Picking Wolves from Sheep

For many decades, humans have been overpopulating our planet and after centuries of manipulating nature, we are changing our climate among other things. This population growth and increased industrialisation creates rising energy demand – from this backdrop, global population is anticipated to grow further to nine billion by 2040.

In all this, some of investors’ capital is being directed towards exploiting nature, which in turn is destroying our habitable climate. So investors have a clash of interest – we want to invest well for a comfortable life, but in doing so, we must avoid undermining the environment within which we’d like to live that life.

Climate change is a compelling example of this effect on nature.

Though climate change has been a looming global problem, until now it was slow to rise to a politically urgent level. But now, we must honestly accept the noticeable changes occurring in our climate and also accept the cost to be incurred in keeping our planet habitable. In reaching that acceptance, investors might be wise to vote with their capital. Meanwhile, we must hope it is not already too late to avoid some irreversible change.

Australia has profited from coal and the coal lobby is fighting vigorously to resist the inevitable global community decisions, but we need to ensure their partisan need does not push us to the point of no return. The earth’s natural energy comes from our sun and our creative ancestors learned to utilise stored sunshine energy in the form of carbonised coal, oil and gas. Faced with a degrading climate, we need to stop using these carbon fuels – perhaps more urgently than many realised.

Even so, the Institute of Energy Research expects fossil fuel consumption to keep rising. Within that, it expects coal usage to decline by 2035 and oil’s proportion to also fall, while gas use is expected to rise. They expect renewables to still be less than 10% of the total. Hopefully, renewable energy will actually grow its share of energy needs, but fossil fuels may remain a large part of the overall energy mix for many years yet.

At the Paris climate conference, world leaders committed to tackling climate change so perhaps a binding deal of significance may be struck, but many issues still need to be resolved. One issue is that developing countries need money to make any major policy shift. It remains to be seen whether governments would support the will of their political leaders. Our Coalition government here in Australia is struggling to face reality and US Republicans may not go as far as Obama in helping emerging nations cut carbon emissions. Even so, some positive conference announcements involved; a US$1 trillion solar power venture between India and France, Bill Gates collecting billions for energy research and development.

Scientists encourage us to limit climate warming to no more than 2°C. With this target in mind, we may be about to invest many billions unwisely over the next decade in new global projects (like Adani) and in existing projects. Why? Because it is possible that no new coal will be needed, oil demand might peak around 2020 and growth in gas might actually disappoint industry expectations. If this is so, then investors should factor this into their choices, especially in a mining market like Australia.

Major energy companies may not be sufficiently cognisant of rapid advances in clean technologies that could undermine their businesses (renewables, battery storage and electric cars). Investors in new mines like Gina Rinehart might be heading for trouble. If the oil sector does not need to expand, what are the fair value prices of oil companies? Investors will want to know what decisions are being taken by companies to align them with a 2˚C objective. Company analysts are seeking sensitivity analysis for stocks most resilient against this 2˚C goal and investors will want to adjust their exposure accordingly.

For stocks like Woodside and Santos, the impact of the Paris talks is limited in the short term while structural demand for their product remains. As always, cyclical forces will push commodity prices around. For oil and gas in the short term, emergence of US shale gas and reintroduced oil supply from Iran are more significant than climate change. So for investors, it may be unwise to flinch in the face of price volatility just yet… but keep watching.

But in the longer term, increasing renewable energy sources will create another factor capping potential commodity prices. The price impact of new energy outputs (like a breakthrough in renewables) will vary depending on the strength of energy demand at the time. As an example, new shale gas had great impact on prices because demand was soft over the last few years.

Obviously, climate change will be an emerging theme to influence investing decisions more and more over time. It would be important to keep our eye out on individual stocks that will benefit from new energy technologies.