Rethinking Portfolio Risk
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Transcript of Rethinking Portfolio Risk
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1Portfolio Risk: Changing Perspectives
www.resourcient.com J. Stephan Dolezalek
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2Life is About Making Intelligent Choices
Are you sure these new clean technologies will
float?
Cant those idiots see that their only hope
is onboard these new Tesla
electric lifeboats?
Time is running out you must divest now!
Sure, we might be listing a bit and have taken on some
water, but compared to those fools down there, life up here
on the coal, oil & gas deckchair is good!
I bet everything on biofuels
Trust me, these new yieldco boats
are safe!
Dont worry, our new gas turbines will have us up and running in no time!
Making money is about making them when they arent obvious
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3The Conventional Wisdom:We have developed diversification and other business models to minimize risk
such as commodity and currency risk, inflation risk, and other economic factors, but future environmental or resource concerns are neither quantifiable nor should we account for them in our portfolio strategies except under general ESG principles.
The Emergent Wisdom:Resource risks (including, but not limited to climate) are likely to have a broader and
greater influence on portfolio outcomes than many risks we explicitly account for. However, our current portfolio models struggle to properly account for them, our
securities disclosures inadequately address them and liability insurance is unlikely to cover us for our shortcomings.
World leaders are increasingly concerned that a $6 trillion wave ofinvestment into the nexus of oil, gas, and coal since 2007 is based on falseassumptions, leaving companies with an overhang of debt and "strandedassets" that cannot easily be burned under CO2 emission limits.
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4Energy is an Ever-Evolving Commodity
0%
25%
50%
75%
100%
1850 1870 1890 1910 1930 1950 1970 1990 2010
Perc
enta
ge o
f U.S
. Ene
rgy
Con
sum
ptio
n
50 years
Wood
Coal
Hydro
OilNatural Gas
Renewables
75% 75%
Sources: EIA, Annual Energy Review: 2008; EIA, Annual Energy Outlook: 2009 with Recovery Act Update
50 years
75%
Nuclear
50 years
?
Global economic growth has been based on upgrading 75% of our energy mix roughly every 50 years. If anything, we are late in making the next change and by resisting it, are likely slowing rather than protecting economic growth.
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5Risk # 1: Newer & Cheaper Technologies
Both wind and solar already are, or are rapidly becoming cheaper than all fossil alternatives, even when (as chart below shows) one takes away all wind/solar subsidies, but leaves fossil subsidies in
Dont bet against technology progress: Subsidies may have been very important in driving down the costs of wind and solar technologies (as they were in driving down the cost of coal, oil, gas, nuclear and shale (fracking) technologies, but we have arrived at a point where the continuing cost declines of the newer technologies are simply outpacing the ability of conventional fossil fuels to compete.
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6Risk # 2: Increasing Fossil Risk
Europe as leading indicator. Since 2008 the top 20 European utilities (then worth $1.3 trillion) have lost half their value. As major asset holders of conventional power generation, utilities are at enormous risk; to survive they must embrace new distributed generation and service business models. U.S. utilities now struggling with managing same changes.
Coal
Oil
Utilities
Dirtiest of fossil fuels has already taken biggest hit, from cheaper natural gas prices, the higher cost of building newer cleaner plants, the aging infrastructure of current plants and a growing set of policy shifts in the U.S., China and India; more reductions are likely, but much of the portfolio damage is already done.
Oil isnt going away, but extraction costs continue to increase, borrowing has risen rapidly and now, prices have fallen, potentially stranding the most expensive extraction methods, even without political pressures around carbon; all while transport efficiency increases. Think peak demand, not peak oil, and focus holdings on cheapest production.
GasGas remains the natural bridging fuel to renewables because of its ability to be used in the latest power turbines and to compensate for the intermittency of renewables. But, even here, margins are tight and supply forecasts suggest greater price pressures by 2020. In addition, gas is CO2 positive on the burning, but less so on the extraction side.
Notwithstanding these risks, investment in oil & gas is now almost 20% of total U.S. private fixed infrastructure investment its highest ever level.
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7Risk # 3: Carbon Bubble Risk
Amount of carbon in proven coal, oil, and gas reserves of fossil-fuel companies, and countries that act like fossil-fuel companies
Maximum temperature increase to avert amplifying carbon cycle feedbacks
Amount of carbon we can emit into the atmosphere by 2050 with some reasonable hope of staying below 2 degrees. Coal is clearly largest loser.
According to IEA two thirds of all declared energy reserves ($28 trillion) become stranded over next 20 years if there is a binding deal limit to C02 levels to 450 particles per million by the year 2100.
2o Celsius
565 Gigatons
2,795 Gigatons
$28 Trillion
Former US Treasury Secretary Hank Paulson: When the credit bubble burst in 2008, the damage was devastating. Were making the same mistake today with climate change. Were staring down a climate bubble that poses enormous risks to both our environment and economy.
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8Coal: Already Down, Unlikely to Recover Lower natural gas prices, greater flexibility
of natural gas turbines and aging plants all continue to threaten coal;
Coal economics worsen as usage declines. Even though cleaner coal plants are
possible, they require large new CAPEX investments and are less flexible than gas generation.
Employment in wind and solar sectors has now far outpaced coal employment, so there is far less ongoing political power in coal.
The divestment movement (13 universities, 31 cities, 41 religious institutions and 28 foundations and growing) that started in April 2012, came too late to prevent institutional stock losses, but continues to gain momentum.
European oil companies now banding together to push further coal reductions.
U.S. Coal - Commodity and ETF Valuations
Global Coal ETF Valuations
Coal versus Nat Gas in Power Generation
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9Oil: Fundamentals Under Stress
The industry needs $100/barrel oil
Spending on Extraction Keeps Going Up
Capex per Barrel Growing at 10+% CAGR
Source: Douglas-Westwood, Barclays Capital
Rapidly rising supplies due to U.S. shale growth have reset pricing expectations, but not changed underlying fundamentals for most of the business.
Impact of lower prices is still working its way through system, but is likely to drive increased risk perception among lenders.
Likely result is continued volatility among many players and a reassessment of risk and reward under new normal.
Largest impact continues to be on transportation fuels, as oils contribution to power generation is small and shrinking.
IHS: Discoveries of new oil and gas reserves have dropped to their lowest level in at least two decades in 2014.
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10
Utilities: Transform or ShrinkFalling wholesale electricity prices match falling equity values for German utilities
European Utilities Under Fire: E.On after reporting a $3.2 billion loss (largest in its history) splits its business in half, selling off its generation,
upstream and global commodities units. In same year, EONs wind and solar business saw a 20% growth. RWE, restructures its business to get out of generation assets and become an energy service company; saying big fossil
asset ownership is no longer attractive. GDF Suez takes $18Bn write-off on conventional generation assets
U.S. utilities are increasingly feeling the same pressures and some stock analysts are already downgrading
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11
Transport: Incredibly Inefficient
Productive use
An American road reaches peak throughput only 5% of the time...
...and even then, it is only 10% covered with cars
Energy flow through a combustion engine
86% of fuel never reaches the wheels
0.8% looking for parking
0.5% sitting incongestion
Rolling resistance
Energy used tomove the person
Aerodynamics
Transmission losses
Idling
Engine losses
2.6% driving
The typical American carspends 96% of its time parked
Inertia
Auxilliary power
Deaths per year from transport
More than 33,000 in US$300B annually in cost
>95% Caused by human error
US Transit - 5% of trips, 77% on-time vs 90%+ OECD, frequencies of 20-60 min in most citiesStarved infrastructure: 2.4% of GDP on transportinfrastructure (vs. 5% Europe, 9% China, 5%+ US before 1960) and
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12
Growth Impacts of Changing Energy MixActual 2012 Global Energy
Supply by TypeWhat EIA (US) Predicts for 2035 2035 Stranded Asset Scenario
Based on IEA (Global) Analysis
Oil Natural Gas Hydro Nuclear GeoThermal Wind SolarCoal
U.S. Energy Information Administration wind +960%; solar +1,600% in next 20 years. Global International Energy Agency, the Stranded Asset problem and needed
cutbacks in coal, oil and gas, implies growth rates of approximately +4,000% in wind and +4,500% in solar over same 15 years to produce necessary global energy output.
Even the more aggressive IEA numbers only require a 30% compounded growth rate, solar has averaged a 45% CAGR from 2007 to 2015.
Source: BP Energy Survey, Alliance Bernstein
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13
Divestiture vs. Portfolio RebalancingShould you have divested from coal, oil and fracking stocks in mid 2011 (when the first calls for divestment were being made) or as late as Jan 2013?
If you held $10 million in each of KOL (the coal ETF), OIL (the US oil ETF), and FRAK (the US Fracking ETF) then and continued to hold it today, those three positions would be worth the following (all as of 5/29/2015):
KOL: $10,000,000 $2,504,000 $5,169,000OIL: $10,000,000 $4,813,000 $5,586,000FRAK: $10,000,000 $8,455,000 $9,569,000
But, if you divested those positions and bought three solar stocks instead (SolarCity (SCTY), SunEdison (SUNE) and SunPower (SPWR) then that $30,000,000 (assuming you bought $10M each of SCTY, SUNE, SPWR) would be worth:Divest: $30,000,000 $82,050,990 $154,600,000
If you split the $30 million four ways and bought the three solar stocks but you also bought Tesla (TSLA), splitting the investment in four, you today would have:Divest: $30,000,000 $118,257,750 $161,625,000
(7/2011 to 5/2015) (starting with $10M on 1/2013 to 5/2015)
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14
What is Your Risk Mitigation Strategy?
Stay the Course Business as usual the world cant or wont face environmental and resource
limitation issues, new energy technologies will remain niche and population and GDP growth will drive up conventional energy values
Decrease Direct Exposure to Stranded Assets
Follow the lead of a growing number of funds, in starting with coal and gradually divesting fossil fuel positions
Invest in new publicly traded indices that avoid direct carbon exposure (i.e. Blackrock/NRDC/FTSE ex-Fossil Fuels Index)
Decrease Correlated Risk of Primary and Secondary Exposure
Recognize that much more than just fossil fuel companies face significant exposure and start limiting positions with direct as well as indirect risk
Shareholder activism encourage portfolio companies to themselves take necessary steps to mitigate carbon and resource risks.
Invest in New Energy Infrastructure Follow Buffet, KKR and others in owning wind farms, solar parks and YieldCos
Actively Hedge Risky Assets
Design the appropriate short position to cover a deflating carbon bubble Note: Hank Paulsen and the Bank of England have both recently described the
analogy to the sub-prime risk/opportunity
Intelligently Invest in the Upside AvoidPortfolio Correlation
Increasingly own and hold positions in companies and income yielding instruments that are creating and/or benefiting from the new energy paradigm
Focus a portion of portfolio on low holding costs and on positions that gain most from a rapid shift to lower carbon energy
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Portfolio Risk: Changing PerspectivesLife is About Making Intelligent ChoicesSlide Number 3Energy is an Ever-Evolving CommodityRisk # 1: Newer & Cheaper Technologies Risk # 2: Increasing Fossil RiskRisk # 3: Carbon Bubble RiskCoal: Already Down, Unlikely to RecoverSlide Number 9Utilities: Transform or ShrinkTransport: Incredibly InefficientGrowth Impacts of Changing Energy MixDivestiture vs. Portfolio RebalancingWhat is Your Risk Mitigation Strategy?