02-10-2015, 07:50 AM
- Oct 2 2015 at 7:30 AM
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[img=620x0]http://www.afr.com/content/dam/images/g/j/x/v/6/s/image.related.afrArticleLead.620x350.gjzayx.png/1443735030180.jpg[/img]Bank of England governor Mark Carney warned investors that they face huge climate change losses.Bloomberg
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by Matthew Stevens
It has been another defining and difficult week across both hemispheres of the energy globe once dominated by old king coal.
Down here in the southern hemisphere Australia's third biggest coal producer Rio Tinto quietly but effectively described its exit strategy from the fossil fuel cycle through the sale of a small Hunter Valley coal project and the broader restructure that allowed this pretty staggering $US606 million deal to be completed.
Then, wedged serendipitously between the Tuesday's formal consummation and Wednesday's announcement of that deal, the Governor of the Bank of England described climate change as the "tragedy of the horizon" before warning systemic financial risk could be triggered by the rigorous enforcement of a 2 degree world.
In what will stand a landmark in the great carbon debate, former Goldman's banker (which is globally synonymous with the phrase "smart guy") and current BoE boss, Mark Carney, talked of the risk to the global financial system of the potential that the carbon constraint the global community now regards as essential to managing climate change.
In a high-level address to an equally high-level host at Lloyds of London, Carney talked of the potential that a wealth of fossil fuel assets could necessarily be rendered worthless by this shift in energy demand required to meet future emissions targets. In doing so he used language that more usually decorates the commentary of the anti-carbon lobby.
Most notably, the Governor talked of the risk that vast reserves of oil, gas and coal that currently sit as assets on the balance sheets of miners and petroleum companies would be left "stranded" by this shift in global energy priorities.
"Take, for example, the IPCC (Intergovernment Panel on Climate Change) estimate of a carbon budget that would likely limit global temperature rises to 2 degrees above pre-industrial levels," Carney proposed.
"That budget amounts to between one fifth and one third (of) the world's proven reserves of oil, gas and coal. If that estimate is even approximately correct it would render the vast majority of reserves `stranded' – oil, gas and coal that will literally be un-burnable with expensive carbon capture technology, which itself alters fossil fuel economics.
"The exposure of UK investors, including insurance companies, to these shifts is potentially huge," he said.
Carney noted that 19 per cent of FTSE100 companies are in the natural resources business and that another 11 per cent by value are either customers of service providers to the miners and drillers.
Carney said that "de-carbonisation" of the global economy implied a "sweeping reallocation of resources and a technological revolution" that would necessarily require investment in long-term infrastructure assets at roughly quadruple the present rate.
"For this to happen, 'green' finance cannot conceivably remain a niche interest over the medium term," he advised a room populated by the elites of London's financial community.
As you might expect, the views of the BoE's man have caused a bit of heartburn around a fossil fuel world that is working desperately across a host of critical constituencies to promote the potential of technology to effectively mitigate fossil fuel emissions risk and the unyielding reality that coal will continue to be the energy building block the majority of the world's emerging economies.
Meanwhile, global mining is trying to get its head around the idea that Rio Tinto might very soon not be a coal miner. This is a concept that would have seemed inconceivable even two years ago and it is one that has even Rio people shaking their heads in amazement. But the decision is made.
The financial hard-heads have recovered control of this famously disciplined business and their view is that coal as an asset class would never again be competitive in Rio's internal race for capital and that it carries a now definable and undesirable long-tail of financial and reputational risk.
A shaping fact in this decision is that Rio is essentially a thermal coal producer and, on a global scale, not a massively big one. Past management attempted to change the product and geographic balance of Rio coal portfolio in 2011 through the $US3.7 billion acquisition of coking coal opportunities in Mozambique.
But, for a bunch of reasons including quality and a lack of logistics infrastructure, that investment was a dud. Within two years Rio had written off $US3 billion and the bloke who laid the bet, energy boss Doug Ritchie, was sacked. So was his boss, the Rio chief executive, Tom Albanese.
The longer result of that failure is that Rio is leaving coal. But that decision would likely have been more textured had the coking coal play proved successful.
Rio's in-house view is that coking and thermal coal are now set on quite different trajectories. That is because the world might find replacements for thermal coal (which is used to fuel power stations) but technology has so far given us nothing that can replace coking coal in the steel and aluminium cycle.
This view of a coal world divided will be welcomed at BHP Billiton. It has very famously reduced itself to a business of four pillars that includes coal. But the vast majority of its coal output is coking coal.
There is a bit more to the BHP coal story than there might appear. In November 2011 – at the very same time that Rio was completing its Mozambique mistake – the BHP board was asked to consider the results of Project Fresh. The idea was to bundle up the coal business and deliver it in a demerger to BHP shareholders. Management had recommended the deal and proposed that then chief financial officer Alex Vanselow should run it.
The logic was that coal prices had peaked and it was an asset class that could be left uncompetitive against other investment options and that its risk profile potentially left it ill-suited to the Global Australian's investment proposition, which remains that it offers defensive, annuity exposure to the resources sector.
If that all sounds familiar, then it should. The board decided to keep coal. But the possibilities of de-merger lived on through the Project River team that ended up generating South32.
There is something deeply miserable in the fact that Arrium might sell the best of itself to secure a future for its legacy operations, but such are the decisions forced on those who have arrived at the bottom of their business cycle with too much debt.
Just ask Santos.
That Arrium's debt is priced in US dollars and has been thrown at a second tier (and I am being kind there) iron ore business only makes diversified steel-maker's dilemma all the more disappointing.
But Arrium has confirmed that the sale of its world class "mining consumables" business has moved to a definitive final stage that will see a handful of bidders make their best pitch. Arrium has apparently made it clear to the bidders for Moly-Cop that they should not imagine a deal is done, it will not sell unless value hurdles are cleared.
Whether or not the bidders believe that, time will tell. And time is one of the few things working here in Arrium's favour. Its view is that it has not callable debt obligations until 2018 so it is under no particular pressure to make a deal.
Mind you, to accept that, you have to accept that Arrium is prepared to sit in a semi-permanent standstill, forced by its dysfunctional balance sheet, that is punctuated only by further cost cutting through both its steel and mining operations.
But, in reality, that is not an option. Given Arriun can manufacture a future from its legacy, then there are big investment decisions ahead. Not the least of them will be deciding at some point before the end of the decade whether or not to extend the life of Whyalla's blast furnace and thus the whole South Australian steel complex. To make that happen Arrium needs to lift the anchor of debt from its balance sheet.
So Arrium has time but it really has no option. In the end, Moly-Cop will be sold.