History is full of things the government tries to ban phase out. But what happens each time they do (try)? An investment opportunity promising outsized gains is born. The campaign against fossil fuels is going to be a rather good example of this, if it isn’t already.
That’s why, this week, my old friend and long-time energy expert James Allen is busy preparing to reveal how to play the supposed phaseout of dirty energy.
What makes that so interesting is simple. James is a green energy and climate change believer. And yet, he sees fossil fuels making a necessary and dramatic comeback which investors can’t afford to ignore.
As I see it, James’ belief in a net zero world has had a reality check even he can’t afford to ignore. See what you think about his plan to turn this into a reality cheque by keeping an eye out for more details on Thursday…
Speaking of which, “The capital strike against coal has failed,” reports the Australian Financial Review newspaper, publishing from The Economist. Presumably it’s the The Economist, but I’m not sure.
The image used as suitable clickbait for the article features a group of anti-fossil fuel protesters with a sign claiming “no sustainability without divestment”.
The protesters in question, in their quest for credibility, have divested themselves of their clothing. Presumably this is a rare acknowledgement of the role oil plays in the garment industry. But, being students, you never know why they might be nude.
Unfortunately, I think they’ve misunderstood the nature off economics, capital markets and commodity supply. Fortunately, I think they’ve created the investment opportunity of the century.
Think about it this way. Imagine you are an investor who believes fossil fuels will play a crucial and underestimated role in the economy for much longer than is currently expected. What government policy would you dream up to increase your overall returns as this reality dawns on London, Brussels and Washington?
You’d dream of constrained future supply, and an undervalued investment opportunity, right? But how?
The campaign for divestment from fossil fuels delivers both perfectly.
The first thing it does is reduce capital investment in future supply of fossil fuels. That’s the whole point, after all.
By making less money available to the companies trying to keep the lights on, their cost of capital goes up. This makes less projects and less expansions of existing projects viable. And so, over time, it reduces supply of the underlying resources being produced. That means higher prices.
Secondly, divestment prevents a long list of large and savvy investors from deploying capital in a particular segment of the market. Investors interested in that segment don’t have to compete with those institutions. The result is undervaluation – the opportunity to buy stocks on the cheap.
What happens next?
Well, if fossil fuels really do turn out to be an important part of our energy mix for decades to come, then the supply shortage caused by divestment will lead to price spikes. The companies that did manage to produce fossil fuels stand to benefit from this with outsized profits. And the investors who backed them will presumably profit disproportionately, because they were the only ones allowed to invest under divestment policies.
It’s a dream scenario. And it’s playing out right now.
The Economist and AFR explain how the plan to undermine coal was supposed to play out:
This is mainly meant to happen by starving the supply chain of funding. More than 200 of the world’s largest financiers, including 87 banks, have announced policies restricting investments in coal mining or coal-fired power plants. Lenders representing 41 per cent of global banking assets have signed up to the Net-Zero Banking Alliance, pledging to align portfolios with net-zero emissions by 2050.
Unfortunately, capitalism has a nasty habit of finding a way to get people what they want in the end, whatever the government policy says.
Indeed, the more divestment succeeds in strangling fossil fuel production, the more the coal price will rise, making the incentive to produce and invest even stronger.
The Economist and AFR report on the results of trying to constrain coal investment by major financial institutions: “Last year, some [coal] traders were forced to borrow from private vehicles, often backed by wealthy individuals, at annual rates nearing 25 per cent – about five times standard costs.” So investors are minting it!
What about the coal companies? Can they handle such higher cost of financing? “A banker says some of his coal-trading clients saw profits grow ten-fold in 2022. One in London witnessed his total equity leap from £50 million ($94 million) in 2021 to £700 million in 2023.”
This divestment business is a veritable money-making machine for investors willing to bet against it!
The funniest part is that coal supply doesn’t seem that constrained at all, despite the investment. Coal production recently hit record levels. The divestment of large companies from coal just allowed other investors to profit disproportionately instead.
It seems that coal demand, the other side of the equation that environmentalists like to target, is booming. And so, even though the divestment campaign has failed to phase out coal, it has managed to raise returns for investors in the area.
Anyone would think it’s a racket…
But it’s all so familiar. The same phenomenon played out with other companies subjected to similar government campaigns against their profits.
Cigarette companies are famous for their good stock market performance in the face of a campaign to phase them out. And you can imagine what happened to the profitability of alcohol stocks after prohibition was ended in the US…
The threat of windfall taxes may also signal an investment opportunity, because it would make mining and energy stocks cheap. However, I’m weary about this one. Because a windfall tax also signals that the resources are likely to be at a peak in their boom and bust cycle. Politicians have a habit of wanting to tax cyclical industries just as they’ve peaked…
But carry our logic a little forward and you’ll notice what effect a windfall tax might have on the supply of the resource being produced. Will higher taxes on profits encourage or discourage production of the good that is surging in price because of supply shortages? Will such a tax result in higher or lower prices?
Indeed, how much of the mining and energy sectors’ profit has come from the inability to invest in new projects because of political constraints? If they can’t spend the money looking for future mines and wells, it gets left as “profit”. But that’s a bad sign for future supply. Which means higher prices in the future.
Anyway, as the campaign against carbon plays out, I think it’s time to take advantage of the opportunity the latest government bogey man’s vilification. The attack on one particular sector of the economy is about to backfire spectacularly.
On Thursday, we’ll reveal how you could profit.
Until next time,
Editor, Fortune & Freedom