Fossil Fuels Are Becoming Stranded Assets

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Includes: HASI, JKS, NEP
by: Bruce Vanderveen

Summary

We're seeing big price declines in fossil fuels.

Technology is the hero -- or culprit, depending on your point of view.

EVs will be the death knell for oil.

The move away from fossil fuels: Is it just in time?

Here are three clean energy stocks to consider.

In January, Exxon Mobil (XOM) wrote $2 billion off the value of its U.S. natural gas fields. Then, in February, the company wiped 3.3 billion barrels of oil off its books. Exxon Mobil is not alone. As of mid-2016, oil and gas companies wrote off over $185 billion off the value of their fossil fuel reserves.

Big price declines in fossil fuels

Not too long ago, investors (myself included), thought some of the best companies to invest in were those which controlled huge amounts of coal, oil, or gas. After all, a growing, energy-hungry world needs increasing amounts of these fossil fuels. Right?

And how well did that strategy work out?

Well... Peabody (BTU), the U.S.'s largest coal producer, went bankrupt. Canadian Oil Sands (OTCQX:COSWF), with its massive oil sand holdings, failed. Chesapeake Energy (CHK) has extensive natural gas acreage yet saw its stock fall 90%.

In retrospect, investing in energy companies which control large amounts of coal, oil, and gas was a terrible strategy. Only a few years ago, with Peak Oil thinking in vogue, who would've guessed?

Today, all three major fossil fuels -- coal, oil, and natural gas -- are priced below their 2009 Great Recession lows. This is especially surprising considering the huge central bank fueled monetary supply expansions since 2007. (Wasn't that was supposed to be inflationary?)

Peabody and other coal company bankruptcies show that renewables are killing coal in the U.S., China, India, and elsewhere. In a touch of irony some coal plants are being resurrected as solar farms. (I guess they figure much of the infrastructure can be recycled and there are likely very few other buyers for old coal power facilities.)

Oil is faring no better. Prices for oil were mostly over $100/bbl from mid 2010 through 2014. Now they hover around $45/bbl. The low prices have oil companies abandoning promising (but costly to develop) offshore and arctic oil projects. Environmentalists should applaud.

Even natural gas, the "fuel of the future," has been unable to climb out of the hole of its 2009 price collapse. Prices are now around $3/MMBtu, back in 2008 they were over $12/MMBtu. Even with the U.S. now shipping LNG to Europe, Asia, and South America, futures prices haven't responded.

A prolonged economic slump could explain the price declines in coal, oil, and gas but actually the opposite has happened. Emerging market economies have expanded considerably in the last 10 years. China, for example, the world's largest market, has seen its GNP triple since 2007. So, how do we explain the low prices?

Technology is the hero -- or culprit, depending on your point of view

The reason, I believe, can be summed up in one word: Technology.

Technology is fast transforming both our means of extraction and use of fossil fuels. First, new technologies, such as fracking, makes it less costly to extract fossil fuels - increasing supply. Second, and even more importantly, technology makes it easier than ever for consumers to efficiently use energy.

Fracking has reversed declining U.S. oil and gas production and the U.S., much to the dismay of OPEC, is now one of the world's top oil producers. Even Saudi Arabia is worried. There is a new oil minister and the country is planning to begin a (limited) exit from the oil business. You may soon be able to buy shares in Saudi Aramco (ARMCO). Not sure I'd recommend it, though, the way things are going for oil.

Both wind and solar can now, in much of the world, generate electricity cheaper than fossil fuels. On the user end: LED lighting, digital TVs, and all sorts of electrical devices from smartphones to air conditioners need considerably less power than they did just a few years ago.

EVs will be the death knell for oil

But now the biggest threat yet to oil yet looms dead ahead.

Bureau of Transportation statistics show that in 1980 new U.S. vehicles got an average of 24.3 MPG, by 2000 it was 28.4 MPG, and then by 2014 it was 36.4 MPG. Technology kept improving internal combustion engines (ICEs).

But look at electric vehicles (EVs): The 2017 Toyota Prius (hybrid) gets up to 58 MPG, my 2016 Nissan Leaf gets 112 MPGe, and the 2017 Chevy Bolt gets 119 MPGe. So, looking just at the efficiency component, pure electric EVs get 3-4 times the mileage of standard ICE vehicles get. Some Bolt drivers claim to be getting over 300 miles before needing to charge up and they say EV battery technology improvements are just getting started.

That's all bad news for oil, but its gets even worse: Electric motors in vehicles use absolutely no gasoline (or diesel fuel) at all. With 65-70% of crude oil refined to gasoline and diesel fuel, you don't have to be a rocket scientist to see the precipice ahead for oil.

All major auto manufactures are now (or soon will be) offering EVs, both hybrids and pure electric models. VW, the world's largest auto manufacturer, in a step away from diesel, plans up to 30 EV models. Their goal? To leapfrog Tesla (NASDAQ:TSLA).

None of this will happen overnight, of course. Coal-powered power plants continue to be built (although at a much reduced rate) and decommissioning is far off for many existing ones. 99% of vehicles on the road are still ICEs and many will undoubtedly still be around 10 years from now. Natural gas is still a top fuel for new power plants.

Renewables, however, are now the go-to source for new energy projects and the writing appears to be on the wall for fossil fuels. Fossil fuels are being made obsolete, becoming stranded assets on company balance sheets.

The move away from fossil fuels: Is it just in time?

The move away from fossil fuels may be just in time. Since the start of the industrial age incessant burning of fossil fuels (especially coal) has relentlessly boosted the greenhouse gas CO2's concentration in the atmosphere. In 1820 it was 250 ppm, now it's 410 ppm -- it just keeps going up.

What's notable here is that the atmospheric CO2 concentration is now higher than at any time in the last 400,000 years (or more). Does this mean that the climate will soon be warmer than at any time during the last 400,000 years? No one really knows -- climate changes don't happen overnight. But even the possibility is frightening. 125,000 years ago sea levels were 20-30 feet higher than today. A study just in claims 2 billion people may be forced from their homes by the end of the century.

Correlation is not necessarily causation of course, but look at this chart. All of us, including environmentalists, should hope Trump is right.

Three clean energy stocks to consider

No matter what your beliefs on climate change, it appears that we are on the cusp of a renewable driven energy revolution.

Below are the profiles of three clean energy stocks. For readers who wish a more in depth analysis of the company I provide links to Seeking Alpha articles whose authors have written in greater detail on the companies.

NextEra Energy Partners (NEP)

NextEra Energy Partners is a is a growth-oriented limited partnership formed by NextEra Energy (NYSE:NEE) in 2014. NEP is a yieldco and the company acquires, manages and owns clean energy assets which have stable, long-term contracted cash flows. Most of NEPs properties are in the U.S. These include 18 wind farms with a total of 5.925 megawatts of capacity, 5 solar farms with a total of 442 megawatts in capacity, and seven natural gas pipelines in Texas.

In the company's June 2017 Investor Conference presentation they see rapid growth with continued drop-downs from its sponsor and General Partner NextEra Energy (which might quadruple their size). Additional growth sources are organic growth -- pipelines and repowerings (conversion of retired coal plants to natural gas or solar) and third party acquisitions.

NEP has raised its dividend (current yield: 3.95%) every quarter for the last 11 quarters. The company has set a goal to grow it's distribution 15% a year for the foreseeable future. NEP is treated as a C-Corp and it issues a 1099 tax form so investors need not worry about K-1 complexities at tax time.

You can read an excellent, more detailed, article on NEP by fellow Seeking Alpha author Michael Fitzsimmons here.

Hannon Armstrong Sustainable Infrastructure Capital (HASI)

HASI is a Real Estate Investment Trust (REIT). Its major business is investing in clean infrastructure projects for government, Global 1000 corporations, and private developers using preferred or senior level financing. This provides the company with long-term, recurring, and predictable cash flows. Assets financed include renewable energy projects and energy efficient improvements such as lighting, controls, roofs, pumps, windows, building shells, HVAC, and power systems.

The electric power industry is undergoing a major transformation and HASI is there with the money and expertise to oversee it. HASI seems to have cracked the nut on how to profit from the renewable revolution -- the company has grown core EPS/share 12% annually since 2014. Since HASI is a REIT they must distribute 90% of taxable earnings to shareholders and the quarterly dividend has increased from 22 cents/share in 2014 to the current 33 cents/share. The current yield is 5.77%.

Seeking Alpha author Brad Thomas has written several Editor's Pick articles about HASI. I urge readers who want more information on HASI to read them.

JinkoSolar Holding (JKS)

JinkoSolar is one of the largest, if not the largest, of the Chinese based solar companies. Since much of the world's solar equipment is manufactured in China, the company is worth looking at. The company designs, develops, produces, and markets polycrystalline photovoltaic modules which it sells worldwide, about 60% of sales are in the Asian Pacific area (35% in China).

JinkoSolar started out as a small wafer manufacturer in 2006 but its founders have steadily grown the company to its size today. The company prides itself on its technologically advanced products and has one of the lowest production costs in the industry. JinkoSolar's business has traditionally been primarily in China but in recent years it has gone international. In just in the last few months projects in Japan, the Middle East (Abu Dhabi, Saudi Arabia), Turkey, and California have been started or discussed. Since solar has just recently become the cheapest way to generate electricity in many places demand is skyrocketing for JinkoSolar's products.

JKS does not pay a dividend but the company's financial metrics are good. Finviz shows a P/E of 5.9 (Yahoo Finance has 2.9). EPS is up 37% this year and is estimated to be up 35% next year. Over the last 5 years EPS has averaged 19% growth, and annual sales growth over the last 5 years has been 23.7%. With a share price of $20.8, the company has almost $12 in cash per share. One caution: The total debt/equity ratio is 1.74, on the high side.

Readers who wish to learn more about JinkoSolar should look at Seeking Alpha author Growth And Value's June 8, 2017, article, a review of first quarter 2017 earnings.

Final thoughts

Not too long ago solar and wind generated electricity was the domain of counterculture types and hobbyists -- interesting, but not very practical. Now, however, thanks to technology, renewable energy is beginning to threaten the huge multi-trillion global fossil fuel complex built up over the last two centuries.

Coal and oil and gas companies are starting to shrink as they write downs assets they might never tap, assets now becoming stranded assets. And with climate change threatening this could be for the best.

It's a sign of the times: In March of this year, wind and solar generated 10% of U.S. electricity. The trend is clear. We might debate how quickly change will happen but, as they say, you can't stop the wind from blowing (or the sun from shining). The best ways for investors too profit from the renewable revolution is still uncertain. The three companies profiled above appear to be among the early winners.

Disclaimer: This article is for informational purposes only and should not be taken as investment recommendations. Investing in stocks is risky and investors should use all due diligence and consult a financial advisor before investing.

Disclosure: I am/we are long NEP, HASI, JKS.

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.