by Richard T. Stuebi
An investment banker was quoted in Sunday’s Financial Times as stating that the global financial market “changed more in the past 10 days than it had in the previous 70 years.”
Given such a profound shattering of the status quo, I am skeptical that anyone can yet provide clear perspective or accurate clairvoyance stemming from the unprecedented meltdown still underway. Far be it from me to assume that I’m especially well-positioned to develop a superior synthesis – especially since so many of the pieces are still moving.
Even so, it is my professional responsibility – both to myself and to those I serve – to begin speculating how the current crisis may affect the realm of clean energy. I cannot claim much insight yet, but the following represents a few disparate thoughts that I offer to my colleagues across the physical and virtual worlds to advance the discourse.
Lower growth in demand. For virtually all goods and services for customers in the developed world, it is hard to escape the conclusion that demand will abate. (Whether the economy falls into a severe recession, or deepens into a full depression, is anyone’s guess.) In turn, this means that energy demand will also see a softening. In the past year, demand has already declined measurably for gasoline, as customers have responded to higher prices by driving fewer miles and beginning to buy more efficient vehicles. Demand destruction will now be amplified by the effect of decreasing corporate and personal incomes.
Weaker dollar. In the wake of the calamities of the past few weeks, it is also hard to envision that the dollar can do anything but fall. If true, imported goods into the U.S. will become dearer (thereby further discouraging demands), though it will create new opportunities for exporters, such as those developing and manufacturing clean energy products and services in the U.S. In addition, foreign direct investment in the U.S. will become more attractive.
Less debt, costlier debt. With even lending between banks at a standstill, it seems pretty clear that credit markets will be much tighter and debt will be much more expensive for a long time to come. Marginal credit risks – such as ventures in high-growth mode, or projects entailing new technologies – are much less likely to be approved for loans. Even if approved, debt coverage ratios will increase. This means….
More need for equity. With less debt to fund expansion, companies and projects alike will require more equity in their balance sheets to achieve growth. Assuming an unchanged supply of equity (perhaps an optimistic assumption), higher demand will drive up the cost of equity alongside the rising cost of debt. A higher cost of capital (both debt and equity) in turn means….
Declining company/project valuations and increased investment hurdles. Higher discount rates (corresponding to an increased cost of capital) means relatively more value associated with current results and less value ascribed to future possibilities. Certainty and stability become more prized, and potentialities with limited near-term returns are punished. Fewer transactions/projects occur – and those that do occur will happen at lower valuations.
Glut of financial professionals, illiquidity in carbon markets. As the financial institutions get swallowed up, shut down or shrink, lots of bankers and traders will be looking for work. Many of these people were likely to have worked in companies that were the leading players in the still-nascent carbon markets, so it is quite possible that those markets (and monetization of carbon reductions) will dry up.
Increased oil price volatility. With weakening economic conditions, there will be declining demand for oil from the developed economies, from which one might expect prices to generally decline. However, it is eminently possible that demand growth from the developing economies (especially the still-booming China and India) will more than take up the slack. Furthermore, the declining dollar will also put upward pressure on world oil markets, which are supplied mainly from overseas and increasingly denominated in Euros. Lastly, investment in new oil infrastructure or projects may be depressed by the adverse climate. All told, it’s hard to have much conviction about the future direction of oil prices – other than they will continue to fluctuate, perhaps even more severely than of late.
Risks to climate legislation. Though both the McCain and Obama candidacies have stated support to enact cap-and-trade legislation that would drive reductions in U.S. carbon emissions, the dramatically worsened economic conditions might cause either President-elect – and even more importantly, the new Congress – to be more wary of imposing a new set of environmental requirements that would entail a net cost to the economy. On the other hand….
Reduced appetite for laissez-faire capitalism. A wide variety of observers are clamoring that the current financial crisis is rooted in many years of lax regulatory oversight and excesses of unbridled capitalism. Whatever the merits of this logic, to the extent that such thinking takes hold of the public and political imagination, it could imply a general trend towards more interventionist policies and regulations in the energy sphere (and in other aspects of society). In the extreme….
Possibility of nationalization of energy activities in the U.S. I never thought I would write this, but the recent actions to essentially nationalize large parts of a financial industry formerly in private ownership provides a precedent for a not-too-distant U.S. government to take control of a similarly fundamental and strategically-critical industry being besieged by crisis. Given the daunting challenges likely to be faced by the energy industry in decades to come, it’s not out of the question to see the same game played out in the energy sector.
Buying opportunities? Short of the U.S. stepping in, many companies and assets will be available to purchase. Savvy players with strong positions will be able to make some really good buys on the cheap. Potential case in point: the Mid-American Energy arm of Berkshire Hathaway (NYSE: BRK.A, BRK.B) announced that is snapping up Constellation Energy Group (NYSE: CEG) whose trading desk was essentially pushed to the brink by the lack of liquidity in the credit markets. By adding Constellation, the Warren Buffett investment vehicle is slowly but surely becoming an energy behemoth.
End of American financial hegemony. With the recent convulsions, I think it’s becoming clear that the era of undisputed U.S. pre-eminence is coming to a close, if not already having closed. The 21st Century will belong not to the U.S. but to other powers – primarily China, but also India and (unless we move off of oil sometime soon) the OPEC economies. This means that U.S. interests cannot afford to think and behave as parochially as we have through most of our history. As I argued in a recent editorial in The Plain-Dealer, and in a recent post in CleanTechBlog.com, many of the best opportunities for many U.S. players will lie in China. The U.S. will simply be unable to afford to consider itself the only, or even the most, important market on the planet.
In the coming weeks, as the outline of our society’s next-generation financial system becomes clearer, perhaps I will become more confident to offer more definitive speculations about the future of the clean energy world. Maybe some stronger causes for optimism will emerge. Until then, like everyone else, I too must resort to buckling up and watching events unfold further. Meanwhile, the storm rages on, and I expect more dominoes may fall.