Popping the Carbon Bubble

Last week in Oslo, Marius Holm of the ZERO Foundation presented a report that I co-wrote this summer along with a number of environmental and financial professionals making the case for fossil fuel divestment in Norway’s government pension fund, a portfolio so large that it dwarfs the size of all American university endowments combined. Many of the arguments were specific to Norway, which, as one of the largest producers of oil and gas in the world, is ill-advised to double down on its exposure to shifts within the fossil energy industry. As a fund that already has in place the type of Environmental, Social, and Governance (ESG) criteria for investment missing from Middlebury’s endowment, the debate in Norway is not over whether divestment is an appropriate tool for creating change, but rather how far that tool should be extended. While Middlebury would be well advised to lead the way by creating similar investment screens, even in the absence of concerns about endowment ethics the arguments for divestment in Norway can inform the ongoing debate on this campus.

- Art by Amr Thameen

– Art by Amr Thameen

Over the past six months, many market analysts have revised their predictions for future oil prices from around $110 per barrel to down into the $80 to $90 range. A number of factors are driving this downward trend — increased efficiency of automobiles, uncertainty over future regulations and a Chinese economy far more overleveraged than that of the United States prior to the financial crisis. All of these factors contribute to falling oil demand, which in a world of abundant oil supply means that prices must soon begin to fall.

At lower prices, many of the types of tar sands, ultra-deepwater and shale oil projects currently under development would fail to earn back their investment capital. Any regulatory action that limits carbon dioxide emissions will inevitably require some of these reserves — which have already been factored into the share value of oil companies — to remain in the ground. Expectations about reserves have a significant effect on the share price of fossil fuel companies. When Shell reduced its estimated reserves by 20 percent in January 2004, its share price plunged by 10 percent in a single week. These concerns recently led a large group of investors representing over $100 billion in assets managed by companies that include Boston Common Asset Management and Storebrand Asset Management to issue a call that Norwegian Oil Company Statoil withdraw from tar sands extraction.

World Financial Markets – and, by proxy, the Middlebury College Endowment – are being inflated by a looming Carbon bubble. If you accept that there is a scant one-in-four chance that the world will meet the IEA’s targets to limit global warming to two degrees Celsius, the expected value of the endowment’s position in fossil energy equities is already ten percent inflated.  The loss of value if climate change is defeated would be forty percent, which would affect the College’s ability to pay employees, undergo capital projects and award financial aid to deserving students.

The College Administration and Trustees no doubt have faith that, as professional investment managers, Investure will be able to anticipate the shift in fossil energy share prices before they actually arrive. But that poses a significant risk to the endowment – a risk that we would do well to avoid. When financial markets adjust to reflect the changing reality of fossil fuel use, the adjustment will not be smooth or gradual. It will come suddenly and leave those too slow to act with heavy losses. For some of the market, it already has. After an energy speech by President Obama that pledged increased regulation of power plants and an end to international development aid for non-Carbon Capture and Storage (CCS) coal plants, the shares of coal companies including Peabody Energy and Walter Energy took dives of 3.4 and 10.4 percent respectively, adding to a year in which Peabody Energy has lost half its value and Walter Energy has lost three quarters. The Stowe Global Coal index, which lists coal-producing companies, fell the same day to its lowest level since the 2009 financial crisis. Utilities across Europe have similarly plunged unexpectedly in response to competition from renewable energy.

To be bullish on the future of the fossil fuel industry is the rough equivalent of a bullish outlook on the nuclear industry sometime after the alarm bells went off at Three Mile Island or after the wave headed for Fukushima. It is comparable to a bet on CFC-producing companies sometime between the discovery of the massive hole in the Ozone layer and the ratification of the Montreal protocol, or a bet on fax machines after the invention of the Internet. Coal and oil powered the 19th and 20th centuries. Their glory days are past. To bet on their future is to bet either against the future of humanity or against the overwhelming judgment of science.

Bubbles in the Ground: Is Natural Gas Too Cheap and Does Fracking Make Money?

Key Takeaways:

  • Gas companies have sunk large amounts of money into shale gas production
  • Current market prices are too low and will likely rise in the near future
  • Most US Natural gas reserves will not require fracking

I recently came across a blog post by a man named Mark Anthony arguing that natural gas produced is substantially underpriced in the United States, and that the companies producing it are carrying huge debt burdens relative to the value of this gas.

If his data are correct, then the actual cost of natural gas should be significantly higher than it is. He tallies debts of $500 billion from selected natural gas companies and the majors against production of 23 TCF of shale gas. This produces a debt load of $21.32 per million BTUs of shale gas produced so far – much, much higher than a price that has hovered between $3 and $4/MMBtu. Combined with the fact that the number of new wells drilled for fracking has plateaued, this would be terrible news for the companies. In his words:

The shale gas is neither cheap nor abundant…had gas prices been $2/mmBtu or $3/mmBtu higher, the industry would have taken home $46B or $69B more revenue. It would not have made a difference in the industry’s $500B collective debts.

What would you think if the US coal sector had accumulated half a trillion dollars of debts after producing coal for two decades? Patriot Coal went bankrupt for a mere $600M of debts, not $600B. I foresee a looming debt crisis of the NG industry. The debts must be resolved in one of two ways. Either NG prices go to ridiculous high levels and stay there sustainable, so the industry makes enough profits to pay off the debts before the gas runs out. If that does not happen, then many NG producers and banks in the shale business will go belly up.

Since there is such a huge discrepancy between the debt load and the market price, and since he did not source his data, I decided to attempt to reproduce his results myself. His production numbers were from 2011; by 2012 United States shale gas production totaled 32.75 trillion cubic feet, for an approximate revenue at $3.50 per million Btu of $117 billion.

Source: EIA

Source: EIA

So far, this is far below Anthony’s stated debt. But it turns out that his debt numbers were overstated by an average of 100 percent per company, excluding the majors (Exxon, Chevron, and company), which he lumped together. Continue reading