies in this area include, besides the refiners, fuel brokers, and ship owners, also companies that use ocean shipping (that is, nearly all manufacturers, retailers, etc.)  and have commitments to lowering carbon footprint  (that is, many companies).

Why were refiners and shipping companies caught flatfooted?

There was an expectation that everyone would kick the can down the road, and extend the deadline to 2022. But the deadline was not extended.

Why can’t the US and others simply frack their way out of a supply problem, as in the past?

It’s not something you can frack your way out of. It’s not only about crude inventories but about low-sulphur refining capacity.

Tough timing for a shortage

The shift in demand — 2 million barrels per day — comes at a time when global diesel demand for road transport and other uses is on the rise. The resulting shortage of low-sulphur diesel leads to the bid-up in “light sweet” crudes and a shift to producing more diesel and less gasoline from those crudes — and the price increase that facilitates this supply and demand shift is in the $160 to $200 range. Enough to tip the global economy into recession or depression, says Verleger.

As Verleger points out, there’s already a world commodity except perhaps wine that has so much variance, and especially so in sulphur content. As Verleger notes, “the diesel fuel produced from Nigeria’s best crude oil has a sulfur content of 0.13 percent when refined, while the diesel refined from Middle East light crude oil, one of the most common crudes, contains 0.53 percent. The Arab Heavy crude that generally upticks in supply to meet demand increases contains between 1.8 and two percent sulfur. Shale oil from fracking operations is loaded with sulphur — so it is not a case where fracking operations will necessarily save the day.

So, the swing producer necessary to moderate prices when demand shifts is going to be hard to find, despite the fact that, as Verleger notes, “the public-health arguments for the IMO 2020 rule are incontestable and compelling,” and the refiners and shipping owners have had 12 years to make ready.

The impact?

Verleger writes: “The crude price rise will send all product prices higher. Diesel prices will lead, but gasoline and jet fuel will follow. US consumers could pay as much as $6 per gallon for gasoline and $8 or $9 per gallon for diesel fuel.”

Will compliance be forgotten? Can the world simply embrace sulphur-laden marine fuel forever?

IMO’s secretary-general Kitack Lim told Platts recently: “At this point, the regulation which brings into force the 0.5% limit in sulfur in fuel oil from January 1, 2020 cannot be changed from a legal perspective, so there is no possibility of delay.” As far as individual countries simply ignoring the requirements for operating with low-sulphur fuels, it’s worth noting that the predictions for $200 oil do not relate to low-sulphur oil, but all oil.

Mitigation steps that might be taken

There are several options, although installing equipment faster at global refineries does not appear to be one of them. Fuel-switching to liquid natural gas is one. Adding sulphur-scrubbing equipment to ships is another (unlikely). Re-visiting the rule is a third, and very unlikely — the IMO recently voted 171-3 to reduce greenhouse gas emissions. The US could release light sweet crude from the Strategic Petroleum Reserve. Non-compliance is a risky option — shippers that violate the rule are likely to have their insurance invalidated, based on recent IMO moves.

The biofuels option: biorefining capacity eases the oil refining strain

As Fenwick told The Digest. “Biodiesel will play a role, whether it is on the ship, or backfilling the low-sulphur road transport volumes that are diverted from traditional oil refineries to serve the new demand for low-sulphur marine fuel.” Already biodiesel and renewable diesel have extended the global refining capacity and fuel supply by 4-4/12 percent. There’s an opportunity to step up here to supply more low-sulphur fuel, and it is estimated that one billion gallons per year could be added to the supply of low-sulphur fuels./

As we reported in March 2017, the International Standards Organization has created the new F class of marine fuels that allows for blending of up to 7% of FAME biodiesel, allowing for more 10 ppm sulfur automotive fossil diesel to be used in the marine fuel pool. Adding Cloud Point and CFPP (Cold Filter Plugging Point) to the specifications are meant to help increase the uptake of biodiesel in marine fuels by letting operators know when fuels need to be heated.

Fenwick commented, “A few years ago there were no grades. Those grades are minimal demand right now as shippers become used to them. I expect they will become significant in the next two years.”

And, there’s renewable diesel. Although production quantities are small, so far, in the context of the global marine trade, $160-$200 per barrel low-sulphur crude prices will shine more attention on sulphur-free biodiesel and renewable diesel. For example, a 7 percent biodiesel blend with Middle East light crude oil (0.53 percent sulphur), brings that fuel into compliance. And there’s reason to cheer on that score.

An an Exxon Mobil found in a study on marine biodiesel:

The results obtained during the biodiesel trial have shown no negative impacts. Biodiesel has been used for many years in similar engines in land-based applications with no adverse effects. Biodiesel blends (B5 and B7) can be utilized in the marine environment onboard a properly operated and maintained vessel with a diesel engine. As with any fuel, proper storage and handling are key in maintaining fuel quality to ensure trouble-free operation.

How much excess capacity is available?

The estimates we have received suggest that as much as 1 billion gallons per year in excess capacity is in place around the world — or 65,000 barrels per day. Enough to support 7 percent blends of one million barrels per day. And, when you think about it, global biodiesel and renewable diesel could all be put to use in supporting a transition to low-sulphur fuels — and with as much as 4 billion gallons of capacity, there’s enough to support the 2 million barrels per day volumes that analysts say are needed — at 14 percent blends. That supports compliance via all that Arab Heavy .

Combined with some fuel switching to LNG, and targeting the right crudes for expanded diesel supply — we might find that global recession might well be averted. And, should actions not be taken to bring a supply of biodiesel and renewable diesel into marine fuels — we might find that $9 per gallon US fuel prices might well provide the incentive necessary to re-invigorate the discussions around alternatives.

Who is impacted?

Companies like REG [REGI], World Energy, Diamond Green (the Valero-Darling [DAR] Joint Venture), Ensyn, Gevo [GEVO], Fulcrum BioEnergy, Red Rock Biofuels — all of these are in the conversation when it comes to expanding diesel capacity. And a host of smaller biodiesel producers in the US, across the Americas and in Europe and Asia. Also, think DME – such as Oberon Fuels.

What can Congress do?

Distribution of this Verleger report on Capitol Hill might help. Experts tell us that ‘anything that educates the Congress that petroleum is a global market with a global price is a good thing. Also, the US government might well mandate more biodiesel to make sure those backfilling volumes of ULS diesel is available for road transport.

NBB’s Scott Fenwick observed, “Congress did create the RFS to extend and expand the nation’s refining capacity – and with low carbon, low sulphur technology in mind. They could not have foreseen this particular supply crunch but they did prepare us for a crunch with the RFS

Further reading

Here’s a relatiovely definitive report on the topic from NEXANT:

PERP 2017S7: Technologies to Meet New Bunker Fuel Specifications.

Bio-methanol  is covered, along with other feasible bio-bunkers in Nexant’s recent report, Biorenewable Insights: Biofuels for Land and Sea.  This report presents technoeconomics for a very wide range of land and marine biofuels . The TOC is here and the abstract is here.

And, could bio-methanol be a significant player in marine fuels in the future? The Methanol Insitute believs so, and here’s their latest deck exploring the options and opportunities.

In addition, for Nexant’s somewhat more conservative counter-view to Verleger’s, see the TOC for Petroleum and Petrochemical Dynamics, Refined Products, December 2017.

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by Garvin Jabusch

Sempra Energy’s leaking gas field in Porter Ranch, CA, near Los Angeles, has been making national headlines recently, as it now enters its third month of being the largest methane leak in U.S. history. How big is that? The LA Times says that, “by early January, state air quality regulators estimate, the leak had released more than 77 million kilograms of methane, the environmental equivalent of putting 1.9 million metric tons of carbon dioxide in the air.”

1.9 million metric tons of carbon dioxide and counting. In addition, methane isn’t only a powerful greenhouse gas, it can have health consequences for those exposed. In reporting that California Governor Jerry Brown has formally declared the leak an emergency, the New York Times on January 6 wrote that, “already, more than 2,000 families have left this affluent suburb because of the terrible smell and its side effects, which include nosebleeds, headaches, dizziness and vomiting.”

What does it all have to do with investing? It tells us more than you might think, and it speaks volumes about how many investment managers think about the idea of a sustainable economy, and also about the limited tools they have to construct a portfolio that reflects actual long-term viability of the global economic system. As economist and sustainability expert Ken Coulsen tweeted recently, “I thought the idea in #trading was to ask ALL the [questions] – most investment groups refuse to go deep on the intersection of #science [and] #economics.”

Coulsen’s right. Investment managers are supposed to be assimilating all the risks, so why do some have a blind spot when it comes to natural gas and other fossil fuels? Part of it is inertia, a sense that doing things the way they’ve always been done must be “right.” Part of it is ideological and a tribal affiliation among some institutions and investors who resist the idea of an economic switch to renewables as simply contrary to the way they view the world.

The fact that Ted Cruz, a  leading  GOP candidate for the U.S. presidency,  recently described  signatories to the COP12 agreement as, “ideologues, they don’t focus on the facts, they won’t address the facts, and what they’re interested [in] instead is more and more government power” tells us all we need to know about both the  politics involved and the power of Orwellian rhetoric in claiming truth in the opposite of reality. 

Finally, the standard tool kit used by most portfolio managers, collectively called modern portfolio theory, doesn’t particularly allow one to attempt to look forward in assessing risk, basing almost all such calculations on the way stocks and groups of stocks have performed historically.

In any event, Sempra’s utility SoCalGas didn’t think too much about the risks, and neither did a lot of energy investors. SoCalGas/Sempra, as reported by Newsweek, had not installed a “subsurface safety valve that was found faulty and removed in 1979but never replaced, because the well was not close enough to residential areas to necessitate such a valve. [Rodger] Schwecke, the SoCalGas vice president, says he does not know why the valve was removed and never replaced, but he downplays the ability of a subsurface valve to stop a powerful leak like this one. “It wasn’t a requirement,” he says without much contrition.”

Zero Hedge reports that, “The Company Behind LA’s Methane Disaster Knew Its Well Was Leaking 24 Years Ago,” and yet the firm was still considered an upright corporate citizen, among the finest and safest of our fossil fuels firms. Many money managers did not perceive a risk. According to StreetInsider.com, on October 30th eight days after the leak was detected, “Standard & Poor’s Ratings Services affirmed its ‘BBB+’ issuer credit rating (ICR) on Sempra Energy (NYSE: SRE) and our ‘A’ ICRs on subsidiaries San Diego Gas & Electric Co. (SDG&E) and Southern California Gas Co. (SoCal Gas). The outlook remains stable.”

Then, on November 16, seven weeks after the world became aware that the leak had begun, the company itself announced that, “Sempra Energy (NYSE: SRE) has been selected for the S&P 500 Climate Disclosure Leadership Index in 2015. The S&P 500 Climate Disclosure Leadership Index lists the top 10 percent of companies within the S&P 500 Index for the depth and quality of climate change data disclosed to investors and the global marketplace.”

Obviously, there is a disconnect between real world, scientifically verifiable risks and traditionally contemplated investment risks, at least in the case of SoCalGas at Sempra. Which is a danger when you get into the business of looking for standouts in an inherently destructive business: even the very best are still destructive. It’s like trying to decide which cancer you would like to get. Maybe you’d select skin cancer because it’s eminently curable if caught early, but the real answer is you don’t want cancer at all.

The risks are real. The Los Angeles Daily News says that “Since Oct. 23, Southern California Gas Co. has spent $50 million to try to stem the flow from the nation’s fifth largest natural gas field, while relocating two schools and some 12,000 residents, many of them sickened by gas detection fumes. A fix may not be in the works until March.”

That means SoCalGas may still be in for more expenses than they thought. Maybe a lot more. Again, from the Los Angeles Daily News, “the researchers recorded elevated levels of the main ingredient in natural gas10 miles away from the nation’s largest gas leak.” A recent essay from the Union of Concerned Scientists adds, “while this is just the most recent in a long history of oil and gas industry disasters, the particulars of this circumstance are unprecedented (sadly not unheard of). Legal experts predict that SoCal Gas will be on the hook for billions over a long period of time,” and “3,000 more [families] are waiting to be relocated…As these houses sit empty, they become vulnerable to crime and decline in value. And beyond paying to fix the leak, cover medical costs, and relocate families, SoCal Gas is already fielding 25 lawsuits with more expected in the coming weeks, months and perhaps years.”

The traditional way of thinking about investment risks
excludes hugely important ones that should have been incorporated into the fiduciary standard a long time ago, begging the question: what is the fiduciary standard for if not to assess these risks? We allow extremely risky activities from a regulatory point of view and then ignore these risks in investment management. But if you don’t include these risks, you’re exposing yourself and your clients to them, and the minute these risks are recognized for what they really are, you could see your value in certain companies, such as SoCal Gas, evaporate before you can get your next statement.  So why build a portfolio with only the ‘good cancers’ in it? Why not build one with no disease at all?

As Newsweek points out, “The methane leak in Porter Ranch, though, is an apt demonstration of our complex affair with carbon fuels. The natural gas stored in Aliso Canyon flows to the homes of about 20 million customers in the greater Los Angeles area. So while we contemplate wind farms and solar arrays, we remain married to an antiquated infrastructure that lets us do what we have done for centuries: extracting energy by burning carbon.” And so, sometimes ignoring all seemingly non-financial risks, do fund managers.

But, increasingly, someone has to answer for those risks. Fossil fuels companies don’t think it will be them. EDF.org says it all when they report that, “none of the 65 oil and gas companies reviewed in a just-released study by Environmental Defense Fund disclose targets to reduce methane emissions, the main ingredient in natural gas.”

You don’t manage a risk you don’t think you’re going to have to pay for, and therefore most oil and gas companies don’t manage them adequately. For portfolio managers it’s different though, we can and should be thinking about risks even when companies themselves don’t. Our clients’ financial well-being is at stake.

Yet portfolio management, populated with professionals who try to leave no stone unturned in rooting out risks and dangers associated with every stock, has a blind spot when it comes to fossil fuels. In a time when it is clear that the beginning of the end of the fossil fuels era has begun, when we know fossil fuels contribute massive risks to the global economy from all the outcomes of warming to failing health to destruction of land and biodiversity, when we can say with certainty that for many purposes renewable energies are now more economically competitive, most investment professionals still continue to hold coal, oil and gas stocks. They have their stated reasons: diversification, historical performance, modern portfolio theory and fiduciary standard requirements. But backward-looking diversification methodology (again, the standard in present day investment management) has allowed construction of portfolios fraught with systemic risks.

What the LA methane leak tells us about investing today is as much about inertia as it is about research and new ideas. This is probably inevitable and to be expected, but it’s a shame, because where capital is invested in this world is where change happens, and it’s time professional investors realized they need to stop investing in the world’s greatest systemic risk.

Given the tools provided by modern portfolio theory, mainstream investment management only seems to be able to think as far as: “we need to be sustainable, so which fossil fuels firms are greenest?” This is shortsighted. The world economic forum at Davos now sees climate as the world’s number one economic risk; why don’t most portfolio managers and other fiduciaries?

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, the Green Alpha Growth & Income Portfolio, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club’s green economics blog, “Green Alpha’s Next Economy.”

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Tom Konrad CFA

Anew report written by Nathaniel Bullard at Bloomberg New Energy Finance highlights the difficulties large institutional investors would have divesting from fossil fuels. What it does not specifically discuss is that these difficulties could lead to large financial losses for investors who see the difficulty of divesting as a reason to delay.

Just as we can’t easily fill up our cars with solar power instead of gasoline, the report points out that there is no asset class that can directly substitute for oil and gas in large institutional portfolios.

A person with a short commute can simply ditch gasoline for renewable fuel by riding a bike, and small investors can easily divest from fossil fuels without sacrificing growth or yield by using small capitalization stocks and yield cos.

The relatively high yield of oil and gas stocks is the most difficult to replicate, even at its level of 2.41%, which the report describes as “not enormous.” According to the report, the only sector with a higher average yield is REITs (at 4.55%). REITs have a total market capitalization of less than a third of oil and gas stocks, so it would be impossible for more than a fraction of large investors to replace their oil and gas holdings with REITs.

The Instructive Case of Coal

In contrast to oil and gas, the report makes the point that because the market capitalization of coal companies is much smaller, divesting from coal alone is much easier than divesting from oil and gas. The report states that “Coal equities are less than 5% the total value of oil and gas equities, and have already trended down nearly 50% in the past five years… as a result, divesting from coal would be much easier then divesting from oil and gas.”

The report’s author Nathaniel Bullard, told me in an interview that divesting from coal would have been more difficult just three years ago. He says, “US coal has had clear indicators of future change in place for a while. … Some coal equities have lost 90% of their value since 2011… This much diminished size means that… the same number of shares will represent a much smaller portion of an investor’s overall portfolio relative to 2011.”

Hold High, Sell Low?

To put it more bluntly, investors who have already lost their shirts in coal stocks will have a much easier time selling their much-diminished holdings today than they would have when coal stocks were at their peak. Ironically, it’s easier to sell low and buy high than vice-versa, especially for investors who manage large pools of money.

It does not take a multi-million dollar salary to know that waiting until your stocks have fallen by half before you sell is a suboptimal investment strategy. Despite past “clear indicators of future change” and lower estimates of future coal demand due to air pollution regulations in the coal industry, institutions like Stanford are only now beginning to divest from the sector. Most have not yet budged.

Are Oil and Gas Next?

The report begins with a quote from an executive who describes the divestment movement as “one of the fastest-moving debates I think I’ve seen in my 30 years in the markets”. If this fast-moving debate leads to fast-moving divestment, the sheer size of institutional oil and gas holdings would lead to a scale of the selling that could easily drive down prices of oil and gas stocks as fast as coal stocks have fallen over the past few years.

The divestment movement was only in its infancy when coal stocks peaked in 2011, so divestment has been only a minor contributor to their decline. Bullard attributes most of the decline to fundamental factors, such as low gas prices and (to a limited extent) wind power in the US, and concerns about air pollution in China.

That said, the long term fundamentals of oil and gas are not favorable. Industry costs are rising as producers shift towards unconventional sources such as tar sands and tight oil and gas which are extracted with relatively expensive techniques such as hydraulic fracturing (“fracking”). Meanwhile, high fuel prices are beginning to reduce average driving distances in mature markets such as the US and Europe while the declining costs of efficiency technologies such as hybrid and electric vehicles further lower demand. In the fastest growing vehicle fuel market, China, air pollution concerns have led the government to aggressively promote “new energy” vehicles, particularly hybrids and EVs.

Natural gas faces increasingly inexpensive competition in electricity markets from wind and solar generation. That, combined with technologies such as storage, smart grid, demand response, and better transmission which make it easier and cheaper for these variable sources to supply a larger portion of electricity demand with less reliance on dispatchable generation such as natural gas, hydropower, and biomass-fired electricity.

The fundamentals of all fossil fuels will be further undermined if the world ever makes a concerted effort to rein in carbon emissions. At the moment, the prospects for large scale regulatory moves seem dim, but at some point the increasing costs in terms of falling crop yields, widespread and severe heat waves and droughts, ocean acidification and the like will lead to political action. At this point it will almost certainly be too late to avoid significant economic and human costs from climate change, but that does not mean that it will not help us avoid even greater damage. And the longer we delay taking substantive actions to curb greenhouse gas emissions, the more draconian those actions will have to be. Drastic moves to curb carbon emissions will have even more drastic effects on the fundamentals of fossil fuel industries.

Conclusion

In part because it is so hard for large investors to exit fossil fuels, it is unlikely that a majority of such investors will move to divest before they have lost a large portion of their current holdings to price declines driven by the fundamental factors outlined above and selling from more motivated investors.

Some of the factors listed above, such as concerted political action to curb carbon emissions, may take a long time to be felt. Other factors, such as the declining cost of renewable energy and efficiency technologies and the increasing costs of fossil fuels are moving energy markets today.

When these factors will begin to hurt oil and gas stocks is unclear, but the coal industry shows that, although divesting is hard, it does not pay to wait too long.

This is where the analogy to replacing fossil fuels in your commute by buying an electric car breaks down. With electric cars, the more people own them, the easier and cheaper they will be to use: growth in charging infrastructure will rise with the adoption of plug-in vehicles, while higher volumes should help bring down their initial cost.

In contrast, it pays to be first rather than last when divesting from fossil fuels. While it is possible to be too early, at some point the worsening fundamentals
of fossil fuel industries and/or a large scale divestment movement will undermine the value of all fossil fuel stocks. Those who divest sooner will have much more money to invest elsewhere than those who delay because divesting is just too hard.

Fortunately, small investors have it easy. Divesting, for once, is a place where the small investor has the advantage on Wall Street.

This article was first published on Renewable Energy World, and is republished with permission.

The post Divesting: Last One Out Loses appeared first on Alternative Energy Stocks.

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 reve
nue 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.”

The post Ten Economic Risks of Fossil Fuels appeared first on Alternative Energy Stocks.

Tom Konrad CFA

The unprecedented boom in natural gas supplies over the last few years as been one of the few tail-winds for the US economy over the last few years, as plummeting natural gas prices have lowered costs for both industry and consumers.  Few outside the natural gas industry even understood the shear scale of the shale gas resource, although industry insiders did.

The Shale Gas Glut

In 2008, I recall a natural gas executive complaining about how he could not get policymakers to understand the sheer scale of the shale gas resource.   To be honest, I did not take his comments seriously, either.  That was a mistake.  Shale gas has transformed our economy in many ways, and changed the economics of competing fuels, from coal and nuclear to renewables like solar, wind, and geothermal.  Cheap natural gas is even doing what Pickens failed to do: get a major oil company to invest in natural gas filling stations.

While shale gas transformed our economy, it also transformed the stock market, which is why I should have paid more attention.  Low natural gas prices have not only hurt renewable energy stocks, they have also helped chemical and fertilizer companies that use natural gas as a feedstock.  I first came across LSB Industries (NYSE:LXU), a geothermal heat pump (GHP) and chemical company that uses a lot of natural gas a couple month’s after I heard the natural gas executive’s rant.   I bought both LXU and its pure-play GHP rival Waterfurnace (TSX:WFI,OTC:WFIFF) at the time, but I sold LXU a few months later, congratulating myself on a quick double at $16, while holding Waterfurnace.  Waterfurnace is down a little since I bought it (although it has been paying a nice dividend along the way, while LSB doubled again, in large part because of the tail winds from low natural gas prices.

I don’t plan to make the same mistake again, so I pay more attention to what’s going on with fossil fuels.  To that end, I attended the 2012 Symposium on Oil Supply and Demand: Studying the Wildcards, where industry experts tried to predict the next fossil fuel “surprise” that should not be a surprise, if we’d only been paying attention.  (The presentations and video proceedings are available at oilwildcards.com.)

NGLs: The Next Shale Gas?

If there is going to be another fossil fuel glut to follow natural gas, it will probably be Natural Gas Liquids (NGLs, not to be confused with Liquefied Natural Gas, or LNG).  Natural gas liquids are the slightly larger carbon compounds such as ethane, pentane, and propane, which are co-produced with natural gas, but are usually counted with oil production in industry statistics.  But, as I learned at the symposium, NGLs should not really be counted with oil or gas, or even separately.  Each NGL has its own uses, and its own market, and they need to be considered separately if we are to understand the price dynamics.

Perhaps most importantly for those of us worried about the ability of oil production to keep up with demand, NGLs are not used as transportation fuel (with a tiny exception for propane in forklifts and the like.)  Hence, even though NGLs are often counted as part of the oil supply, they do not ease the constraints on the supply of gas or diesel.

The reason NGLs are interesting now is because recent low natural gas prices have led natural gas producers to dramatically shift drilling away from “lean” prospects (which produce natural gas but few NGLs) to “rich” ones (which produce significant NGLs along with the natural gas.)  This trend was highlighted at the Symposium by Adam Bedard, Senior Director at BENTEK Energy, an energy markets analytics company (see graph above).  So far, relatively high prices for NGLs have kept many wet gas wells profitable despite low gas prices.  In a sense, gas companies are drilling for NGLs, and producing natural gas a a byproduct.

The problem is that the rapid shift towards NGL-rich plays is liable to produce more NGLs than the market can handle.    According to George Little, a partner at Groppe, Long & Littell, an oil and gas analysis and forecast provider speaking at the Symposium, the leading indicators of periods of NGL oversupply are the relative prices of olefins ethylene and propylene, which are made from NGLs.

When propylene prices are above ethylene prices, it is a leading indicator for ethane being sold for its heat value into the natural gas market, rather than being sold into the chemicals market.  That indicator, according to Little,  is currently “flashing red” (see graph above.)  The problem with selling ethane into the natural gas markets is that, with current low natural gas prices, it will only fetch $0.10 to $0.16 per gallon, a fraction of the current price.

Competition with natural gas for industrial uses and heating has also been eroding the propane market.  The butane market is similarly stagnant.

Stocks to Avoid

With stagnant demand in most NGL markets, it’s no surprise that new supply has been dramatically reducing NGL prices.  The coming flood of new supply will only push NGL prices down further.  Natural gas producers that are counting on high NGL prices to maintain profitability are likely to find it as hard to profit from NGLs over the next few years as it recently has been to make a profit from natural gas.

Which natural gas producers are most reliant on NGLs, and hence vulnerable to a price collapse?  Devon Energy (NYSE: DVN), recently announced a sixth consecutive quarter of increasing NGL production and an 80% year over year increase in NGLs from the Cana Woodford shale.  On the other hand, Chesapeake Energy (NYSE:CHK) may be less vulnerable, since that company recently trimmed its projections for NGL production.

On the green side of the coin, biochemical companies which have turned to these higher-margin businesses in order to escape commodity squeezes in biofuels may see the same story repeating itself in chemicals.  Investors should not count on high-margin biochemicals to remain high-margin if they replace petrochemicals made from NGLs.

Likely Winners

On the other hand, midstream NGL companies should be able to produce increasing profits from NGL bottlenecks.  Pipeline operator ONEOK Partners (NYSE:OKS) and Enterprise Products P
artners (NYSE:EPD) have both been seeing increasing margins from their NGL operations.  Those trends are likely to continue as the growing NGL glut increases demand for NGL transportation and processing infrastructure.

Disclosure: Long LXU, WFIFF

This article was first published on the author’s Forbes.com blog, Green Stocks.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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Tom Konrad CFA

Photo: Robin Lucas, via Wikimedia Commo

With friends like these, who needs enemies?

The Sierra Club is fighting new Liquified Natural Gas (LNG) export terminals, because they believe LNG exports would reward and encourage producers of shale gas.

Fighting shale gas has blinded them to the bigger picture.

If LNG exports were to reward shale gas producers, they would have to be significant enough to raise the price of domestic natural gas. Such large exports would also lower the world price of LNG.

Effects on Domestic Markets

Higher domestic natural gas prices would help shale gas producers, but they would also help other producers of domestic energy which compete with natural gas. Domestic consumers of natural gas would also have stronger incentives to use gas more efficiently, or switch to other options. Solar, wind, geothermal and energy efficiency industries (of which the Sierra Club is a vociferous supporter) are all hurt by low natural gas prices because it lowers the price they are able to get for the power they sell.

The Case of the Bi-Fuel Truck

The case for electric and hybrid vehicles is hurt as well when low gas prices make the economics of natural gas vehicles look better. GM and Chevrolet both recently announced bi-fuel pickups able to run on natural gas. The selling point for such vehicles is the lower running cost when using cheap natural gas, despite the initial up-front cost. The companies are oddly silent on the additional cost of such vehicles, but the trade-off between higher up-front costs and lower operating costs sounds eerily similar to that for hybrids and EVs.

The Hybrid Chevrolet Silverado costs an additional $2500 up-front, but will also save fuel costs with an EPA fuel economy of 20 mpg for city driving, and 23 highway, compared to 14 mpg city/ 19 highway for the base model, and also comes with four 20 amp A/C outlets allowing it to function as a work-site generator. If we assume 10,000 miles each of city and highway driving annually, the hybrid Silverado will save an annual savings of 306 gallons or $1224, at $4 gas, which will pay for the additional cost in 2 years. Perhaps the bi-fuel pickups will have quicker paybacks (although I doubt it, given the manufacturers’ unwillingness to quote prices), but any payback for a bi-fuel truck will depend on natural gas prices staying low.

In other words, the Sierra Club is promoting natural gas vehicles over hybrids, and natural gas power generation over renewables and efficiency by fighting LNG exports.

Effects on World Markets

LNG exports would also lower world LNG prices, hurting LNG exporters in other countries, something the Sierra Club should support, since making LNG has such a high carbon footprint.

Meanwhile, the world’s largest LNG importer has long been Japan, and Japan’s LNG imports have skyrocketed to make up for electricity from shut-down nuclear reactors. Cheaper LNG imports could help Japan afford the aggressive move to renewable energy and efficiency the country is embarking on.

Conclusion

Hydrofracking for shale gas can be harmful to the environment, especially when it is poorly regulated as it is in much of the United States, and cash-strapped drillers take shortcuts with safety and environmental protection. But if drillers are not going to take shortcuts, they need to be able to afford proper precautions, and funds need to be made available for proper oversight of their operations. All of this cannot happen at today’s low extremely low gas prices.

If the Sierra Club wants to stop dangerous fracking, they should not be fighting export terminals, they should be working to force the industry to fund proper oversight. Perhaps a levy on natural gas produced by fracking to fund safety and environmental inspections could be passed as part of a deal to allow LNG export terminals.

Such a deal would be a win for the environment, for renewable energy developers, for energy efficiency, and for the Japanese, who are bravely trying to find their way to a nuclear-free future.

This article was first published on Forbes.com.
DISCLOSURE: None.
DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

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Tom Konrad CFA

The last ten years have brought a structural change to the world oil market, with changes in demand increasingly playing a role in maintaining the supply/demand balance.  These changes will come at an increasingly onerous cost to our economy unless we take steps to make our demand for oil more flexible.

We’re not running out of oil.  There’s still plenty of oil still in the ground.  Oil which was previously too expensive to exploit becomes economic with a rising oil price.  To the uncritical observer, it might seem as if there is nothing to worry about in the oil market.

Unfortunately, there is something to worry about, at least if we want a healthy economy.  The new oil reserves we’re now exploiting are not only more expensive to develop, but they also take much longer between the time the first well is drilled and the when the first oil is produced.  That means it takes longer for oil supply to respond to changes in price. 

In economic terms, the oil supply is becoming less elastic as new oil supplies come increasingly from unconventional oil.  Elasticity is the term economists use to describe how much supply or demand responds to changes in price.  If a small change in price produces a large change in demand, demand is said to be elastic.  If a large change in price produces a small change in supply, then supply is said to be inelastic.

Elasticity of Demand

On the demand side, the elasticity of our demand for oil reflects the options we have to using oil for our daily needs. At a personal level, we can quickly cut our demand for oil a little bit by combining car trips, keeping our tires properly inflated, etc.  But the ability to make such reductions is often limited, and even such simple measures come at a cost of time or convenience, which is why we’re not doing them already.  If we live in an area without good public transport (as most of us do) we can’t stop driving to work without losing our job, so we keep driving to work, and paying more for the gas to get there.

Over the longer term, our personal options to cut oil consumption increase.  We can move closer to work, or to somewhere where we can walk or use public transport to get to our job. This is why the most fuel-efficient vehicle is a moving van. 

Replacing a car with a more fuel efficient vehicle is an option for those who have money or credit, but the people who are under the most pressure from high fuel prices are unlikely to be able to afford such options.  If they can’t resort to ride sharing or public transport, they may simply lose their jobs because they can’t afford to get there. 

The reduction in fuel use that comes from people losing their jobs and no longer commuting to work also contributes to the elasticity of demand, and I mention it to highlight the point that while reductions in fuel use can be benign (properly inflated tires, for instance), they can also be harmful to the economy.  Reductions in demand due to high prices are often called demand destruction, and it’s just as unpleasant as it sounds.

Elasticity of Supply

Since our options for reducing oil demand in response to rising prices range from inconvenient to expensive, to downright painful, it’s clear why the media and politicians focus so much attention on the other half of the equation: When supply adapts to changes in demand, voters don’t have to make uncomfortable choices. 

But there are also limits to the ability of oil supply to adjust.  Most OPEC nations, including Saudi Arabia, need at least a $100/bbl for oil to keep their budgets in balance, so why would they increase production to reduce the price below that?  In fact, as (subsidized and hence inelastic) OPEC domestic consumption continues to increase faster than supply, OPEC net exports will continue to fall, further raising the price needed to balance exporters’ budgets. 

While fiscal issues constrain OPEC’s elasticity of supply, geology and politics constrain oil supply elsewhere.  Brazil’s giant pre-salt fields, like deep water discoveries in the Gulf of Mexico and elsewhere, are much more expensive and slow to develop than were past discoveries.  Canada’s tar sands are large mining operations, and are similarly slow and expensive to develop.

Put simply, if the oil were quick and easy to get at, we’d have gotten it already.  All these factors mean that the elasticity of oil supply is falling, so oil demand has to adjust more in response to changes in price than in the past.

Data

Since there is little reason to assume that the elasticity of oil demand has changed significantly (do we have more options for doing without oil than we did ten or twenty years ago?) while the elasticity of oil supply has fallen, we have to expect that overall oil price elasticity has fallen as well, and these changes should show up in oil market data.

Using oil annual supply, price and consumption data from the EIA and IEA, and making some back-of the envelope adjustments to account for the difference between their different definitions of what constitutes oil, I made some estimates of the price elasticity of oil supply and demand.

Since neither demand nor supply can respond instantly to changes in price, I first had to estimate the average reaction time.  To do this, I looked at the correlation between changes in the oil price and changes in supply and demand with various lags.  I used price and volume changes over a period of three years because three year changes gave me the strongest results, although one and two year changes were similar. 

Below you can see the correlations between three year changes US and worldwide supply and demand with three year changes in US oil prices (WTI) and world oil prices (Brent), after various lags:

Note that we’re looking for negative correlation between price and demand (we use less oil when we have to pay more for it), and positive correlation between price and supply (companies produce more oil if they can get more money for it.) 

From the chart, we can see that world oil supply has historically taken about one year to respond to changes in world prices (the blue line peaks at 40% correlation with a one year lag), while domestic US oil production (supply) has typically taken about four years to respond to changes in the oil price, but that response is much stronger than the response of world supply.

The difference between the response between US and world oil supply makes sense because domestic oil production operates in a much freer market than world oil supply, where changes are mostly dominated by political decisions in a few OPEC nations.  Political decisions are quicker than drilling new wells (one year as opposed to four), but they are only about half as responsive to changes in price.

On the demand side, we see very little response to changes in price at all.  The correlation between demand and price is always positive, showing that changes in supply have accounted for virtually all of the market response to oil price changes over the period. 

Changes Over Time

To test
my hypothesis that supply is becoming less elastic, I split my data set into two periods, one from 1987 to 2000, and one from 2001 to 2010.  If the hypothesis is correct, we will see less supply and more demand price response in the later period than in the earlier one.

The graphs which follow show significant changes in how both supply and demand respond to changes in price.  Perhaps the most significant change is that we now see a response in the demand for oil to the oil price.

In the early period, only US demand for oil shows a small response to price, with a slight negative correlation (-30%) between three year changes in US demand and changes in price.  World oil demand still shows no measurable price response.   I take this to indicate that at the end of the last century, Americans responded to changes in the oil price by using the relatively easy options such as eliminating discretionary trips when oil prices rose, but price was not an important factor for determining world oil consumption.

In the later period, the US demand no longer shows a short-term response to rises in the oil price, perhaps because the easy reductions in oil use have already been made, but we now see a relatively strong response to higher oil prices (with a -90% correlation) over a period of four years for both US and world oil demand.  This probably corresponds to such changes as purchasing more efficient vehicles, and minimizing commutes by moving closer to work or working more from home.

Confirmation

World oil demand’s very significant response to changes in the oil price implies that demand is now playing a much bigger role in the adjustments the oil market makes to changes in price than it has in the past. 

Because oil supply has become less elastic and less responsive to changes in price, oil prices have become much more volatile in order to force market adjustments. 

The chart below shows that while the magnitude (either up or down) of annual changes in supply and consumption have been in the 3% to 7% range for the last quarter of a century, the magnitude of oil price changes has been rising relentlessly.  In the 1990s, oil prices usually changed by an average of 25% or less per year, while they now typically change by three or four times that amount in any given year.

If the price elasticity of the oil market had not been falling over time, the increasing magnitude of changes in oil prices would have produced a similar increase in the magnitude changes in oil supply and demand.

As the Market For Oil Becomes Less Flexible, We Should Make the Market for Transportation Services More Flexible to Compensate

If what we care about are the effects on the economy, it does not matter how much oil is in the ground.  Over the last ten years, we have see a structural change in the oil market which will continue to have far-reaching effects on the economy even if we manage to increase the amount of oil produced. 

Before 2000, oil supply did the heavy lifting when it came to balancing supply and demand in the oil market.  That is no longer the case, and the oil price signal has grown significantly stronger in order to elicit a response in demand.

With 2% of the world’s oil reserves, changes in the US supply of oil will remain insignificant in the world oil supply demand picture, developments in the Bakken shale and cheer leading from political leaders notwithstanding.  On the other hand, as the consumer of a quarter of the world’s oil supply, we can have a significant effect on the world oil market by making sure that our economy can adjust quickly and easily to changes in the oil price.

What measures can we take to increase the elasticity of oil demand, and reduce the pain of demand destruction?  Measures which increase our citizen’s options for reducing oil use. 

• Increased investment in alternative modes of transport, such as mass transit (both buses and rail), bike lanes, bike and car sharing, and walking improvements to allow many more workers the option of getting to their jobs without the use of a personal car.
• Improvements in our nation’s rail system to allow more freight to be shifted from truck to rail.
• Increasing gas taxes slowly and predictably over time to both fund the above improvements, and to signal to consumers that they need to prepare for long term higher prices by purchasing more efficient vehicles and changing where they live so that they have the ability to reduce their driving.
• The use of road congestion pricing, pay as you drive insurance, and other price signals that give people the right market signals and enhance the most efficient use of our nation’s roadways.
• Encouraging the electrification of transport (including the alternative transport options mentioned above) to provide transport options which are not dependent on oil.

In short, we need to make the market for transportation services more efficient by encouraging new entrants (mass transit, bikes, trains) and competition with the incumbent car/internal combustion engine infrastructure.  Competition within the car infrastructure should also be encouraged by sending price signals such as the slowly and predictably increasing gas tax mentioned above to better reflect the dangers to our economy posed by the new oil market regime.

Thanks to Jim Hansen of Ravenna Capital Management for his help.  This article was first published on Forbes.com.

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