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Two books on Oil and our Energy Future – very different authors with some suprisingly similar conclusions

5 October 2011, 11:48 am

Two authors, with very different styles, approaches and opinions, write books about oil and our energy future. Reading them together, it is easy to imagine a provocative and enlightening panel with the two authors. But the real takeaway are the points on which they both come to very similar conclusions.

Kenneth Deffeyes, the author of When Oil Peaked, is a petroleum geologist and emeritus professor of geology at Princeton who began his career in research at Shell. You can imagine his being entertaining in the classroom, as he writes in a breezy style, seeming almost to toss out ideas as they occur to him.

Leonardo Maugeri, the author of Beyond the Age of Oil, is the senior executive vice president of strategies and development for Italian oil and gas giant Eni SpA. His approach is more methodical, more based on the business numbers involved in energy.

The two authors bring very different perspectives on key issues:

  • Deffeyes is a strong supporter of the peak oil hypothesis, having also written the book “Hubbard’s Peak”. Maugeri argues that there is not a shortage of recoverable fossil fuels.
  • Deffeyes thinks of the climate change movement as wanting to take us back to pre-industrial society. Maugeri sees climate change as a defining moral challenge for our society.
  • Both men view climate change itself as a real problem. Deffeyes approaches it as an engineering problem with an engineering solution (not necessarily geo-engineering). Maugeri is concerned about the societal shift required before the problem can be truly tackled.

There are other differences along the way as the authors proceed through their analysis of all the alternative sources of energy. And not surprisingly, their specific recommendations on how to reach our energy future also differ.

So what is worth noting is the strong convergence from both authors on several conclusions:

  • We must move away from fossil fuels.
  • Energy from the sun is the potentially limitless energy resource. Tapping it successfully, though, will take perhaps 50 years.
  • Renewables today are a very small part of the solution, though growing rapidly.
  • Coal, gas and nuclear will therefore be major energy sources for many years. We must make the tough choices of how much of each we will use and how to mitigate the problems they cause.
  • The low price of fossil fuels (along with the volatility) is a significant barrier to progress.

Of the two books, I found Maugeri’s Beyond the Age of Oil more satisfying because it was more information-rich and more reflective about the author’s opinions and biases. But both are well worth reading, and I highly recommend reading them together to get the most out of both books.

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Beyond a niche – BSAS session on ESG integration

4 October 2011, 1:16 pm

We designed the September 27th BSAS lunch session on ESG Integration to highlight a development that is further along than many in the investment community realize – the progress ESG is making towards incorporation in the mainstream.

Putting it in the familiar terms of the technology adoption lifecycle model, our panelists’ presentations made a case that the integration of Environmental, Social and Governance factors is well along in the early adopter phase.

Noel Friedman, Vice President of ESG Business Development at MSCI, pointed to several trends driving integration.

  • Asset owners are increasingly demanding ESG reporting and incorporation from their asset managers.  Signatories to the UN Principles for Responsible Investment now represent $30 trillion in assets under management.
  • Asset managers are increasingly seeing that ESG factors capture externalities that can represent mispriced risks and therefore opportunities.

Noel expanded on these opportunities with several examples using different industries, issues and metrics.  He walked through identifying an ESG issue with potential impact on a specific industry, presenting data for analysis and drawing possible conclusions that could influence investment choices.  Examples included:

  • water management in the worldwide steel sector
  • the impact of electricity cost increases on industrial gas manufacturers
  • the implications of the wide range of  the  higher-risk loans/equity ratio among banks
  • sensitivity to labor conflict in the airline industry

Michael Cantara, an Institutional Portfolio Manager and Co-Chairperson of MFS Responsible Investment Committee at MFS Investment Management, followed by picking up the themes of investor demand for and opportunity to create value with ESG integration.

Their conclusion is that long term value creation is consistent with many ESG principles.  That led to a decision for a firm-wide integration of ESG considerations into the investment process.   Rather than create a separate team of ESG specialists, ESG training and tools were provided to the entire investment team.  Armed with that understanding, the  teams themselves decide how to apply them.  The integration is overseen by a firm-wide senior Rersponsible Investing Committee.

Michael followed that overview with several examples  from their experience demonstrating  how their investment teams incorporate ESG assessment as a component of their investment case. The examples considered a specific environmental, social or governance issue and the resultant impact on their investment case for a given company.   There may be no change at all; in other examples the ESG factors led to a more positive investment case or removed a potential negative.

Taken together, the panel presentations and discussion provide evidence that demand for ESG integration is growing and investment managers are discovering competitive advantage by responding.

(The presentation materials from both panelists are available by request. Please contact me to be put in touch with either Noel or Michael.)

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ESG Performance white paper asks a bigger question

16 August 2011, 7:01 pm

A recently published white paper from RCM provides evidence of outperformance generated through best-in-class ESG investing.  Because it examined a sizable number of stocks (more than 900 spread across three geographic portfolios) over a period encompassing a wide range of market conditions (December 2005 to September 2010), it  raises the conversation about ESG investing to a broader market level than the specialty niche to which it is too often confined.

The RCM team used the widely-available MSCI ESG research to divide companies chosen from the MSCI US, Europe and World indices  into five tiers of ESG ranking from A (best) to E (worst).  They then compared the performance of these constructed portfolios against their respective indices for the 12/05 to 9/10 period.

  • A best-in-class portfolio (A and B ranked stocks) outperformed its index by 1.6% (Europe), 1.6% (World) and 2% (US).
  • A worst-in-class portfolio (D and E ranked stocks)  underperformed its index by -2.5% (Europe), -0.5% (World) and -0.3% (US).

These portfolios achieved their results with volatility similar to that of their respective indices, so at the aggregate level, the hypothetical investor in these portfolios was not asked to assume additional risk for the outperformance.

The white paper is, certainly one more data point of a growing number that support the idea that integrating ESG factors into investment decisions can benefit investors.  But consider it important for another reason -we are now at the point where a large enough number of companies can be evaluated by their ESG posture over a long enough period that ESG performance can increasingly be examined on a much wider scale.  Investors should expect – and demand – that their managers and fiduciaries provide that analysis.

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The high cost of oil – in jobs

7 June 2011, 2:29 pm

Efforts to address energy and climate challenges are now reflexively branded as “job killers” by one part of the political spectrum. Amazingly, this happens even when the proposals are defined in terms of their positive economic impact, as in the development of new companies and industries.

Perhaps we should consider the true job killing impact of our current dependence on fossil fuels. Today’s Heard on the Street column in the Wall Street Journal includes an item titled “Oil Should Fuel Next Aircraft Boom”. It posits that a decade-low CapEx of 8% by the airline industry, combined with current price of fuel and an aging medium-range fleet means good times ahead for aircraft manufacturers as they provide new, more fuel-efficient aircraft. So far so good.

But flip back to the start of the article and you see another story. Fuel now accounts for 30% of operating costs, up from 13% 10 years ago.  Labor, which 10 years ago accounted for 35% of operating costs, is now 25%.  Even allowing for some efficiencies, that’s a lot of jobs traded away to pay for fuel.  And anyone who’s flown in the last few years can tell you that the airline industry could use some of those jobs to provide a semblance of service to the customers they abuse so badly.

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Restructuring Roundtable April presentations available

27 May 2011, 9:47 am

Presentations from the April 15th Electricity Restructuring Roundtable are available on Raab Associates’ web site. One session, a presentation by Peter Fox-Penner, offered two business models likely to replace the current utility industry structure. The second, a panel discussion, considered how the adoption of electric vehicles and energy storage technology would transform the electric grid.

Fox-Penner argued that, after nearly a century of stability, the electric utility industry is undergoing a series of massive changes:

  • Flat or declining growth in sales
  • Decarbonization of electric supply
  • Growth in renewables
  • Energy Efficiency as a source of cost-effective supply
  • Smart Grid

that will drive the adoption of one of two business models for the future:

  • a Smart Integrator – a regulated distributor that delivers purchased power and other services to downstream customers (an extension of today’s leading edge)
  • an Energy Services Utility that mixes purchased power and services with its own offerings, all focused customer service

The panel considered:

  • the electrification of vehicles with presentations from A123 Systemsand the Electrification Coalition
  • energy storage technologies, with presentations from Beacon Power (flywheel storage) and Xtreme Power (large scale dry battery storage)
  • the impact on utilities and power providers, with presentations from NRG Energy and Northeast Utilities

Presentations are available here on Raab Associates’ web site.

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Cape Wind: 10 years and counting – Donghai Bridge: 4 years

22 April 2011, 10:23 am

The race for the clean economy may be a marathon and not a sprint, but the intermediate times you collect along the way tell you a lot about how you’re doing. Secretary of the Interior Ken Salazar’s Tuesday announcement that his approval of Cape Wind’s Construction and Operations Plan “suggests that construction…could begin as early as this fall” is one such milestone, and not an encouraging one, for the United States.

It has taken ten years for Cape Wind to get to this point, and construction has not even begun. Meanwhile, the Donghai Bridge Wind Farm off the coast of Shanghai began producing power last July. The project took about four years from start to completion.

Such comparisons inevitably lead to a round of increasingly complex arguments about the political, economic, social and regulatory differences between China and the United States. Those are important issues that have to be discussed. That’s how you identify solutions to the competitive challenges that cause the gap. But what gets lost when those arguments begin is the sense of urgency that the original comparison should have created.

To capture that sense of urgency, think of it in terms of two companies competing in a growing technology industry. You’ve taken 10 years to bring a new product line to market, your competition has done it in 4. The message is crystal clear – that large a gap will doom the company. The company’s resources and talent must now be concentrated on closing that gap.

Now when a company starts examining those political, economic, social and regulatory differences, they are doing so with a purpose. For each difference, the decision tree might look like this:

  • Does this challenge have a large impact on our competitiveness?
  • If not, ignore it and move on.
  • If yes, do we as a company have the internal capability to address it, through business process changes or innovation?
    • If yes, make these the focus of your efforts. Differentiate between those where the response would be only a catch-up and those where you can gain a competitive advantage.
    • If no, does this affect others in our industry?
      • If no, put this in the queue for the next strategic strategic review. Competition with China is a symptom of a more basic problem in the business.
      • If yes, consider collaborative efforts (partnering, joint ventures, through industry associations, with government) to address the challenge.

Every company completing such a review should have generated some actions to take. If not, that may be a sign that the business isn’t viable in the long term.

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Water…what is it good for…absolutely everything

4 February 2011, 7:45 pm

Journalist Steven Solomon has written an epic social, geopolitical and economic history of water. At 490 pages and covering the world from ancient Sumer to the future economic opportunities for industrialized democracies in a multipolar world, it is comprehensive and compelling.

“Water” will reward the curious reader with an illuminating perspective on how obtaining, using and controlling this most basic of natural resources shaped each of the major civilizations and eras of human history to the present day.

By tracing an arc from the earliest civilizations for whom water was the defining variable of development to the modern world where Europe and later an America rich in natural resources and technical prowess combined to create unparalleled wealth, the author sets the stage for a coming “age of scarcity”. In this future, the vastly increased demand of modern civilization, supply depletion, environmental damage and population growth combine to make water once again the limiting variable.

The last third of the book is Solomon’s take on what that scarcity means for the economies and the people of major regions of the world, and on how they might respond to overcome those challenges. If you’ve followed me this far, the titles of his last three chapters:

  • Thicker than Blood: The Water-Famished Middle East
  • From Have to Have-Not: Mounting Water Distress in Asia’s Rising Giants
  • Opportunity from Scarcity: The New Politics of Water in the Industrial Democracies

should be all the further incentive you need to read this book.

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Large potential increase in domestic natural gas supply welcome, but not a panacea

21 December 2010, 2:19 pm

Last week’s announcement of the Early Release version of the US Energy Information’s Annual Energy Outlook for 2011 prompted a number of reactions along the lines of the NY Times’s Green Blog posting “The energy future ain’t what it used to be“.  Driving that reaction is the opening bullet of the Executive Summary, which highlights a significant increase from the 2010 report in estimates of domestic shale gas resources.  That leads in turn to a lower projected cost for gas and electricity in 2035 than in last year’s report (though still higher than today’s prices). 

Undoubtedly, that will be enough for some to cite the report as evidence that the development of US shale gas reserves are our energy silver bullet.  No more need to promote  renewable energy development,  take action on climate change, put a price on carbon, be concerned about energy independence and energy-related national security threats, increase energy efficiency and certainly no need to de-carbonize the economy.  That would be wrong, and a closer look at the report demonstrates why.

The projected increase in shale gas resources is in unproved resources, a much more speculative number that proven reserves. The 480 trillion cubic feet increase is dramatic, but tells us very little about how much will ultimately be delivered for use. Yet the model does assume a doubling in delivered supply over last year’s prediction.

Shale gas is a relatively new resource, and the techniques to extract it are also new and at the cutting edge.  The EIA only started tracking the production of shale gas in 2007.  The model’s projection of future supply and prices assumes that production of shale gas will grow four-fold from current levels by 2035. Most of that growth will be needed just to make up for an expected 30% decline in conventional production. Even if the technologies involved had no anticipated downside risk, that level of growth could be a stretch.

But there are potential concerns with the technologies involved with large-scale shale gas extraction – especially hydraulic fracturing (“fracking”). Fracking involves the injection of large quantities of water & chemicals into the ground to fracture rock and release the gas. Serious questions have been raised about potential damage to water supplies. Even if one believes that the concerns are overstated and any problems are surmountable, a significant element of risk has been added. That the claims of safety are being made by the same extraction industry that gave the world the Gulf Oil spill is not going to inspire a high level of trust.

Even if the extraction problems never materialize or are solved, all that additional gas barely moves the needle on reducing greenhouse gas emissions from electricity generation. Even with low gas prices and low cost of construction for gas-fired power plants, reliance on the existing fleet of coal-fired power plans means that the dirtiest fuel will go from generating 45% of 4 trillion kilowatthours of electricity each year in 2009 to generating 43% of 5 trillion kilowatthours of electricity in 2035. A more aggressive retirement of coal plants would improve that picture, but that would require significant market incentives and/or regulation. And, given the projected decline in conventional gas production, it would require an even greater increase in shale gas recovery.

Finally, there’s the global picture. Natural gas is a commodity in a global market. The technologies and infrastructure for using natural gas – power plants, heating and cooling systems for buildings – are global products. The supply and demand picture for natural gas looks very different for the rest of the world than for the US.

  • European import dependence – the US imports only about 10% of its natural gas today, and the projected increase in production from shale gas could eliminate virtually all those imports. Europe imports 50% of its needs today, and that number will increase as European gas production declines over the next twenty years.
  • Less stable sources of supply – Russia, Iran, Central Asia, North Africa and the Middle East produce 50% of the world’s supply of natural gas. Americans have not had to face the prospect of a mid-winter cutoff of the natural gas that heats their homes and offices, but Europeans have.
  • Significant growth in demand from emerging Asia – Over the forecast period, the demand for gas from China, India and other developing Asian countries is expected to increase two and a half times. From using about 1/2 the natural gas that the US does today, by 2035 those nations will slightly exceed total US demand.

So while the possibility of a significant increase in the domestic supply of a cleaner fossil fuel is welcome, it is not a panacea for our energy and climate challenges. Increasing energy efficiency, advancing renewables, reducing our reliance on oil and phasing out coal power are all important elements in our energy portfolio planning.

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SEC Climate Change Disclosure Requirements: What you need to know – Legal, Analyst, Corporate and Asset Manager Perspectives

1 December 2010, 10:21 am

Please join us for a BSAS panel on SEC Climate Change Disclosure Requirements on December 14th. The investment community has an opportunity to shape the future of public disclosure by getting involved early (and often). This program is one of several the SRI program sub-committee of the BSAS is planning for the coming year. If you have any questions, please contact me.

Boston Security Analysts Society Luncheon Program
Tuesday, December 14th, 2010, 12:15 – 2:00 pm
Hyatt Regency, Boston
Registration and Additional Details

SEC requirements for disclosure of material climate change impacts became effective earlier this year upon the publication of clarifying guidance by the agency. With the upcoming flood of annual filings following the end of this calendar year, virtually all public companies will be reporting based on their assessments of how climate change will affect their business, most for the first time.

Join our panelists to learn what the disclosure requirements are (and aren’t), what good disclosure practices are and what you can learn from companies who practice them, what you can expect to see and what opportunities these new guidelines may offer for analysts and asset managers to shape more informative disclosure going forward.

Panelists:

  • Chris Davis, Director of Investor Programs, CERES, and environmental attorney. Former partner, Goodwin-Procter.
  • Adam Kanzer, Managing Director and General Counsel of Domini Social Investments. Member of SEC Investor Advisory Committee
  • David Lodemore, Senior Vice President of Risk Management at National Grid
  • Rebecca Henson, Sustainability Analyst, Calvert
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Are Commoditization or Aggregation solutions for small-scale project finamce?

28 October 2010, 2:00 am

There is general agreement that, below a certain size, the transaction costs of a renewable energy project become prohibitive relative to the scale of the benefits. Typical transaction costs include the time and cost involved in:

  • The many legal documents and agreements – land leases, power purchase agreements, financing, agreements among partners and owners, construction documents
  • The due diligence for financing the project
  • Permitting and zoning

The problem is the cost and time required for these steps do not scale with the size of the project. There is a huge fixed component to each of them. They are substantial enough that even mid-scale projects – 500 kW to 2 MW wind or solar – suffer from the effect of these costs. So although there may be a huge potential volume of distributed generation projects at this level and below, funding them is proving very difficult.

This phenomenon is not new with renewable energy finance. It has happened repeatedly in funding capital investments involving new technologies or new business models. The problem is fundamentally one of reducing risk for those who will approve, fund and ultimately be responsible for a long-lived, income-producing asset. So each project carefully goes through the same series of steps, consuming significant amounts of time and money.

There are two basic ways out of this dilemma – commoditization or aggregation.

Commoditization reduces the cost and complexity of a transaction, making it replicable over a wide variety of circumstances. It identifies the critical elements common to most projects, creating a single set of transactions that can be repeatedly executed successfully at much lower cost. It works when a large enough volume of projects fit those criteria.

Aggregation combines a large number of projects into a single larger project. It too employs a simpler set of transactions to reduce the costs, but accepts more variability in the individual transactions. It spreads the cost of individual failures that might have been caught with the more expensive process over a large number of successful transactions. It works when that incremental cost is less than the savings each project realizes from the simpler process.

Both commoditization and aggregation have been successfully used over the last several hundred years to drive economic growth by enabling widespread adoption of new technologies and business models. There have always been barriers of complexity and uncertainty to overcome, and the case of clean energy projects is no different.

Aggregation is usually the simpler path, at least initially. It requires less detailed and certain knowledge than commoditization. Unfortunately, the pigs’ breakfast the financial services industry made of the economy by pursuing that strategy beyond any rational bounds with mortgage financing has all but closed that avenue for now. Reopening it by rebuilding confidence is a necessary step.

Commoditization is often the path to greater long-term growth. For clean energy projects, it must overcome two significant obstacles:

  • Inertia – the intermediaries, largely service providers, that benefit from the transaction costs have little motivation to implement a lower-cost system. Even though the overall business volume could be much greater, the professionals who do this work are not generally well-positioned for high-volume low-cost service delivery. Overcoming this barrier requires that some entrepreneurial service providers step up.
  • Experience-based knowledge – the process of commoditization, whether of a product or a process, requires an understanding how the product works in different conditions that is only available through real-world experience. The volume of clean energy projects is growing, but still limited, and much of the useful experiential information is proprietary. Public funding that is helping establish the market should be coupled with public policy that ensures the necessary information is gathered and made available.

Clean energy projects may never become as commoditized as personal computers and car leases nor as aggregated as home mortgages, but the opportunity for significant market growth lies in pursuing those alternatives as far as they can reasonably go.

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