Monthly Archives: April 2013

Behind the continuing negotiations on new nuclear in the UK one big question remains unanswered. Who is going to pay? Senior officials are concerned that the pressure to close a deal is undermining a sensible negotiating strategy by separating the terms – including the strike price and the issues of risk allocation – from the question of funding.

To grasp what is happening you have to understand the degree of desperation which now exists in Government to deliver growth. Growth is the justification of the whole economic strategy and of course the solution to the challenge of rising borrowing. Growth is seen as the only platform from which either coalition party can go back to the electorate. But growth is elusive and time is running out. 

A report from the Grantham Institute and the Carbon Tracker initiative, titled “Unburnable Carbon”, has produced a studied silence from the energy industry. The study, published last week, is privately being dismissed as the predictable conclusions of people who don’t understand business. But investors should take it more seriously because it opens up some very interesting questions about what energy companies are doing with their money.

In summary, the report says the investment of more capital to find hydrocarbons is a waste of money. More than enough has been already identified to fulfill the world’s needs if we are to meet the carbon limits implied by international agreements on climate change. Under those agreements, carbon use will be reduced over the next four decades, leaving substantial supplies stranded. On this basis, some companies – and therefore the funds which hold them – are carrying dangerous levels of risk, based on the false assumption that the international agreement will never be implemented. The companies are overvalued because some of their assets will never be used.

I have two points of doubt about this thesis. 

A Chinese miner unloads coal from a train

Those who keep talking down shale gas should read the views of Elizabeth Muller. Ms Muller does not run a shale gas company. She is co founder and executive Director of Berkeley Earth, an impeccably green non profit research group in California.

In her opinion, environmentalists in the US and elsewhere should be encouraging China to develop its shale gas resources. Those resources are huge – perhaps 50 per cent greater than those of the US, and have yet to be explored in detail. That process is just beginning and includes a number of international companies including Shell.

Ms Muller’s argument, which is unanswerable, is that any development of shale gas will offset the use of some coal. Shale gas is not carbon free but it is cleaner than coal which is China’s basic fuel now. And unless things can be changed radically, will be the dominant source of energy for the next several decades. If shale gas could back out some amount of China’s coal consumption, emissions could be materially reduced. 

Those who think that the best responses to the risks of climate change are ever stronger regulation, complex international agreements and higher energy prices should take a look at what is happening in America.

In the US, carbon emissions have fallen by 13 per cent in the last five years and are at their lowest level since 1994. Energy demand is flat even though the economy is growing. The key statistics to watch are oil demand, which is at a 15 year low, and coal demand in the power sector, which is down by more than 20 per cent since 2008.

Furthermore, energy prices are also falling thanks to shale gas. They have yet to stabilise and there will have to be a shakeout within the gas sector. But prices will settle in the range of $4.50 to $5 – sustaining development but also providing a sharp reduction in input costs for consumers including manufacturing industry. Shale gas, however, is not the whole story. Next will come tight oil, which is oil from shale rocks. Then and potentially most important of all will come advances in energy storage. Bill Gates has just made his third major investment in an energy storage technology business. 

The Brent oil price has fallen by more than $10 – which means 10 per cent – in less than two weeks and now stands below $ 100. The precise number matters less than the trend. Now the question is how much further prices will fall.

Saudi Arabia is the only country in the world with the ability to cut production and to keep prices up. Some feel the Saudis are using the fall to discourage investment in high-cost projects including tight oil and some deep water ventures. I am not convinced. The Saudi oil minister, Dr Al Naimi looks tired and unsuited to such a high-stakes game. I expect the Saudis to pursue the tactic of making small incremental cuts in output in the hope that the market will stabilise. I doubt if this will work. Only a cut of 1.5m to 2m b/d will suffice to maintain prices and that would squeeze Saudi revenues too much. With growing domestic demand Saudi Arabia has little room for manoeuvre. As noted last week, the Saudis seem to be in process of losing control of the oil price.