Clean Coal and Energy Efficiency
When I boarded the plane for Tokyo, I expected focus of this year’s Group of Eight (G8) Summit in Hokkaido, Japan, to be alternative energy. Although we’ve certainly made money in alternatives, I see this as a highly limited solution for rising energy prices and environmental concerns.
I was pleasantly surprised to see the major discussions turn to more practical, workable solutions, such as clean coal and energy efficiency. In this week’s issue, I highlight some of the main impressions and trends I gleaned from this year’s summit.
A communique from the summit noted the G8’s commitment to reduce by 50 percent greenhouse-gas emissions by 2050. More specific targets also look set to come down the pike by the end of 2009. See Climate Change Regulation.
With the G8 no longer holding the reigns to the majority of energy demand, developing nations were also included in this summit’s energy discussions. Although not as concrete as the communiques from the actual G8 meetings, the leaders from these countries have put forth a desire to decrease emissions as well. See A Different Tone.
When I first wrote my editorial piece for the G8 Summit, I was unsure about my inclusion of coal and clean coal technologies. However, these topics were prevalent among many of the discussions at the summit, and we may soon see clean coal technologies become more mainstream. See Coal Is Still King.
The second most-important theme of the summit was energy efficiency, which many countries have already been practicing over the past 15 years. And rising energy prices are naturally aiding the process as well. See Energy Efficiency.
The recent pullbacks in oil and natural gas offer great buying opportunities for some of the Portfolio holdings. See Portfolio Update.
I’m recommending or reiterating my recommendation in the following stocks:
Every year the host nation of the G8 has some latitude in deciding which issues will be central to the summit dialogue. Japan made this year’s central themes climate change and energy security–issues at the heart of the energy debate and The Energy Strategist. Both topics will have huge implications for investors in coming years.
The most recognizable outcome of G8 meetings is the official communiques issued following major meetings between world leaders. Traditionally, these statements are issued jointly by the heads of the eight big industrial powers (the G8), representing a sort of compromise and give-and-take between world leaders. However, this year the summit was far more inclusive than that, with 22 nations participating.
The scope of participation in this year’s meeting is a testament to the rising importance of emerging economies such as China, India and Brazil; these nations all sent delegations to Hokkaido. These larger groups of nations also issued statements. In fact, some of the more interesting conclusions drawn from the meetings this year spring from the contrasts between the statements issued by the G8 and the more-inclusive communiques from the group of “major economies.”
But there’s more to be gleaned from the summit than just the official pronouncements and communiques. The G8 summit isn’t a single event; rather, there are several meetings between government officials that lead up to the annual summit. In addition, G8 leaders often form subgroups to look into, study and report on various topics.
For example, the G8 Plan of Action on Climate Change was inaugurated at the 2005 Gleneagles Summit in the UK and has held numerous meetings and summits since that time. The Plan of Action also enlisted the help of international organizations, including the International Energy Agency (IEA), in gathering data and statistics. The final reports relating the Gleneagles Plan of Action and the IEA’s specific recommendations were released during this year’s summit.
Finally, the host country often uses the summit venue itself to showcase key issues. This year, the International Media Center (IMC), where I spent most of the summit, was really an exhibition of clean energy technologies and R&D work undertaken by Japanese firms.
Taken together, the official communiques, reports and the IMC showcase offer some interesting insights into key trends underway in the energy industry.
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What’s really important is government action and policy. The simple fact is that governments all over the world are taking steps such as regulations, tax policy and subsidies to address climate change. These steps don’t just affect the public sector; they also have a very real impact on business and the stock market.
In fact, the collective actions of governments on climate change offer significant opportunities for investors. Ignoring these investment themes is akin to leaving money sitting on the table.
At last year’s summit in Germany, world leaders agreed to “seriously consider” a target of reducing by 50 percent global greenhouse-gas emissions by 2050. This year, the G8 actually committed to that target. There’s no unclear or ambiguous language in this year’s communique:
For those unfamiliar with this alphabet soup of acronyms, the IPCC is a scientific group put together to evaluate global warming and climate change. The IPCC released its fourth assessment in November 2007 and made a few key conclusions.
Among those is that there’s no doubt a warming trend is underway in Earth’s climate and it’s already having effects. The report went on to describe some of the negative impacts, including increased tropical storm activity, more heat waves and disruptions to rainfall patterns with a negative impact on agriculture. The report also concluded, with 90 percent certainty, that these changes are due to human activity.
To make a long story short, the IPCC assessment referenced in the G8 communique above is a fairly direct and specific treatise on the dangers and causes of climate change. The G8 communique essentially accepts this IPCC assessment as fact, a strong endorsement for the idea that climate change is an important issue that needs to be addressed.
The UNFCCC is the UN body that administers the Kyoto Protocol, the agreement made between certain countries to target carbon-dioxide emissions reductions. The Kyoto agreement provides targets for emissions reductions through 2012.
The UFCCC has plans to establish new targets beyond that date. The current plan is for agreement on the new targets before the end of 2009; a UN meeting scheduled for Copenhagen in November/December of 2009 is the target date for an agreement.
The G8 further agreed on adopting a specific, long-term target for emissions reductions. That target is a 50 percent or higher reduction of global emissions by 2050. The base year for this reduction target is 2005; as I detail below, a 50 percent reduction in emissions is an extremely aggressive, challenging target.
My point in publishing this quote is simply to note that this communique represents by far the strongest endorsement yet by the G8 of the dangers of climate change and the need to tackle the issue with aggressive targets. It represents a real hardening of the tone from the 2007 G8 communique. This is a clear indication that, like it or not, climate change regulations and policies will become reality in the developed world.
Of course, long-term targets are often meaningless. It’s a fair bet that none of the world leaders at this year’s G8 Summit will still be in power in 2050, so the resolutions have little immediate impact. However, the statement offers more specifics than simply a long-term target. Leaders went on to stress the urgency of adopting measures to stimulate the development of clean-energy technologies:
Through this, the G8 has also resolved to establish nearer-term goals for emissions reductions and greenhouse-gas mitigation. The other interesting point is that the communique suggests the major developed economies recognize a leadership role and are likely willing to agree to some mitigation efforts even if developing nations don’t agree to targets.
Bottom line: Whether you feel climate change is the most important issue facing the world or a complete hoax, from an investors’ standpoint, carbon regulations are a reality that can’t be ignored.
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Looking at it from an energy standpoint, in 1975 the six largest economies in the world accounted for 55 percent of total global oil demand. Now those original G6 nations account for less than 40 percent of global oil consumption; the enlarged G8 accounts for just 45 percent.
Even more important, energy demand in the big industrialized countries is growing relatively slowly. In the case of oil, demand from the G8 has actually fallen over the past three years by nearly 400,000 barrels per day. The real growth in energy demand is coming from the developing, not the developed, world.
The same basic pattern is obvious in carbon-dioxide emissions. Check out the chart of the Energy Information Administration’s (EIA) forecasts for global carbon-dioxide emissions.
Source: EIA
According to EIA data, countries outside the Organization for Economic Cooperation and Development (OECD), a proxy for the emerging markets, actually emitted slightly more carbon in 2005 than the developed OECD countries. This disparity is only going to grow in coming years; by 2030 the EIA projects that non-OECD nations will emit 73 percent more carbon than the developed world. Between 2005 and 2030, OECD carbon emissions are projected to grow just 14 percent, compared to a near doubling in the developing world.
Clearly, hosting a summit to discuss energy security and climate change without including nations outside the G8 would be laughable. Even if G8 countries were to cut by 75 percent their total emissions by 2030, it would not offset the projected growth in non-OECD carbon output.
At this year’s G8, several developing nations were included in enlarged discussions on these issues. These dialogues were dubbed the “Leaders Meeting of Major Economies” and included a total of 16 countries. China, India and Brazil, among other fast-growing developing countries, were part of these meetings.
The official communiques released from the leaders meetings were somewhat less aggressive in declaring targets and committing to carbon reduction efforts. For example, the leaders’ communique reads:
The leaders’ statement also indicates that climate change is a threat. But the key difference is that, in this communique, the nations don’t agree to a specific target; note, in particular, the language in the second paragraph talks about the concept of a target but offers no concrete numbers.
The third paragraph indicates that the developed countries have committed to going ahead with emissions targets and reduction schemes even if the developing countries won’t commit to firm targets.
We shouldn’t be surprised by the different language adopted by the G8 and leaders’ statements. Developing countries such as China and India are the fastest-growing source of carbon-dioxide emissions and are actually more important from a carbon standpoint than the G8 nations. At the same time, these countries would have an extraordinarily difficult time actually meeting a 50 percent reduction goal. In fact, I don’t see a way that China could reduce its emissions outright in the foreseeable future.
The reason is simply that many developing nations are experiencing strong economic growth at this time. Their growth in energy demand and carbon emissions is a consequence of that growth.
This is nothing at all new or unusual; the US, the UK, Japan and all other G8 nations are now mature countries with slow energy demand growth. But each of these countries was, at one point, a developing nation. During that phase, each country saw a similar, rapid run-up in energy demand.
For example, the UK’s industrialization in the 18th and 19th centuries was built largely on steam power generated by coal. And in the 20th century, Japan experienced strong growth in the post-World War II era, eventually becoming the second-largest economy in the world. From 1950 to 1990, Japanese annual crude oil demand jumped from one barrel per person to 15 barrels.
Chinese annual oil demand, while growing rapidly, is still less than 2.2 barrels per person and India’s annual oil demand less than one barrel per person. This is a tiny fraction of the consumption levels that prevail in the US, Western Europe and other developed countries. Most emerging markets are still in the early stages of what’s likely to be years of strong energy demand growth.
Given this dynamic, it’s hardly surprising that China, India and other developing countries are reluctant to sign on to carbon-emissions reduction targets. These countries’ rapid economic growth in recent years has meant strong growth in energy demand. Actions to sharply curb emissions would threaten that growth. After all, today’s G8 relied on energy to fuel their development in decades past; China and India are simply following the same path.
That isn’t to say that the developing world won’t take action to curb emissions. The Chinese government is clearly concerned about pollution. Pollutants, including sulphur dioxide and nitrous oxide, are so onerous in China that the nation is curbing construction and driving ahead of the Olympics this year in an effort to put a good face forward for the rest of the world. China has also taken steps to shut down small, coal-fired power plants that are particularly inefficient and polluting.
And China and India are equally concerned about the security of their energy supplies. This is at last part of the impetus behind both nations’ efforts to diversify energy supply to include nuclear power, renewables and greater energy efficiency. These steps will also reduce emissions of carbon dioxide and pollutants.
And don’t forget there are other motivations for the developing world to diversify their energy supplies. Global energy prices have skyrocketed in recent years; higher energy prices act as a signal for consumers and businesses to look for ways to cut back their energy demand and/or explore alternative sources of power. Developing countries are clearly concerned about obtaining cost-effective energy supplies needed to promote economic growth.
But with the developed world determined to regulate carbon emissions and the developing world likely to go along with this plan to at least some extent, the big question is how to achieve these targets. Or, more specific, the key question is: What technologies and fuel sources will be promoted as a means to reduce emissions and enhance energy security?
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One partial solution that received considerable attention at the G8: good old coal.
A few days after completing my editorial for the G8 magazine, I reread my article. My first reaction was that I had spent far too much time discussing coal and clean coal technologies. At the time, I thought that perhaps writing about the dirtiest of all fossil fuels in a summit devoted to climate change and clean energy technologies wouldn’t be appropriate. However, I decided to leave the piece as written because I firmly believe that any global energy strategy that doesn’t address coal as a key energy source is doomed to failure.
As it turned out, one of the most surprising outcomes of this year’s summit was the amount of attention paid to clean coal and the development of so-called carbon capture and sequestration (CCS) technologies. CCS is simply a technology for capturing carbon from power plant emissions and then permanently storing that carbon dioxide underground.
Most proposals for CCS involve capturing carbon dioxide and storing it in natural underground rock formations. This isn’t a pie-in-the-sky notion. After all, natural gas (methane) doesn’t exist underground in giant caverns but in the pores, cracks and crevices of underground rock formations. In a natural reservoir, gas doesn’t escape to the surface because there’s an impermeable cap rock above the formation that won’t allow the gas to pass through. CCS would involve injecting carbon dioxide into similar formations.
In fact, CCS is already being done on a commercial scale, though not to trap power-plant emissions. Norway’s Sleipner field in the North Sea contains natural gas mixed with unusually large quantities of carbon dioxide. Norway imposes a tax on carbon emissions so the operator of the field, Statoil, can’t simply separate and flare the carbon dioxide.
Instead, the company uses a technique known as amine scrubbing to remove and isolate the carbon dioxide. In amine scrubbing, the gas is mixed with liquid amine; this chemical absorbs gaseous carbon dioxide. The amine solvent and carbon dioxide can then be separated using heat, and the amine can be reused.
In the case of Sleipner, Statoil injects the separated carbon dioxide into a shallower rock formation located above the gas-producing Sleipner field, which contains mainly salt water. This formation is sealed, so the gas can’t escape. Statoil monitors the formation to ensure that no gas accidentally escapes. Sleipner captures a total of about 1 million tons of carbon dioxide annually, and the rock formation used for sequestration has enough volume to store decades’ worth of produced carbon dioxide safely.
Although Sleipner involves capturing less carbon that the average coal plant, it’s still a valuable illustration that CCS is possible.
CCS and clean coal technologies were a centerpiece of just about every report and action plan that was drawn up for the G8 this year. And coal featured prominently in the official communiques both of the G8 itself and the broader leaders’ statements. Consider the following statement from the G8 communique:
It’s tough to imagine a more direct endorsement for clean coal technologies and CCS. The G8 communique essentially adopted the IEA’s Plan of Action recommendations; the final version of this plan was released during the summit. A key part of the IEA’s plan was to launch these 20 large-scale CCS demonstration projects and try to commercialize the technology by 2020. For a closer look, check out the chart below.
Source: IEA G8 Plan of Action
In the IEA’s report, the organization published several different emissions scenarios. The first is basically a business-as-usual scenario; this is a forecast of global carbon-dioxide emissions assuming no changes to the status quo. In this case, emissions would grow from 28 gigatonnes (Gt) in 2005 to about 62 Gt in 2050.
The IEA’s second scenario is a stabilization of emissions near the 2005 level; the IEA calls this its ACT scenario. The final scenario is the plan endorsed by the G8, an attempt to cut carbon-dioxide emissions to 14 Gt by 2050, half their 2005 level. This aggressive plan is known as the BLUE scenario.
The chart above shows the contributions of different technologies and strategies to achieving BLUE. Roughly 20 percent of the total reduction targeted under BLUE comes from CCS both in industrial applications (such as sequestering carbon produced in steel production) and CCS equipment installed on coal-fired plants.
The mistake many investors make is to assume that coal is a dead fuel. After all, resistance by environmental groups in the US has derailed many planned coal-fired facilities in the US. As I noted at some length in the April 23, 2008, issue, Electric Charge, US utilities are reluctant to build new coal plants because they’re unsure as to future carbon-dioxide regulations.
However, to blindly oppose new coal plant construction is condemnation to irrelevance. According to the IEA’s statistics for 2005, just less than 80 percent of China’s electricity comes form coal. And at roughly 70 percent, India is nearly as reliant on coal. And it’s not just the developing world; the US and Germany each derive about half their electricity from coal-fired plants.
I’ve highlighted the reasons for this dependence before in TES–namely the Sept. 5, 2007, and Nov. 7, 2007, issues, entitled Australia, Asia and Coal and Coal and Services, respectively. I won’t belabor the point here, but suffice it to say, coal is the cheapest source of fuel for electric power plants even after the recent run-up in prices. Moreover, big consumers such as China and the US have large reserves of domestic coal; many nations are less dependent on coal imports, compared to oil or natural gas.
By highlighting coal and CCS, the G8 is tacitly acknowledging that a failure to address coal will derail any ambitions it may have to achieve the IEA’s BLUE or, for that matter, ACT scenarios. Clearly, the G8 recognizes that, to have any hope of an agreement that includes China and India, any global climate arrangement will have to provide for clean coal technologies.
This focus is even more apparent in the leaders’ statement. See the following quote from that pronouncement:
All this rhetoric is an undeniable positive for coal-related stocks. Although coal stocks, including those in the TES portfolios, have performed well over the past year, there are still plenty of people worried about the potential impact of carbon-dioxide legislation. In fact, whenever I speak about coal and investing in the fuel, environmental concerns are the most common pushback I get from investors.
A real, working, commercial-scale demonstration of CCS would remove this cloud of doubt for good. Given the G8 commitment to climate change and CCS as a key enabling technology, I suspect we’ll see real progress on CCS over the next five years.
I recommended taking a large profit in MacArthur Coal earlier this year, but I still have three recommendations related to coal. First, Peabody Energy is the world’s largest pure-play coal mining firm. The company has reserves located in two main coal-producing regions: the US Powder River Basin (PRB) and Australia.
Coal in the PRB is found relatively close to the surface of the Earth, making it relatively cheap to mine compared to coal from underground reserves located in Appalachia. In addition, most PRB coal is low in sulphur; low-sulphur coal produces less sulphur-dioxide pollution when burned, making it desirable as a power-plant fuel. Peabody has some of the most desirable mines in the PRB.
Noted at length in the Sept. 5, 2007, issue, Australia is a key coal export market. The country is a large supplier of both metallurgical coal used to produce steel and thermal coal used in power plants. China became a net importer of coal last year; until recently, the country was a key exporter in Asia. Peabody’s mines in Australia are direct plays on the strength of Asian demand for coal and China and India’s thirst for imports.
Longtime subscribers who got into Peabody on my original recommendation last year are showing a big profit; I recommended ways to hedge this gain in the June 12, 2008, flash alert, Unsteady as She Goes. If you have a large profit in Peabody, it’s not too late to take that advice to protect profits.
However, the recent pullback in Peabody stock appears to be a knee-jerk reaction to the sell-off in crude oil, while the fundamentals of coal remain largely unchanged. Strong import demand for coal has supercharged US coal exports. And the loss of coal to export markets has significantly tightened up the US coal inventory picture. As the chart below indicates, coal prices remain strong.
Source: Bloomberg
Bottom line: Even if oil pulls back further, I don’t see Peabody trading under $60 for long. I’m raising my buy target for Peabody Energy to 75 and see the current pullback as a good opportunity to jump in if you don’t have a position. Also note my higher recommended stop, designed to lock in larger profits in Peabody.
Second, Peabody spun off Patriot Coal late last year; I recommended holding on to the Patriot shares. This stock has been a real moon shot: It started trading at $35.55 and has rallied to as high as $161 before pulling back recently to about $120. Because Peabody shareholders received one share of Patriot for every 10 shares of Peabody owned, this is equivalent to about $12 in additional value per Peabody share.
Patriot basically was formed for ownership of Peabody’s East Coast mines, located in regions like Appalachia. Traditionally, I haven’t been enamored with eastern-centric coal mining firms because of their higher cost structure, trouble getting skilled labor and intense regulatory hurdles.
However, I began to change my opinion late last year because, with many of the world’s key coal exporters sending their coal to Asia, Europe has been having difficulty securing coal imports. It’s now turned to the Saudi Arabia of coal, the US. Many European utilities are signing multiyear supply deals at high prices that offer solid returns for eastern miners despite their high cost structures. And because of their proximity to export ports on the East Coast, the miners in Appalachia are taking full advantage.
In addition, Appalachia does have some of the world’s highest-quality metallurgical coal reserves; this coal is highly prized in steelmaking. With some of the best mines in the east, I recommend holding on to Patriot Coal for now.
The railroads are a final play on coal. I highlighted my rationale for recommending Norfolk Southern in the July 2, 2008, issue, Take a Ride.
Finally, given the continued strong market for coal and coal stocks and the recent temporary dip in prices, I’m upgrading most of the coal stocks in the How They Rate Table, with an eye toward an additional Portfolio play in coming weeks. Right now I’m focused on two stocks:
Consol Energy–Consol’s main reserves are high-sulphur coal in northern Appalachia. Northern Appalachian mines haven’t seen the same level of cost inflation and regulatory burden that mines in Central Appalachia have over the past few years. In addition, more utilities are adding advanced scrubbers to their smokestacks; this allows them to burn the higher-sulphur coals that Consol produces. This is one reason why the premium prices attached to low-sulphur coal have been shrinking of late.
China is facing a big problem right now: looming power shortages. Low rainfall is impacting the country’s hydropower production, and domestic coal production just isn’t keeping pace with demand. This is hardly surprising when you consider that China builds a new plant once every seven to 10 days. That’s equivalent to adding the UK’s annual electric capacity.
The US has become the supplier of last resort for coal, thanks to its huge reserve base. Consol is particularly well positioned to benefit for two reasons: It has the capacity to significantly grow production from current mines, and the company owns the coal export terminal in the Port of Baltimore, giving it direct access to the ultra-strong export market.
Consol Energy rates a buy in the How They Rate Table. I’m looking to take advantage of the recent weakness in the stock to potentially add it to the Gushers Portfolio.
International Coal Group–For a long time, International Coal was a chronic underperformer I recommended avoiding like the plague. The problem with the firm is that it owns high cost mines in Central Appalachia, a region where coal mines are extremely mature.
However, the big change in the coal mining industry over the past 12 months is that it’s increasingly moving from a domestic demand story to an international, export-driven market. Eastern miners are benefiting because they can sell their output at sky-high prices into export markets.
In fact, because of rising export prices, International Coal has moved from a money loser to a profitable firm. I’m raising International Coal to a buy in the How They Rate Table.
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There’s good reason for this focus: Boosting energy efficiency is, in most cases, the cheapest means of cutting carbon-dioxide emissions and reducing fuel costs. As the chart earlier in this issue indicates, the IEA projects that energy-efficiency improvements are capable of producing nearly half the total carbon-dioxide emissions reductions under its BLUE scenario.
Energy efficiency is a broad term that refers to efficiency gains in power plants, transportation, industry and, of course, the home. This isn’t just projection of what’s possible; most developed economies have already seen dramatic gains in energy efficiency over the past few decades. In fact, the IEA noted an amazing statistic in its report to the G8: If there were no energy efficiency gains in IEA countries since 1973, global energy use would have been 58 percent higher in 2005 than it actually was.
The IEA did focus somewhat on government action as a means of promoting energy efficiency. I disagree somewhat with that notion; in my view, the free market is the prime driver of efficiency gains.
Consider that, according to the IEA, efficiency gains in OECD countries over the past 15 years is about half what the case was back in the 1970s and ’80s. The main reason was the ’70s and early ’80s was a period of rapidly rising energy costs. Companies and consumers alike were looking for ways to save on fuel costs; rising energy prices drove efficiency.
In contrast, for much of the past 15 years, energy prices really weren’t an issue. With fuel costs relatively low, looking for ways to increase efficiency was a far-less-attractive proposition.
But with energy prices again on the rise, the IEA’s and G8’s focus on efficiency is appropriate. Just as we saw in the ’70s, rising energy prices will drive a desire to save on fuel costs. The addition of carbon-based targets will, if anything, just serve to accelerate that trend. Check out the chart below for a breakdown of where the IEA believes these savings can come.
Source: IEA, “IEA Work for the G8,” July 2008
In many cases, the IEA believes that energy efficiency gains actually have a negative cost given current high energy prices. In other words, it costs money to make the improvements to machinery, equipment and building design that are needed to save energy. However, in many cases, the value of the fuel saved exceeds the cost of improvements even if there is no specific carbon-dioxide tax or incentive.
There are ways to play the drive for energy efficiency globally. One of the most obvious is closely related to my discussion of coal above: the drive for greater efficiency in fossil-fuel power plants. I highlighted this trend in the May 16, 2008, issue of The Energy Letter, Coal Investors Take Their Lumps.
The IEA estimates that, if all power plants globally were upgraded to state-of-the-art facilities, total fossil fuel consumption for power generation would drop between 23 and 32 percent. The largest source of these savings would be upgrading the world’s fleet of coal-fired plants.
The developing world could certainly benefit from upgrading the quality of their coal-fired power plants. For example, India’s average efficiency for fossil-fuel power plant generation is just 28 percent, the lowest of the countries the IEA studied. This is mainly because of a large reliance on very older, inefficient coal plants.
The best coal plants in the world today run at around 43 percent efficiency. India could save considerable fuel and massively reduce emissions from its coal-fired plants by gradually retiring these older plants and replacing them with more fuel-efficient facilities.
But power-plant efficiency gains aren’t just a developing world phenomenon. In the US, environmental groups are actively blocking new coal-plant construction on the theory that coal is the world’s major source of greenhouse-gas emissions. This policy is, however, having the opposite of the intended effect. New US coal plants are much more efficient than the current fleet of plants that are, on average, three decades old.
This is why US fossil-fuel fired generation efficiency is among the lowest of any OECD country. It’s also why the US has seen very little increase in overall average efficiency since 1990.
As an aside, it’s totally impractical to install CCS equipment on older coal-fired plants. By opposing new plant construction, US environmental groups are actually limiting the potential for the US to meaningfully reduce greenhouse-gas emissions when this new technology is rolled out commercially post-2020.
At any rate, fuel efficiency considerations are already driving new, efficient plant construction the world over. China has been closing small, old coal-fired facilities and building more state-of-the-art plants; it’s not inconceivable that China will surpass the US in energy efficiency in the coming decade if this trend continues.
But in the developed world, there’s also a growing push for efficiency. The G8 and IEA have adopted very strong language supporting upgrades to coal-fired plants both for the immediate efficiency gains as well as for the eventual CCS potential. This is filling the order books of companies involved in state-of-the-art power-plant construction.
Of course, power generation is only one aspect of energy efficiency. Transportation is another industry that will likely see a sharp increase in efficiency gains in coming years. Part of this is, of course, a growing preference for smaller, more-efficient cars. The fact that General Motor’s sales of trucks and SUVs is off more than 20 percent so far this year in the US is proof that higher energy prices are already driving that change.
More interesting from an investing standpoint is air and rail transport. As I discussed in the most recent issue of TES, railroads are actually a highly efficient form of freight transport; desire to cut fuel costs is already helping the rails.
We’re also seeing a similar effect when it comes to passenger rail volumes. Ridership is up on subway and passenger rail systems all over the world as some consumers switch from driving to passenger rail transport.
Finally, as I’ve noted before, there’s strong demand for the Boeing 787 Dreamliner aircraft mainly because it’s far lighter than other aircraft of the same size. The plane is capable of cutting airlines’ fuel consumption dramatically.
We’re already playing fuel efficiency in the TES portfolios. Railroad operator Norfolk Southern is one play on fuel efficiency.
In addition, alternatives field bet Hexcel Corp is a bet on the future of aerospace. The company makes carbon fiber, a material that offers high strength and is extremely light. Traditionally, airplanes have been made primarily of aluminum. However, new planes such as the Boeing 787 and the new generation of Airbus aircraft are incorporating much higher percentages of carbon fiber in their construction. This bodes well for Hexcel.
I’m also adding a new play on efficiency to my coverage universe.
Alstom (France: ALO, OTC: AOMFF)–Alstom is a French construction firm that focuses on two major types of project: railroads and power plants. The company builds and supplies parts for modern natural gas, coal, hydropower and even nuclear power plants. In addition, Alstom performs maintenance and upgrades to existing facilities; this makes it a direct beneficiary of the desire to upgrade power-plant efficiency.
The company is also a world leader in urban transport and high-speed passenger train markets. Investment in this type of infrastructure is growing quickly, and rising ridership should help accelerate the trend.
Looking a bit further into the future, Alstom is also working on several CCS demonstration projects worldwide, including a handful of projects in the US. This business is a natural fit for Alstom because it already has years of experience fitting scrubbers on coal-fired plants and building highly efficient coal facilities.
Alstom’s backlog of unfinished orders currently has been soaring, a sure sign that demand is strong. Currently, the backlog sits at EUR42 billion (USD66 billion), equivalent to nearly 30 months of sales. I’m adding Alstom to the How They Rate Table as a buy.
CCS and energy efficiency were just two of the main themes to emerge from this year’s G8. Nuclear power, natural gas and renewables are three additional fuels strongly endorsed by the G8; I’ve already covered these in recent issues of TES.
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As far as crude oil is concerned, it’s ironic that some pundits are now talking about a pullback in crude to $100 per barrel. Some weeks ago a major financial magazine actually called for a pullback to $100 and stated that this was the bursting of the “oil bubble.” It’s easy to forget that last July crude was trading at $70 to $80 per barrel and didn’t actually break above $100 until five months ago.
As I pointed out in the June 4, 2008, issue, Crude Realities, the idea that rising commodity prices are a bubble driven by excess speculation is absolutely ludicrous. The speculation argument is nothing more than politicians looking for an easy way to talk down prices.
As my longtime friend and colleague George Kleinman pointed out in this week’s issue of the indispensable Commodity Trends, open interest in the crude oil futures market has actually been falling for most of 2008. This is a sign that speculators are actually reducing their exposure to oil futures, even as oil prices continue to rise. This effect is clear in the chart below.
Source: Bloomberg
Nonetheless, my opinion remains that crude is likely to remain in a volatile trading range until at least this fall. The downside is limited to around $110 per barrel and the upside to roughly $150. Upside will be capped by fears that a slowdown in the US economy will derail oil demand. Downside is limited by a continued tight global supply picture and strong Asian demand growth. This represents a healthy consolidation of the big run-up in prices over the past year.
I’m more bullish on natural gas. The recent pullback in natural gas prices is a knee-jerk reaction to crude oil’s sudden drop and isn’t grounded in fundamentals. Gas supplies remain tight, and foreign natural gas prices are still above US levels.
Furthermore, Hurricane Dolly may have missed the most sensitive gas infrastructure in the Gulf of Mexico, but it’s a vivid reminder that we’re not even in the heart of the Atlantic hurricane season and have already faced four named storms in the Atlantic and seven in the east Pacific. This qualifies 2008 as a more active season than either 2006 or 2007. Against this backdrop, the recent pullback in gas-related stocks represents a second chance for investors to buy into this bull market at attractive prices.
I’ll offer more details on recent earnings reports in an upcoming TES issue and via flash alerts, but here’s a quick rundown of recent news on portfolio holdings:
Schlumberger–The oil service giant’s release was undeniably positive, and the stock would likely be trading north of $120 is oil prices weren’t pulling back of late. Growth was lead by strong international results, where Schlumberger is clearly benefiting from rapidly rising spending on exploration and development projects. This is a remarkably defensive, commodity-insensitive business, as most international projects are multiyear, multibillion-dollar deals that would be economic even with oil in the $40s.
In addition to international projects, Schlumberger saw strength in integrated project management (IPM) and North American services. IPM is the business of managing entire international projects on behalf of producers. The North American business is recovering thanks to renewed spending on natural gas exploration and development. Buy Schlumberger, and consider any dip a gift.
Acergy–Acergy didn’t react well to its quarterly earnings release. The main problem was that the company’s backlog of unfilled orders dropped for the quarter. This was due to some sluggishness is booking new orders, particularly in Africa.
But the slow order intake isn’t a reflection of weak demand. Rather, Acergy’s business is inherently lumpy from quarter to quarter; the company performs mainly large, multiyear international projects. The timing in booking such deals is highly uncertain. In fact, management commented that the outlook for deepwater spending—the focus of Acergy’s business—remains bright indeed. Buy Acergy.
Compagnie Generale de Geophysique-Veritas (CGG Veritas)–Weakness in seismic services giant CGG Veritas is mainly due to a fleet report released earlier this month that shows a drop in vessel utilization, a measure of how hard CGG’s ships are working.
But this drop is due primarily to seasonal vessel maintenance and already-disclosed damage incurred by one of CGG’s ships. By the end of the quarter, all of CGG’s ships were back to work. Demand for seismic work continues to rise, and there’s no real sign of a slowdown. Buy Compagnie Generale de Geophysique-Veritas.
Norfolk Southern–Railroad operator Norfolk Southern released strong results this morning mainly because of the firm’s ability to push up prices. In fact, revenues surged 16 percent despite a 2 percent fall in volumes. The stock also benefits from falling oil prices; the railroad’s fuel surcharges don’t quite cover its fuel costs. Not surprising, Norfolk Southern’s stock is sharply higher in the wake of this report; I’m raising my buy target accordingly to 77.
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Neil, Roger and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.
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I was pleasantly surprised to see the major discussions turn to more practical, workable solutions, such as clean coal and energy efficiency. In this week’s issue, I highlight some of the main impressions and trends I gleaned from this year’s summit.
In This Issue
I had the opportunity to visit the G8 Summit this month in Japan. These annual summits provide a great opportunity for world leaders to discuss international issues, and this year’s energy-related themes were particularly timely. See Group of Eight.A communique from the summit noted the G8’s commitment to reduce by 50 percent greenhouse-gas emissions by 2050. More specific targets also look set to come down the pike by the end of 2009. See Climate Change Regulation.
With the G8 no longer holding the reigns to the majority of energy demand, developing nations were also included in this summit’s energy discussions. Although not as concrete as the communiques from the actual G8 meetings, the leaders from these countries have put forth a desire to decrease emissions as well. See A Different Tone.
When I first wrote my editorial piece for the G8 Summit, I was unsure about my inclusion of coal and clean coal technologies. However, these topics were prevalent among many of the discussions at the summit, and we may soon see clean coal technologies become more mainstream. See Coal Is Still King.
The second most-important theme of the summit was energy efficiency, which many countries have already been practicing over the past 15 years. And rising energy prices are naturally aiding the process as well. See Energy Efficiency.
The recent pullbacks in oil and natural gas offer great buying opportunities for some of the Portfolio holdings. See Portfolio Update.
I’m recommending or reiterating my recommendation in the following stocks:
- Acergy (NSDQ: ACGY, Norway: ACY)
- Alstom (France: ALO, OTC: AOMFF)
- Compagnie Generale de Geophysique-Veritas (NYSE: CGV, France: GA)
- Consol Energy (NYSE: CNX)
- International Coal Group (NYSE: ICO)
- Norfolk Southern (NYSE: NSC)
- Peabody Energy (NYSE: BTU)
- Schlumberger (NYSE: SLB)
- Patriot Coal (NYSE: PCX)
Group of Eight
Earlier this year I was invited to contribute an editorial for the official magazine of the G8 Summit. As part of that effort, I had the opportunity to attend the annual summit this month in Hokkaido, Japan. My sincere thanks are due both to the Japanese government for putting on an excellent summit in a truly beautiful region of the nation and to Prestige Media, publisher of the annual G8 official magazine. It was a great honor for me to be part of this year’s summit.Every year the host nation of the G8 has some latitude in deciding which issues will be central to the summit dialogue. Japan made this year’s central themes climate change and energy security–issues at the heart of the energy debate and The Energy Strategist. Both topics will have huge implications for investors in coming years.
The most recognizable outcome of G8 meetings is the official communiques issued following major meetings between world leaders. Traditionally, these statements are issued jointly by the heads of the eight big industrial powers (the G8), representing a sort of compromise and give-and-take between world leaders. However, this year the summit was far more inclusive than that, with 22 nations participating.
The scope of participation in this year’s meeting is a testament to the rising importance of emerging economies such as China, India and Brazil; these nations all sent delegations to Hokkaido. These larger groups of nations also issued statements. In fact, some of the more interesting conclusions drawn from the meetings this year spring from the contrasts between the statements issued by the G8 and the more-inclusive communiques from the group of “major economies.”
But there’s more to be gleaned from the summit than just the official pronouncements and communiques. The G8 summit isn’t a single event; rather, there are several meetings between government officials that lead up to the annual summit. In addition, G8 leaders often form subgroups to look into, study and report on various topics.
For example, the G8 Plan of Action on Climate Change was inaugurated at the 2005 Gleneagles Summit in the UK and has held numerous meetings and summits since that time. The Plan of Action also enlisted the help of international organizations, including the International Energy Agency (IEA), in gathering data and statistics. The final reports relating the Gleneagles Plan of Action and the IEA’s specific recommendations were released during this year’s summit.
Finally, the host country often uses the summit venue itself to showcase key issues. This year, the International Media Center (IMC), where I spent most of the summit, was really an exhibition of clean energy technologies and R&D work undertaken by Japanese firms.
Taken together, the official communiques, reports and the IMC showcase offer some interesting insights into key trends underway in the energy industry.
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Climate Change Regulation
The most obvious conclusion to be drawn from this year’s summit is that climate change and global warming will be key investment themes for the foreseeable future. Longtime readers are aware of my stance on global warming: Opinions differ greatly as to the extent and importance of climate change. I’m not a climate expert, and there are others far better positioned to weigh in on those issues. However, as investors we really don’t need to concern ourselves with the scientific debate.What’s really important is government action and policy. The simple fact is that governments all over the world are taking steps such as regulations, tax policy and subsidies to address climate change. These steps don’t just affect the public sector; they also have a very real impact on business and the stock market.
In fact, the collective actions of governments on climate change offer significant opportunities for investors. Ignoring these investment themes is akin to leaving money sitting on the table.
At last year’s summit in Germany, world leaders agreed to “seriously consider” a target of reducing by 50 percent global greenhouse-gas emissions by 2050. This year, the G8 actually committed to that target. There’s no unclear or ambiguous language in this year’s communique:
We confirm the significance of the Fourth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) as providing the most comprehensive assessment of the science and encourage the continuation of the science-based approach that should guide our climate protection effort. We reaffirm our commitment to take strong leadership in combating climate change and in this respect, welcome decisions taken in Bali as the foundation for reaching a global agreement in the United Nations Framework Convention on Climate Change (UNFCCC) process by 2009.
We are committed to avoiding the most serious consequences of climate change and determined to achieve the stabilization of atmospheric concentrations of global greenhouse gases…we seek to share with all parties to the UNFCCC the vision of, and together with them to consider and adopt in the UNFCCC negotiations, the goal of achieving at least 50% reduction of global (carbon dioxide) emissions by 2050, recognizing that this global challenge can only be met by a global response…
We are committed to avoiding the most serious consequences of climate change and determined to achieve the stabilization of atmospheric concentrations of global greenhouse gases…we seek to share with all parties to the UNFCCC the vision of, and together with them to consider and adopt in the UNFCCC negotiations, the goal of achieving at least 50% reduction of global (carbon dioxide) emissions by 2050, recognizing that this global challenge can only be met by a global response…
Source: G8 Communique on Environment and Climate Change, July 8, 2008, G8 Hokkaido Toyako Summit, Japan
For those unfamiliar with this alphabet soup of acronyms, the IPCC is a scientific group put together to evaluate global warming and climate change. The IPCC released its fourth assessment in November 2007 and made a few key conclusions.
Among those is that there’s no doubt a warming trend is underway in Earth’s climate and it’s already having effects. The report went on to describe some of the negative impacts, including increased tropical storm activity, more heat waves and disruptions to rainfall patterns with a negative impact on agriculture. The report also concluded, with 90 percent certainty, that these changes are due to human activity.
To make a long story short, the IPCC assessment referenced in the G8 communique above is a fairly direct and specific treatise on the dangers and causes of climate change. The G8 communique essentially accepts this IPCC assessment as fact, a strong endorsement for the idea that climate change is an important issue that needs to be addressed.
The UNFCCC is the UN body that administers the Kyoto Protocol, the agreement made between certain countries to target carbon-dioxide emissions reductions. The Kyoto agreement provides targets for emissions reductions through 2012.
The UFCCC has plans to establish new targets beyond that date. The current plan is for agreement on the new targets before the end of 2009; a UN meeting scheduled for Copenhagen in November/December of 2009 is the target date for an agreement.
The G8 further agreed on adopting a specific, long-term target for emissions reductions. That target is a 50 percent or higher reduction of global emissions by 2050. The base year for this reduction target is 2005; as I detail below, a 50 percent reduction in emissions is an extremely aggressive, challenging target.
My point in publishing this quote is simply to note that this communique represents by far the strongest endorsement yet by the G8 of the dangers of climate change and the need to tackle the issue with aggressive targets. It represents a real hardening of the tone from the 2007 G8 communique. This is a clear indication that, like it or not, climate change regulations and policies will become reality in the developed world.
Of course, long-term targets are often meaningless. It’s a fair bet that none of the world leaders at this year’s G8 Summit will still be in power in 2050, so the resolutions have little immediate impact. However, the statement offers more specifics than simply a long-term target. Leaders went on to stress the urgency of adopting measures to stimulate the development of clean-energy technologies:
…we acknowledge our leadership role and each of us will implement ambitious economy-wide midterm goals in order to achieve absolute emissions reductions and, where applicable, first stop the growth of emissions as soon as possible, reflecting comparable efforts among all developed economies, taking into account their national circumstances…all major economies will need to commit to meaningful mitigation actions to be bound in the international agreement to be negotiated by the end of 2009.
Source: G8 Communique on Environment and Climate Change, July 8, 2008, G8 Hokkaido Toyako Summit, Japan
Source: G8 Communique on Environment and Climate Change, July 8, 2008, G8 Hokkaido Toyako Summit, Japan
Through this, the G8 has also resolved to establish nearer-term goals for emissions reductions and greenhouse-gas mitigation. The other interesting point is that the communique suggests the major developed economies recognize a leadership role and are likely willing to agree to some mitigation efforts even if developing nations don’t agree to targets.
Bottom line: Whether you feel climate change is the most important issue facing the world or a complete hoax, from an investors’ standpoint, carbon regulations are a reality that can’t be ignored.
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A Different Tone
As I noted above, the G8 meetings are no longer just meetings between the largest industrialized nations in the world. When the G8 summit (then the G6) was first started in 1975, the largest industrialized powers were a good proxy for the global economy as a whole.Looking at it from an energy standpoint, in 1975 the six largest economies in the world accounted for 55 percent of total global oil demand. Now those original G6 nations account for less than 40 percent of global oil consumption; the enlarged G8 accounts for just 45 percent.
Even more important, energy demand in the big industrialized countries is growing relatively slowly. In the case of oil, demand from the G8 has actually fallen over the past three years by nearly 400,000 barrels per day. The real growth in energy demand is coming from the developing, not the developed, world.
The same basic pattern is obvious in carbon-dioxide emissions. Check out the chart of the Energy Information Administration’s (EIA) forecasts for global carbon-dioxide emissions.
Source: EIA
According to EIA data, countries outside the Organization for Economic Cooperation and Development (OECD), a proxy for the emerging markets, actually emitted slightly more carbon in 2005 than the developed OECD countries. This disparity is only going to grow in coming years; by 2030 the EIA projects that non-OECD nations will emit 73 percent more carbon than the developed world. Between 2005 and 2030, OECD carbon emissions are projected to grow just 14 percent, compared to a near doubling in the developing world.
Clearly, hosting a summit to discuss energy security and climate change without including nations outside the G8 would be laughable. Even if G8 countries were to cut by 75 percent their total emissions by 2030, it would not offset the projected growth in non-OECD carbon output.
At this year’s G8, several developing nations were included in enlarged discussions on these issues. These dialogues were dubbed the “Leaders Meeting of Major Economies” and included a total of 16 countries. China, India and Brazil, among other fast-growing developing countries, were part of these meetings.
The official communiques released from the leaders meetings were somewhat less aggressive in declaring targets and committing to carbon reduction efforts. For example, the leaders’ communique reads:
Climate change is one of the great global challenges of our time. Conscious of our leadership role in meeting such challenges, we, the leaders of the world’s major economies, both developed and developing, commit to combat climate change in accordance with our common but differentiated responsibilities…
…We believe that it would be desirable for the Parties to adopt in the negotiations under the Convention a long-term global goal for reducing global emissions, taking into account the principle of equity. We urge that serious consideration be given in particular to ambitious IPCC scenarios.
…the developed major economies will implement, consistent with international obligations, economy-wide midterm goals and take corresponding actions in order to achieve absolute emissions reductions…the developing major economies will pursue, in the context of sustainable development, nationally appropriate mitigation actions…
…We believe that it would be desirable for the Parties to adopt in the negotiations under the Convention a long-term global goal for reducing global emissions, taking into account the principle of equity. We urge that serious consideration be given in particular to ambitious IPCC scenarios.
…the developed major economies will implement, consistent with international obligations, economy-wide midterm goals and take corresponding actions in order to achieve absolute emissions reductions…the developing major economies will pursue, in the context of sustainable development, nationally appropriate mitigation actions…
Source: Declaration of Leaders Meeting of Major Economies on Energy Security and Climate Change, July 9, 2008, G8 Hokkaido Toyako Summit, Japan
The leaders’ statement also indicates that climate change is a threat. But the key difference is that, in this communique, the nations don’t agree to a specific target; note, in particular, the language in the second paragraph talks about the concept of a target but offers no concrete numbers.
The third paragraph indicates that the developed countries have committed to going ahead with emissions targets and reduction schemes even if the developing countries won’t commit to firm targets.
We shouldn’t be surprised by the different language adopted by the G8 and leaders’ statements. Developing countries such as China and India are the fastest-growing source of carbon-dioxide emissions and are actually more important from a carbon standpoint than the G8 nations. At the same time, these countries would have an extraordinarily difficult time actually meeting a 50 percent reduction goal. In fact, I don’t see a way that China could reduce its emissions outright in the foreseeable future.
The reason is simply that many developing nations are experiencing strong economic growth at this time. Their growth in energy demand and carbon emissions is a consequence of that growth.
This is nothing at all new or unusual; the US, the UK, Japan and all other G8 nations are now mature countries with slow energy demand growth. But each of these countries was, at one point, a developing nation. During that phase, each country saw a similar, rapid run-up in energy demand.
For example, the UK’s industrialization in the 18th and 19th centuries was built largely on steam power generated by coal. And in the 20th century, Japan experienced strong growth in the post-World War II era, eventually becoming the second-largest economy in the world. From 1950 to 1990, Japanese annual crude oil demand jumped from one barrel per person to 15 barrels.
Chinese annual oil demand, while growing rapidly, is still less than 2.2 barrels per person and India’s annual oil demand less than one barrel per person. This is a tiny fraction of the consumption levels that prevail in the US, Western Europe and other developed countries. Most emerging markets are still in the early stages of what’s likely to be years of strong energy demand growth.
Given this dynamic, it’s hardly surprising that China, India and other developing countries are reluctant to sign on to carbon-emissions reduction targets. These countries’ rapid economic growth in recent years has meant strong growth in energy demand. Actions to sharply curb emissions would threaten that growth. After all, today’s G8 relied on energy to fuel their development in decades past; China and India are simply following the same path.
That isn’t to say that the developing world won’t take action to curb emissions. The Chinese government is clearly concerned about pollution. Pollutants, including sulphur dioxide and nitrous oxide, are so onerous in China that the nation is curbing construction and driving ahead of the Olympics this year in an effort to put a good face forward for the rest of the world. China has also taken steps to shut down small, coal-fired power plants that are particularly inefficient and polluting.
And China and India are equally concerned about the security of their energy supplies. This is at last part of the impetus behind both nations’ efforts to diversify energy supply to include nuclear power, renewables and greater energy efficiency. These steps will also reduce emissions of carbon dioxide and pollutants.
And don’t forget there are other motivations for the developing world to diversify their energy supplies. Global energy prices have skyrocketed in recent years; higher energy prices act as a signal for consumers and businesses to look for ways to cut back their energy demand and/or explore alternative sources of power. Developing countries are clearly concerned about obtaining cost-effective energy supplies needed to promote economic growth.
But with the developed world determined to regulate carbon emissions and the developing world likely to go along with this plan to at least some extent, the big question is how to achieve these targets. Or, more specific, the key question is: What technologies and fuel sources will be promoted as a means to reduce emissions and enhance energy security?
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Coal Is Still King
The major theme of my editorial for the G8 was that there’s no silver bullet for the world’s energy supply issues or for meeting global demand growth in a cost-effective manner. The real solutions will be a combination of many different energy sources, including traditional fossil fuels, nuclear power, renewables and energy-efficiency gains. In other words, there are many partial solutions to the world’s energy and environmental issues, not a single technology.One partial solution that received considerable attention at the G8: good old coal.
A few days after completing my editorial for the G8 magazine, I reread my article. My first reaction was that I had spent far too much time discussing coal and clean coal technologies. At the time, I thought that perhaps writing about the dirtiest of all fossil fuels in a summit devoted to climate change and clean energy technologies wouldn’t be appropriate. However, I decided to leave the piece as written because I firmly believe that any global energy strategy that doesn’t address coal as a key energy source is doomed to failure.
As it turned out, one of the most surprising outcomes of this year’s summit was the amount of attention paid to clean coal and the development of so-called carbon capture and sequestration (CCS) technologies. CCS is simply a technology for capturing carbon from power plant emissions and then permanently storing that carbon dioxide underground.
Most proposals for CCS involve capturing carbon dioxide and storing it in natural underground rock formations. This isn’t a pie-in-the-sky notion. After all, natural gas (methane) doesn’t exist underground in giant caverns but in the pores, cracks and crevices of underground rock formations. In a natural reservoir, gas doesn’t escape to the surface because there’s an impermeable cap rock above the formation that won’t allow the gas to pass through. CCS would involve injecting carbon dioxide into similar formations.
In fact, CCS is already being done on a commercial scale, though not to trap power-plant emissions. Norway’s Sleipner field in the North Sea contains natural gas mixed with unusually large quantities of carbon dioxide. Norway imposes a tax on carbon emissions so the operator of the field, Statoil, can’t simply separate and flare the carbon dioxide.
Instead, the company uses a technique known as amine scrubbing to remove and isolate the carbon dioxide. In amine scrubbing, the gas is mixed with liquid amine; this chemical absorbs gaseous carbon dioxide. The amine solvent and carbon dioxide can then be separated using heat, and the amine can be reused.
In the case of Sleipner, Statoil injects the separated carbon dioxide into a shallower rock formation located above the gas-producing Sleipner field, which contains mainly salt water. This formation is sealed, so the gas can’t escape. Statoil monitors the formation to ensure that no gas accidentally escapes. Sleipner captures a total of about 1 million tons of carbon dioxide annually, and the rock formation used for sequestration has enough volume to store decades’ worth of produced carbon dioxide safely.
Although Sleipner involves capturing less carbon that the average coal plant, it’s still a valuable illustration that CCS is possible.
CCS and clean coal technologies were a centerpiece of just about every report and action plan that was drawn up for the G8 this year. And coal featured prominently in the official communiques both of the G8 itself and the broader leaders’ statements. Consider the following statement from the G8 communique:
We will establish an international initiative with the support of the IEA to develop roadmaps for innovative technologies and cooperate upon existing and new partnerships, including carbon capture and storage (CCS).
We strongly support the launching of 20 large-scale CCS demonstration projects globally by 2010, taking into account various national circumstances, with a view toward beginning broad deployment of CCS by 2020.
We strongly support the launching of 20 large-scale CCS demonstration projects globally by 2010, taking into account various national circumstances, with a view toward beginning broad deployment of CCS by 2020.
Source: G8 Communique on Environment and Climate Change, July 8, 2008, G8 Hokkaido Toyako Summit, Japan
It’s tough to imagine a more direct endorsement for clean coal technologies and CCS. The G8 communique essentially adopted the IEA’s Plan of Action recommendations; the final version of this plan was released during the summit. A key part of the IEA’s plan was to launch these 20 large-scale CCS demonstration projects and try to commercialize the technology by 2020. For a closer look, check out the chart below.
Source: IEA G8 Plan of Action
In the IEA’s report, the organization published several different emissions scenarios. The first is basically a business-as-usual scenario; this is a forecast of global carbon-dioxide emissions assuming no changes to the status quo. In this case, emissions would grow from 28 gigatonnes (Gt) in 2005 to about 62 Gt in 2050.
The IEA’s second scenario is a stabilization of emissions near the 2005 level; the IEA calls this its ACT scenario. The final scenario is the plan endorsed by the G8, an attempt to cut carbon-dioxide emissions to 14 Gt by 2050, half their 2005 level. This aggressive plan is known as the BLUE scenario.
The chart above shows the contributions of different technologies and strategies to achieving BLUE. Roughly 20 percent of the total reduction targeted under BLUE comes from CCS both in industrial applications (such as sequestering carbon produced in steel production) and CCS equipment installed on coal-fired plants.
The mistake many investors make is to assume that coal is a dead fuel. After all, resistance by environmental groups in the US has derailed many planned coal-fired facilities in the US. As I noted at some length in the April 23, 2008, issue, Electric Charge, US utilities are reluctant to build new coal plants because they’re unsure as to future carbon-dioxide regulations.
However, to blindly oppose new coal plant construction is condemnation to irrelevance. According to the IEA’s statistics for 2005, just less than 80 percent of China’s electricity comes form coal. And at roughly 70 percent, India is nearly as reliant on coal. And it’s not just the developing world; the US and Germany each derive about half their electricity from coal-fired plants.
I’ve highlighted the reasons for this dependence before in TES–namely the Sept. 5, 2007, and Nov. 7, 2007, issues, entitled Australia, Asia and Coal and Coal and Services, respectively. I won’t belabor the point here, but suffice it to say, coal is the cheapest source of fuel for electric power plants even after the recent run-up in prices. Moreover, big consumers such as China and the US have large reserves of domestic coal; many nations are less dependent on coal imports, compared to oil or natural gas.
By highlighting coal and CCS, the G8 is tacitly acknowledging that a failure to address coal will derail any ambitions it may have to achieve the IEA’s BLUE or, for that matter, ACT scenarios. Clearly, the G8 recognizes that, to have any hope of an agreement that includes China and India, any global climate arrangement will have to provide for clean coal technologies.
This focus is even more apparent in the leaders’ statement. See the following quote from that pronouncement:
…Mindful of the important role of a range of alternative energy technologies, we recognize, in particular the need for research, development, and large-scale demonstration of and cooperation on carbon capture and storage.
Source: Declaration of Leaders Meeting of Major Economies on Energy Security and Climate Change, July 9, 2008, G8 Hokkaido Toyako Summit, Japan
Source: Declaration of Leaders Meeting of Major Economies on Energy Security and Climate Change, July 9, 2008, G8 Hokkaido Toyako Summit, Japan
All this rhetoric is an undeniable positive for coal-related stocks. Although coal stocks, including those in the TES portfolios, have performed well over the past year, there are still plenty of people worried about the potential impact of carbon-dioxide legislation. In fact, whenever I speak about coal and investing in the fuel, environmental concerns are the most common pushback I get from investors.
A real, working, commercial-scale demonstration of CCS would remove this cloud of doubt for good. Given the G8 commitment to climate change and CCS as a key enabling technology, I suspect we’ll see real progress on CCS over the next five years.
I recommended taking a large profit in MacArthur Coal earlier this year, but I still have three recommendations related to coal. First, Peabody Energy is the world’s largest pure-play coal mining firm. The company has reserves located in two main coal-producing regions: the US Powder River Basin (PRB) and Australia.
Coal in the PRB is found relatively close to the surface of the Earth, making it relatively cheap to mine compared to coal from underground reserves located in Appalachia. In addition, most PRB coal is low in sulphur; low-sulphur coal produces less sulphur-dioxide pollution when burned, making it desirable as a power-plant fuel. Peabody has some of the most desirable mines in the PRB.
Noted at length in the Sept. 5, 2007, issue, Australia is a key coal export market. The country is a large supplier of both metallurgical coal used to produce steel and thermal coal used in power plants. China became a net importer of coal last year; until recently, the country was a key exporter in Asia. Peabody’s mines in Australia are direct plays on the strength of Asian demand for coal and China and India’s thirst for imports.
Longtime subscribers who got into Peabody on my original recommendation last year are showing a big profit; I recommended ways to hedge this gain in the June 12, 2008, flash alert, Unsteady as She Goes. If you have a large profit in Peabody, it’s not too late to take that advice to protect profits.
However, the recent pullback in Peabody stock appears to be a knee-jerk reaction to the sell-off in crude oil, while the fundamentals of coal remain largely unchanged. Strong import demand for coal has supercharged US coal exports. And the loss of coal to export markets has significantly tightened up the US coal inventory picture. As the chart below indicates, coal prices remain strong.
Source: Bloomberg
Bottom line: Even if oil pulls back further, I don’t see Peabody trading under $60 for long. I’m raising my buy target for Peabody Energy to 75 and see the current pullback as a good opportunity to jump in if you don’t have a position. Also note my higher recommended stop, designed to lock in larger profits in Peabody.
Second, Peabody spun off Patriot Coal late last year; I recommended holding on to the Patriot shares. This stock has been a real moon shot: It started trading at $35.55 and has rallied to as high as $161 before pulling back recently to about $120. Because Peabody shareholders received one share of Patriot for every 10 shares of Peabody owned, this is equivalent to about $12 in additional value per Peabody share.
Patriot basically was formed for ownership of Peabody’s East Coast mines, located in regions like Appalachia. Traditionally, I haven’t been enamored with eastern-centric coal mining firms because of their higher cost structure, trouble getting skilled labor and intense regulatory hurdles.
However, I began to change my opinion late last year because, with many of the world’s key coal exporters sending their coal to Asia, Europe has been having difficulty securing coal imports. It’s now turned to the Saudi Arabia of coal, the US. Many European utilities are signing multiyear supply deals at high prices that offer solid returns for eastern miners despite their high cost structures. And because of their proximity to export ports on the East Coast, the miners in Appalachia are taking full advantage.
In addition, Appalachia does have some of the world’s highest-quality metallurgical coal reserves; this coal is highly prized in steelmaking. With some of the best mines in the east, I recommend holding on to Patriot Coal for now.
The railroads are a final play on coal. I highlighted my rationale for recommending Norfolk Southern in the July 2, 2008, issue, Take a Ride.
Finally, given the continued strong market for coal and coal stocks and the recent temporary dip in prices, I’m upgrading most of the coal stocks in the How They Rate Table, with an eye toward an additional Portfolio play in coming weeks. Right now I’m focused on two stocks:
Consol Energy–Consol’s main reserves are high-sulphur coal in northern Appalachia. Northern Appalachian mines haven’t seen the same level of cost inflation and regulatory burden that mines in Central Appalachia have over the past few years. In addition, more utilities are adding advanced scrubbers to their smokestacks; this allows them to burn the higher-sulphur coals that Consol produces. This is one reason why the premium prices attached to low-sulphur coal have been shrinking of late.
China is facing a big problem right now: looming power shortages. Low rainfall is impacting the country’s hydropower production, and domestic coal production just isn’t keeping pace with demand. This is hardly surprising when you consider that China builds a new plant once every seven to 10 days. That’s equivalent to adding the UK’s annual electric capacity.
The US has become the supplier of last resort for coal, thanks to its huge reserve base. Consol is particularly well positioned to benefit for two reasons: It has the capacity to significantly grow production from current mines, and the company owns the coal export terminal in the Port of Baltimore, giving it direct access to the ultra-strong export market.
Consol Energy rates a buy in the How They Rate Table. I’m looking to take advantage of the recent weakness in the stock to potentially add it to the Gushers Portfolio.
International Coal Group–For a long time, International Coal was a chronic underperformer I recommended avoiding like the plague. The problem with the firm is that it owns high cost mines in Central Appalachia, a region where coal mines are extremely mature.
However, the big change in the coal mining industry over the past 12 months is that it’s increasingly moving from a domestic demand story to an international, export-driven market. Eastern miners are benefiting because they can sell their output at sky-high prices into export markets.
In fact, because of rising export prices, International Coal has moved from a money loser to a profitable firm. I’m raising International Coal to a buy in the How They Rate Table.
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Energy Efficiency
A second major focus of this year’s G8 was energy efficiency. The G8 and leaders’ communiques recognized the importance of energy efficiency in meeting their carbon targets. Both groups also endorsed the IEA’s plan for enhancing global energy-efficiency trends. In addition, many of the displays in the IMC highlighted various technologies for conserving energy.There’s good reason for this focus: Boosting energy efficiency is, in most cases, the cheapest means of cutting carbon-dioxide emissions and reducing fuel costs. As the chart earlier in this issue indicates, the IEA projects that energy-efficiency improvements are capable of producing nearly half the total carbon-dioxide emissions reductions under its BLUE scenario.
Energy efficiency is a broad term that refers to efficiency gains in power plants, transportation, industry and, of course, the home. This isn’t just projection of what’s possible; most developed economies have already seen dramatic gains in energy efficiency over the past few decades. In fact, the IEA noted an amazing statistic in its report to the G8: If there were no energy efficiency gains in IEA countries since 1973, global energy use would have been 58 percent higher in 2005 than it actually was.
The IEA did focus somewhat on government action as a means of promoting energy efficiency. I disagree somewhat with that notion; in my view, the free market is the prime driver of efficiency gains.
Consider that, according to the IEA, efficiency gains in OECD countries over the past 15 years is about half what the case was back in the 1970s and ’80s. The main reason was the ’70s and early ’80s was a period of rapidly rising energy costs. Companies and consumers alike were looking for ways to save on fuel costs; rising energy prices drove efficiency.
In contrast, for much of the past 15 years, energy prices really weren’t an issue. With fuel costs relatively low, looking for ways to increase efficiency was a far-less-attractive proposition.
But with energy prices again on the rise, the IEA’s and G8’s focus on efficiency is appropriate. Just as we saw in the ’70s, rising energy prices will drive a desire to save on fuel costs. The addition of carbon-based targets will, if anything, just serve to accelerate that trend. Check out the chart below for a breakdown of where the IEA believes these savings can come.
Source: IEA, “IEA Work for the G8,” July 2008
In many cases, the IEA believes that energy efficiency gains actually have a negative cost given current high energy prices. In other words, it costs money to make the improvements to machinery, equipment and building design that are needed to save energy. However, in many cases, the value of the fuel saved exceeds the cost of improvements even if there is no specific carbon-dioxide tax or incentive.
There are ways to play the drive for energy efficiency globally. One of the most obvious is closely related to my discussion of coal above: the drive for greater efficiency in fossil-fuel power plants. I highlighted this trend in the May 16, 2008, issue of The Energy Letter, Coal Investors Take Their Lumps.
The IEA estimates that, if all power plants globally were upgraded to state-of-the-art facilities, total fossil fuel consumption for power generation would drop between 23 and 32 percent. The largest source of these savings would be upgrading the world’s fleet of coal-fired plants.
The developing world could certainly benefit from upgrading the quality of their coal-fired power plants. For example, India’s average efficiency for fossil-fuel power plant generation is just 28 percent, the lowest of the countries the IEA studied. This is mainly because of a large reliance on very older, inefficient coal plants.
The best coal plants in the world today run at around 43 percent efficiency. India could save considerable fuel and massively reduce emissions from its coal-fired plants by gradually retiring these older plants and replacing them with more fuel-efficient facilities.
But power-plant efficiency gains aren’t just a developing world phenomenon. In the US, environmental groups are actively blocking new coal-plant construction on the theory that coal is the world’s major source of greenhouse-gas emissions. This policy is, however, having the opposite of the intended effect. New US coal plants are much more efficient than the current fleet of plants that are, on average, three decades old.
This is why US fossil-fuel fired generation efficiency is among the lowest of any OECD country. It’s also why the US has seen very little increase in overall average efficiency since 1990.
As an aside, it’s totally impractical to install CCS equipment on older coal-fired plants. By opposing new plant construction, US environmental groups are actually limiting the potential for the US to meaningfully reduce greenhouse-gas emissions when this new technology is rolled out commercially post-2020.
At any rate, fuel efficiency considerations are already driving new, efficient plant construction the world over. China has been closing small, old coal-fired facilities and building more state-of-the-art plants; it’s not inconceivable that China will surpass the US in energy efficiency in the coming decade if this trend continues.
But in the developed world, there’s also a growing push for efficiency. The G8 and IEA have adopted very strong language supporting upgrades to coal-fired plants both for the immediate efficiency gains as well as for the eventual CCS potential. This is filling the order books of companies involved in state-of-the-art power-plant construction.
Of course, power generation is only one aspect of energy efficiency. Transportation is another industry that will likely see a sharp increase in efficiency gains in coming years. Part of this is, of course, a growing preference for smaller, more-efficient cars. The fact that General Motor’s sales of trucks and SUVs is off more than 20 percent so far this year in the US is proof that higher energy prices are already driving that change.
More interesting from an investing standpoint is air and rail transport. As I discussed in the most recent issue of TES, railroads are actually a highly efficient form of freight transport; desire to cut fuel costs is already helping the rails.
We’re also seeing a similar effect when it comes to passenger rail volumes. Ridership is up on subway and passenger rail systems all over the world as some consumers switch from driving to passenger rail transport.
Finally, as I’ve noted before, there’s strong demand for the Boeing 787 Dreamliner aircraft mainly because it’s far lighter than other aircraft of the same size. The plane is capable of cutting airlines’ fuel consumption dramatically.
We’re already playing fuel efficiency in the TES portfolios. Railroad operator Norfolk Southern is one play on fuel efficiency.
In addition, alternatives field bet Hexcel Corp is a bet on the future of aerospace. The company makes carbon fiber, a material that offers high strength and is extremely light. Traditionally, airplanes have been made primarily of aluminum. However, new planes such as the Boeing 787 and the new generation of Airbus aircraft are incorporating much higher percentages of carbon fiber in their construction. This bodes well for Hexcel.
I’m also adding a new play on efficiency to my coverage universe.
Alstom (France: ALO, OTC: AOMFF)–Alstom is a French construction firm that focuses on two major types of project: railroads and power plants. The company builds and supplies parts for modern natural gas, coal, hydropower and even nuclear power plants. In addition, Alstom performs maintenance and upgrades to existing facilities; this makes it a direct beneficiary of the desire to upgrade power-plant efficiency.
The company is also a world leader in urban transport and high-speed passenger train markets. Investment in this type of infrastructure is growing quickly, and rising ridership should help accelerate the trend.
Looking a bit further into the future, Alstom is also working on several CCS demonstration projects worldwide, including a handful of projects in the US. This business is a natural fit for Alstom because it already has years of experience fitting scrubbers on coal-fired plants and building highly efficient coal facilities.
Alstom’s backlog of unfinished orders currently has been soaring, a sure sign that demand is strong. Currently, the backlog sits at EUR42 billion (USD66 billion), equivalent to nearly 30 months of sales. I’m adding Alstom to the How They Rate Table as a buy.
CCS and energy efficiency were just two of the main themes to emerge from this year’s G8. Nuclear power, natural gas and renewables are three additional fuels strongly endorsed by the G8; I’ve already covered these in recent issues of TES.
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Portfolio Update
As I explained in the July 16, 2008, flash alert, Oil’s Rollercoaster, much of the recent pullback in energy-related stocks is due to a general pullback in oil and natural gas prices, not company-specific issues.As far as crude oil is concerned, it’s ironic that some pundits are now talking about a pullback in crude to $100 per barrel. Some weeks ago a major financial magazine actually called for a pullback to $100 and stated that this was the bursting of the “oil bubble.” It’s easy to forget that last July crude was trading at $70 to $80 per barrel and didn’t actually break above $100 until five months ago.
As I pointed out in the June 4, 2008, issue, Crude Realities, the idea that rising commodity prices are a bubble driven by excess speculation is absolutely ludicrous. The speculation argument is nothing more than politicians looking for an easy way to talk down prices.
As my longtime friend and colleague George Kleinman pointed out in this week’s issue of the indispensable Commodity Trends, open interest in the crude oil futures market has actually been falling for most of 2008. This is a sign that speculators are actually reducing their exposure to oil futures, even as oil prices continue to rise. This effect is clear in the chart below.
Source: Bloomberg
Nonetheless, my opinion remains that crude is likely to remain in a volatile trading range until at least this fall. The downside is limited to around $110 per barrel and the upside to roughly $150. Upside will be capped by fears that a slowdown in the US economy will derail oil demand. Downside is limited by a continued tight global supply picture and strong Asian demand growth. This represents a healthy consolidation of the big run-up in prices over the past year.
I’m more bullish on natural gas. The recent pullback in natural gas prices is a knee-jerk reaction to crude oil’s sudden drop and isn’t grounded in fundamentals. Gas supplies remain tight, and foreign natural gas prices are still above US levels.
Furthermore, Hurricane Dolly may have missed the most sensitive gas infrastructure in the Gulf of Mexico, but it’s a vivid reminder that we’re not even in the heart of the Atlantic hurricane season and have already faced four named storms in the Atlantic and seven in the east Pacific. This qualifies 2008 as a more active season than either 2006 or 2007. Against this backdrop, the recent pullback in gas-related stocks represents a second chance for investors to buy into this bull market at attractive prices.
I’ll offer more details on recent earnings reports in an upcoming TES issue and via flash alerts, but here’s a quick rundown of recent news on portfolio holdings:
Schlumberger–The oil service giant’s release was undeniably positive, and the stock would likely be trading north of $120 is oil prices weren’t pulling back of late. Growth was lead by strong international results, where Schlumberger is clearly benefiting from rapidly rising spending on exploration and development projects. This is a remarkably defensive, commodity-insensitive business, as most international projects are multiyear, multibillion-dollar deals that would be economic even with oil in the $40s.
In addition to international projects, Schlumberger saw strength in integrated project management (IPM) and North American services. IPM is the business of managing entire international projects on behalf of producers. The North American business is recovering thanks to renewed spending on natural gas exploration and development. Buy Schlumberger, and consider any dip a gift.
Acergy–Acergy didn’t react well to its quarterly earnings release. The main problem was that the company’s backlog of unfilled orders dropped for the quarter. This was due to some sluggishness is booking new orders, particularly in Africa.
But the slow order intake isn’t a reflection of weak demand. Rather, Acergy’s business is inherently lumpy from quarter to quarter; the company performs mainly large, multiyear international projects. The timing in booking such deals is highly uncertain. In fact, management commented that the outlook for deepwater spending—the focus of Acergy’s business—remains bright indeed. Buy Acergy.
Compagnie Generale de Geophysique-Veritas (CGG Veritas)–Weakness in seismic services giant CGG Veritas is mainly due to a fleet report released earlier this month that shows a drop in vessel utilization, a measure of how hard CGG’s ships are working.
But this drop is due primarily to seasonal vessel maintenance and already-disclosed damage incurred by one of CGG’s ships. By the end of the quarter, all of CGG’s ships were back to work. Demand for seismic work continues to rise, and there’s no real sign of a slowdown. Buy Compagnie Generale de Geophysique-Veritas.
Norfolk Southern–Railroad operator Norfolk Southern released strong results this morning mainly because of the firm’s ability to push up prices. In fact, revenues surged 16 percent despite a 2 percent fall in volumes. The stock also benefits from falling oil prices; the railroad’s fuel surcharges don’t quite cover its fuel costs. Not surprising, Norfolk Southern’s stock is sharply higher in the wake of this report; I’m raising my buy target accordingly to 77.
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Speaking Engagements
Venture west to one of the most exciting natural settings in the US, San Francisco. I’ll be heading to “The City” with Neil George and Roger Conrad Aug. 7-10, 2008, for the San Francisco Money Show.Neil, Roger and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.
Click here or call 800-970-4355 and refer to priority code 011361 to attend as our guest.
I also have a special invitation for readers to join me and my colleagues Roger Conrad, Gregg Early and Neil George aboard an exciting 11-day investment cruise Dec. 1-12 through the Caribbean and Panama Canal.
This will be a unique opportunity to step away from your daily routines, relax in one of the most beautiful parts of the world and share analysts’ knowledge and passion for the markets. During the sail, you’ll not only explore the cerulean splendor of the Caribbean, but you’ll also delve deep into current markets in search of the most profitable opportunities for your portfolios. You’ll also have the rare chance to sail through one of the world’s engineering marvels, the Panama Canal.
It’s always a special treat to meet and talk with subscribers in person, and we couldn’t have picked a better setting than aboard the six-star Crystal Serenity. This is sure to be an especially memorable experience. We hope you’ll join us.
For more information, please click here or call 877-238-1270.
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