What Does The Coal Industry's Travails Tell Us About The Future Of The Oil Industry?

by: Keith Williams


European coal companies restructured; US coal companies denied the changes, then went bankrupt.

In the oil industry, Total, DONG Energy, Statoil restructuring; BP, Shell, Exxon Mobil, Chevron obfuscating.

Two key issues for the oil industry are: need to reduce CO2 emissions and substitution of electricity for oil in transportation.

Near-term pressure comes from need to reduce dividends by the oil majors.

Reading recent Seeking Alpha articles about the oil majors, notably BP (NYSE:BP), Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and Shell (NYSE:RDS.A) (NYSE:RDS.B), I get an eerie sense of deja vu, because the commentary is so similar to the way coal companies were discussed as they headed for the precipice. The recent oil articles are invariably solely focused on cyclic changes to an industry that has been a safe and secure investment area for decades. There is rarely any discussion about whether there might be long-term structural changes underway.

I suggest that there are major structural changes underway as the world confronts the need to decarbonize because of global warming.

Issues for the coal industry

Andy Roberts from WoodMackenzie, which has been a major optimist for coal expansion, made the point in a recent blog about coal markets.

Thermal coal markets have historically been cyclical, but an end to today's unhealthy markets requires structural, not cyclical, change. Excess capacity must be wrung from the system, but this has been excruciatingly slow to develop.

There has been an excellent recent analysis of Q1 2016 performance metrics for the US coal majors. It isn't a pretty story, with Peabody Energy (NYSE: OTCPK:BTUUQ) the worst performer, with stock price down 89% since January. BTUUQ coal shipments were down almost 30% and revenue down from $1.5 billion to $1.0 billion in Q1 2016 compared with Q1 2015.

China is dramatically slowing its coal production (down 8.7% January-May 2016 year on year) and thermal coal imports (down 17% year on year Jan-April 2016 versus 2015). In the US, coal production January-March 2016 of 173 million tons was down 17% on the previous quarter and the lowest of any quarter since 1981.

The above analysis cited environmental regulations (e.g. Clean Power Plan) and competition with low natural gas prices as key reasons for the dismal US results.

I suggest that there are two additional substantial issues for the US coal industry going forward, even after debt is resolved through restructuring.

Firstly, the reclamation issues are not going to be easily dodged, even though this is what is being attempted as part of restructuring. For example West Virginian regulators are objecting to Alpha Natural Resources' (OTCPK:ANRZQ) proposal to sell their coal resources to a hedge fund and leave the state with the clean-up liabilities. Who pays for cleanup is a question that is not going away.

Secondly, the access to federal land by coal companies is being scrutinised. This is important as ~40% of US coal is mined from federal land and it is argued that taxpayers have forgone large amounts of revenue through mispricing the leases.

The above issues are potent because coal is now seen as a costly and polluting source of energy. Where once coal companies had considerable power, because they were seen as gatekeepers for reliable power supply, this is no longer the case. The light is being shone on the modus operandi of some coal majors and it isn't pretty. Peabody Energy's active support for climate denial groups is a case in point.

What about the oil industry?

As I indicate above, the discussion about the future of the oil industry rarely includes structural changes. An exception is Brian Gilmartin's recent analysis, which provides the argument for near-term value in oil investment in general and XOM in particular, while acknowledging long-term structural changes.

Here I explore further, why I think the threats to oil companies are imminent and investment in oil is not without considerable risk.

I suggest that the oil market is exhibiting the hallmarks of the recent coal experience.

Why the changes?

I suggest that reducing greenhouse gas emissions and the electrification of motor transport are key near-term threats to the oil industry.

Paris climate summit : I have summarized the outcomes of the December 2015 Paris climate summit (COP21) elsewhere and given an update on substantial additional action in April of this year. The summit participants agreed to a less than 2C global temperature increase with a goal of 1.5C.

The agreement was signed by 175 countries in April 2016 and it is possible that it will become binding before the end of 2016, well before the 2020 goal. China and the US have signaled an intention to ratify the COP21 agreement in 2016 and make it legally binding (which requires 55 countries who collectively account for 55% of global emissions). In recent discussions with President Obama, India's PM Modi indicated that India supports the goal of signing in 2016, although this is not yet confirmed.

The COP21 agreement requires dramatic and rapid decrease in CO2 emissions, which requires exit from fossil fuel consumption.

Electric vehicles : The IEA has recently released a comprehensive report on Electric Vehicles, which covers information up to the end of 2015. Interesting statistics include that the number of EVs has increased 100-fold since 2010, and 1.26 million EVs are on the roads as of end 2015.

Indeed, more than 550,000 EVs were sold in 2015, up 70% on 2014 figures. Seven countries (Norway, The Netherlands, Sweden, Denmark, France, China, UK) now have above 1% EVs (Norway has 23% EVs, while The Netherlands has 10%).

China is the largest EV market and it also has the biggest deployment of electric 2 wheel vehicles and buses. In China, so far this year, there were 219,000 EVs sold from Jan-May and the projections are for 1 million EV sales in 2017 as China moves towards its goal of 5 million EVs by 2020.

The above report makes clear that EVs are undergoing major expansion, with many programs driving adoption aggressively. Any threat to internal combustion engine cars is a major problem for the oil industry.

What if the oil price recovers?

For the two reasons given above, I don't expect there to be long-term changes for the better for the oil industry. From here on, we are exiting fossil fuels and it is just a matter of how quickly it is going to happen.

Gary Bourgeault recently gave a nice analysis of the intricacies of the battle between the Middle East and the US shale producers in defining the price of oil in the near future. Clearly, there is nothing simple about the oil industry.

If investors wish to base their fortunes on a recovery in the oil price (which is needed to be able to keep paying dividends and make essential investments in increasingly expensive exploration), it is perhaps worth thinking about how an increase in oil price would play out in the context of the rise of renewable energy. This doesn't get discussed in conventional analysis.

The dramatic expansion in renewable energy investment, which was $286 billion in 2015 and substantially exceeded investment in fossil fuels ($130 billion), has occurred at a time of unprecedented low oil and gas prices.

So wouldn't an increase in the price of oil make investment in renewables even more attractive?

The rationale for investment in renewable energy is :

i) acceptance that the world is transitioning from fossil fuels,

ii) that once built, renewable energy infrastructure has no exploration requirement

iii) there is no uncertainty about pricing of energy inputs (it's the sun and wind),

iv) distributed renewable energy provides energy security (independence from middle east oil).

Moreover, both solar PV and wind power are on substantial cost decrease trajectories at a time when exploration for oil becomes more expensive and more subject to regulatory oversight.

How fast can the transition be?

Lots of people accept that long-term change is in the wind (excuse the pun!) but they think it is a distant issue that has no relevance to their investment decisions. This includes young people making investments for their retirement.

The recent fate of the coal industry is instructive. I began following Peabody Energy in August 2014 when the share price was $250. Today, the company is in Chapter 11 bankruptcy protection. So it took less than 2 years for a dramatic loss of investor value. It is important to remember that the demise of the US coal companies happened while there is still a lot of coal being consumed.

An example where a substitute technology wiped out an established technology involves the switch from landlines to mobile phones. This happened in an astonishingly short time frame. I suggest this is starting to happen with EV substitution of internal combustion engine cars, and the oil industry will be a major collateral damage from this transition.

European oil companies as first movers for the change from fossil fuel

I've written elsewhere about European oil majors Total (NYSE:TOT) and DONG Energy (CPH:DENERG) that are taking decisive action about reorienting their businesses to address CO2 emissions and the need to exit fossil fuels.

Actions by oil majors

Apart from Total, the other oil majors, Exxon Mobil, Chevron, BP and Shell have a similar approach to the way they see the future, and it is very similar to the line that the US coal majors took.

BP: I've written about BP's skepticism that global warming will be restricted to 2C. Indeed, they dismiss this notion and don't even consider it in their planning.

Shell: Shell recently acknowledged that a 2C target might become a reality and so they gave some notional views about it in an update to their 2013 future strategy (New Lens Scenarios).

Here is a link to Shell's "A Better Life with a Healthy Planet: Pathways to Net-Zero Emissions." The report addresses 4 areas: power, buildings, transport and industry.

In what is a depressing echo of a Peabody Energy position, the report makes the following statement upfront so that the reader has clear guidance on what follows: "… we have no immediate plans to move to a net-zero portfolio over our investment horizon of 10-20 years." The note then goes on to say that the Paris Agreement is a start to creating a framework for the journey to net-zero emissions, but they make clear that they have no plans to lead this transition.

Shell has produced a second document "Shell: energy transitions and portfolio resilience" (link here), which says little other than that the company supports carbon pricing, that they think Carbon Capture and Storage is going to work and that there will be an expansion of gas production at the expense of coal. They don't see substantial decrease in oil production.

It is hard to imagine how this will produce a low carbon world. In summary, the document says it is all too hard and there won't be a major transition to a low carbon future in the foreseeable future. I'm having trouble understanding the point of the Net-Zero emissions paper if they have no plans to go there. I've commented on Shell's recent "Capital markets day 2016" presentations elsewhere.

Oil majors resisting change

There are powerful lessons for oil investors from the bankruptcies of major US coal companies, including Peabody Energy, Arch Coal, Walter Energy and Alpha Natural Resources. All of these companies insisted (and some still do) that all would be well for coal and that the problems were short-term supply/demand issues.

The actions of Exxon Mobil and Chevron are similar to those of Shell and BP described above. While these oil majors make some reference to the Paris Climate summit, it is clear that none of them accept that there will be major changes as a result of Paris.

The IEA is working on updated projections based on the recent Paris agreement outcomes, which refer to a maximum 2C rise with a goal of 1.5C. They plan to release a report "Energy and Air Pollution 2016 - World Energy Outlook Special Report" on 27 June and their "World Energy Outlook 2016" report on 16 November. The oil majors may need to think hard about their complacency when they see these reports.

A significant new development is that activist shareholders are making their presence felt and cannot be ignored. In the past, these groups were just brushed aside.


It is a very interesting time for the oil industry. Choose almost any article written recently on Seeking Alpha and you will find a diversity of views about whether or not dividends are in danger, but few authors are seriously saying that we are at the beginning of the end of the oil industry…. except for the leaders of 195 countries who are in the process of signing up to the end of fossil fuels.

This is very serious for investors who currently plan to rely on the oil majors for dividends into the future and to make their retirement income secure.

I don't know how long this will take, but my guess is that it is going to happen much faster than anyone thinks at the moment.

And, with the exception of aware European oil companies, much of the oil industry is the most in denial. Remember that the US coal companies have gone bankrupt long before we stopped using coal.

Think hard about your oil investments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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