Seeking Alpha – Focus on curbing supply as opposed to demand for fossil fuels may lead to permanent under investment in new supply projects.
This creates the risk of a supply-shock and energy crisis in the next decade.
For investors, this will create an opportunity to generate superior returns as supply-side constraints lead to higher prices and profit margins for existing fossil fuel companies.
Two news announcements recently caught our attention. Both announcements provided further comfort in our minds with regard to our positive thesis regarding the outlook for the broader energy sector over the next few years. The recent news announcements we are referring to are, firstly, this announcement by Glencore Plc (OTCPK:GLNCY), the international commodity trading and diversified mining conglomerate, in which it indicated that it would cap its coal production going forward.
The second news item that caught our attention was the announcement made by Norway’s sovereign wealth fund in which they outlined their decision to reduce the exposure of the fund to oil and gas companies. It follows a report from Norway’s central bank in 2017 in which the central bank said that dropping oil and gas investment would be a good economic move. In some ways, the decision by Norway reminds us of the Bank of England’s ill-timed decision to sell all its gold reserves in 1999, below $300 per ounce.
These articles and, in particular, the announcement made by Glencore once again illustrate the increasing pressure being brought to bear on fossil fuel producers by some shareholders as well as activists to reduce carbon emissions. As well-intentioned as these efforts may be, we believe there is an escalating risk that these same efforts that are being made in order to fight climate change may also be leading us towards a major energy crisis in the next decade.
Why do we say this? The central problem with the current climate change agenda and specifically as it pertains to the fossil fuel industry is that it seems more focused on the supply-side of the problem as opposed to the demand-side. The correct policy approach when it comes to climate change may be to focus solely (or chiefly) on the demand-side of the equation. It is only by reducing or eliminating the demand for fossil fuels that we can truly transition to the carbon-free utopia that so many seek.
Similar to policy when it comes to the issue of narcotics, policies that discourage the consumption not the production of fossil fuels will very likely prove more effective over the long-term in addressing the challenge of climate change. It will also mitigate or lower the risk of an energy crisis that spirals the world economy back into recession or even depression. An example of such demand-side policies would include the introduction of a carbon tax.
However, such a tax should be levied on end-user consumption – not production. So, specifically, a carbon tax on gasoline or diesel sales at the retail level or the imposition of an additional carbon tax levied on electricity usage. In an ideal scenario, electricity distribution companies would pay a tax on fossil fuel-sourced electricity, while purchases of renewable electricity would be exempt. Revenues from such carbon taxes could in turn be invested into carbon capture equipment and technology, given that a zero-carbon emission world realistically may be at least three to five decades away.
The disconnect with the climate change agenda is that activists tend to prefer targeting the supply-side of the problem or specifically fossil fuel producers since they are more publicly visible, and it is also a more palatable message politically for the electorate to digest. Raising taxes on end-user consumption (on fossil fuels) is far less politically popular, and one needs to only look at the recent “Yellow Vest” protests in France to find evidence of this political dichotomy.
However, attempting to starve the fossil fuel industry from capital and/or making it difficult for fossil fuel producers to produce and bring to market their output will only lead the global economy straight into an epoch-defining energy crisis, with similar ramifications for inflation, politics, and socioeconomic living standards as was the case with the OPEC-induced oil crisis of the 1970s.
Returning to the coal industry as an example, the aforementioned announcement by Glencore should also be seen in the context of the continued under investment in new coal mines, a theme that Glencore themselves have been pounding the table on since at least 2016.
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