Toward the end of fossil fuels

My name is Ozymandias, King of Kings;

Look on my Works, ye Mighty, and despair!

Nothing beside remains. Round the decay

Of that colossal Wreck, boundless and bare

The lone and level sands stretch far away

The destruction of our world’s climate has to end: this much nearly everyone accepts. For most, the tools to turn around the looming catastrophe are: personal behaviors, government policies and public calls for action. In fact another tool — finance — surely is the most important. Specifically, until bankers starting downgrading or exiting investments in fossil fuels, the problem is not solved. Conversely, when bankers start downgrading these investments (and investors start walking away from fossil fuels), the solution is at hand.

Starting in this note, we’re going to ask the key question: “what has to be true for finance to downgrade investments in fossil fuels?” Or: what will have happened such that our descendants see today’s giants of the fossil fuel economy as ancient relics, notes in a history book?

Important notes:

• Caveat #1: we’re not investment advisors. Nothing here, or in any of the subsequent or related notes, should be read as investment advice.
• Caveat #2: while we’re going to use best-available data — and make our sources and calculations freely visible — we’ll get some things wrong. Stick with us, help make our data more accurate. Let’s get this right.
• A quantitative note: We’ll often use the expression trillion: it means — one thousand billion = one million million. The world’s total economic output for a year is about 100 trillion US dollars — $T100.

The idea that banking, finance, can be part of the resolution of the challenges is not easy to grasp. Reasons include:

• Investment managers are generally expected to act in amoral ways — investing to achieve returns, irrespective of the morality of the underlying actors. Investment funds with moral charters are as yet a small portion of the overall investment universe.
• Investments are expected to achieve returns in quarters and years, whereas the challenges of climate change, even at this relatively late time in their emergence, accumulate in time periods of decades.
• Fossil fuel energy companies are such a large part of the economy that it’s difficult to run a vast fund (e.g. a sovereign wealth fund, or a large pension fund) without putting significant funds into energy. When anti-Apartheid activists, decades ago, created divestiture as a tool to persuade firms to dial down their investments in South Africa that was possible in part because the South African economy is a small fraction of the global economy: plenty of other places to put money to work. That is not the case for the current state of fossil fuels.

Our belief, then, is that for finance to start downgrading their positions, it must be demonstrable that fossil fuel investments are going to become less interesting as investments, by the standards of normal investments. And these demonstrations must be increasingly rigorous, irrefutable, backed by the data and methods that investors themselves use. In these notes, we aim to provide quantitative assessments of the state of the fossil fuel industries to understand how their value as investments can and will wither, how these colossi astride our financial world will be revealed as, or will inevitably become, shams.

How daunting is this prospect? Really hard: energy is about 10% of the world’s economy; energy companies command about $8 trillion per year in aggregate revenues,. Really hard, also, because — despite the screaming evidence of global climate change, the overall picture of energy consumption shows consumption of fossil fuels continues to rise. Fossil fuel energy companies are often huge, and politically mighty, either because they’re government owned and controlled, or because their might means that have sway over governments. And yet …

• And yet: they no longer dominate the lists of most valuable corporations. A decade ago, any list of the top-valued companies would have been led by and studded with energy companies. Today, not so much. In early 2019, only one of the world’s 10 highest-valued public companies is an energy firm (Exxon Mobil); the rest are tech companies (Apple, Alphabet, etc.) or banks.
• And yet: their valuation multiples aren’t impressive (which, of course, explains why they don’t lead the valuable companies lists). The average valuation of publicly traded energy-sector companies is the same as their trailing twelve-month (TTM) revenues, a far lower multiple than pertains to tech-sector companies. For example, Exxon Mobil is valued at about 1.2 times trailing year sales / revenues; the average multiple for publicly traded energy giants is about 1.0. Meanwhile, Apple trades at about 3.6 times TTM revenues.
• Any yet: aggregate revenues aren’t as colossal as this implies. Yes, energy in total is a vast part of the global economy — as much as 10%. Within that, revenues for fossil fuel companies total $US6.3 trillion. And within THAT, wholesale revenues of oil + gas + coal total about $2.8 Trillion per year. Still a great amount of money, but — as we’ll see in future notes — one that is rather more leveraged and vulnerable, and less secure, than one might anticipate.

In some future notes, we’ll look in detail at the numbers, the balance sheets and P/L statements of the world’s energy economy, to understand what has to be true for fossil fuels to be no longer investments worth having.

Footnotes:

1) www.poetryfoundation.org/poems/46565/ozymandias

2) In scientific notation: 1012

3) 2017: $T80.3 at official exchange rates; $T128 PPP (Purchasing Power Parity) www.cia.gov/library/publications/the-world-factbook/geos/xx.html

4) In contrast: the political, social and financial pressures that brought apartheid to its knees in the 1980s were helped by the fact that divesting from South African assets was relatively easy: South Africa’s economy was then and remains a small part of the global economy: investors had many other places to put their money.

5) A rough estimate. We calculate $6.3T as the annual revenues of oil, gas and coal companies; IEA estimates that renewables now account for slightly under 30% of all energy in 2017. So, if revenue / BTU were the same for renewables, that’d add another $3T, but we subtract $1T to allow for double-counting (i.e. where an energy company has extensive renewable assets) or for the possibility of lower revenue per BTU (e.g. from user-owned solar installations without revenue). Thus our total rough estimate is $8T per year. /www.iea.org/newsroom/news/2018/march/global-energy-demand-grew-by-21-in-2017-and-carbon-emissions-rose-for-the-firs.html

6) An older essay gauges US energy expenditures as typically 8% of the US economy. www.instituteforenergyresearch.org/uncategorized/a-primer-on-energy-and-the-economy-energys-large-share-of-the-economy-requires-caution-in-determining-policies-that-affect-it/#_edn3

7) Example: the BP annual compendium of energy statistics, 2018 edition, p10 (note that the percentage of energy derived from fossil fuels is slipping slightly, see same report at p11). www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/energy-economics/statistical-review/bp-stats-review-2018-full-report.pdf

8) www.reuters.com/finance/stocks/financial-highlights/XOM — and 1.2x is a higher-than-average multiple than for most energy firms.

9) www.reuters.com/finance/stocks/financial-highlights/AAPL.O

10) oil, natural gas and coal; wholesale and retail; and including support industries (well equipment, refineries, pipelines, etc.)

11) https://docs.google.com/spreadsheets/d/1-w1uxxLk9lQr9FWbBtLk6uN1iZLqZI25qT-6GMsEk8I/edit#gid=0, work in progress, always.