Do the risks of stranded assets in the petroleum industry extend to its local content-related industries?
Today’s column starts with an offering of a few concluding comments on the topic considered over recent weeks: local content requirements/policies (LCRs) in the petroleum industry, as Guyana prepares for its own industry, scheduled to come on-stream post-2020. After that I shall revisit the related topic of stranded assets. This was introduced in last year’s Christmas Day (December 25, 2016) column. And, today’s presentation posits that the risks posed by stranded assets in the petroleum sector, substantially apply to the sector’s LCR-related industries.
As repeatedly observed, it would be in serious error for anyone to doubt that LCRs are highly contentious. Serious analysts (including mainstream economic theory) along with several major international institutions view LCR policies as hurting other countries and therefore, against WTO principles. They claim these violate the free trade premise of ever expanding global trade founded on market principles as a necessary condition for sustaining globalisation’s success.
As I have previously observed also, despite this often repeated economic orthodoxy underpinning today’s global economy, a wide array of countries violate it. Readers may rightfully ask: why, if this is the case, the so-called ‘hurting economies’ do not report this covert protectionism to the WTO? The answer is simple, most countries, if indeed not all, are themselves violators, as they pursue LCRs policies.
In today’s global trade there are no purely free markets. A close examination would reveal that an enormous range of private businesses of all sizes, legal forms, and competitive structures, participate in global trading markets. Similarly, an enormous mix of government owned, protected, subsidized, sponsored and, in other ways, supported enterprises, operate in these markets. Furthermore, this situation is particularly true for oil and gas and their related industries.
As previously indicated, on this score close consideration should be given to the circumstance where the traditional focus of protection has been on the imposition of tariffs/quotas, and over the past two decades this focus has shifted substantially to other impediments to global trade. These other impediments are the notorious non-tariff barriers (NTBs). This shift of concern is from measures designed to keep out other countries imports to today’s policy concern with hurting other countries’ commercial interests. Bailouts, subsidies and other tax expenditures that favour local enterprises (both private and public) fall in this category; as do LCRs.
Perhaps the most widely advertised example today of LCR policies finding favour in rich countries, is the publicitydriven President Trump calls to American business to “Make America Great Again” and/or “America First”. Such calls rest firmly on the decades-old US trade slogan: ‘Buy American’.
Stranded assets
In the Christmas Day (2016) column referred to above, I had introduced the Carbon Tracker Initiative (CTI), a nongovernmental independent financial think tank. The CTI researches the impact of climate change on capital markets and investments in the petroleum sector as one element of the broader fossil fuels’ market.
The CTI focuses on raising public awareness of the Paris Agreement, 201516. This Agreement limits greenhouse gas emissions in order to contain global warming to within 2ºC by 2050. The CTI indicates that achieving this goal is incompatible with 1) prevailing levels of global fossil fuels resources; 2) the goals of sustainable development (note Guyana’s Green State ambitions); and 3) the projected rates of resource depletion. The CTI therefore projects a substantial portion of global fossil fuel reserves (about two-thirds) may become unburnable, if the global agenda behind the Paris Agreement is in fact substantially realized.
Last Christmas’s column then introduced the well-known finance/economics notion of stranded assets. As observed, while such assets can arise from a multiplicity of factors, the present concern is about assets on an enterprise’s balance sheet becoming obsolete or non-performing and, therefore, having to be recorded on the balance sheet as ‘a loss of profit’. Based on this consideration, clearly today’s global carbon fuels markets carry a number of systemic risks, and so therefore, must be those input (backward) and output (forward) industries founded on it.
In theory such risks can arise from 1) environmental concerns in the global economy; 2) the implications of global climate change; 3) the depletion-rate for fossil fuels reserves; 4) natural and manmade disasters (including social and cultural); 5) changing applicable governmental regulations; and 6) changing social norms and their impact on the way of life for which societies exhibit their preference.
Stranded assets are also considered as wasted capital. In this formulation, the term identifies carbon resources, which, because of global agreements, might become unburnable. The reasoning behind this expectation is that presently identified global fossil fuel reserves exceed the carbon budget permitted to be spent under the Paris Agreement.
Furthermore, CTI estimates reveal that, currently, about one trillion US dollars annually are being spent on developing new fossil fuels reserves. And, therefore, these are potential stranded assets. Given this, the matter is more than one of mere theoretical curiosity for Guyana. The nation must pay attention to the systemic threat this poses to its coming time of first oil in 2020 and beyond. For this, the CTI also estimates that between 60-80 per cent of global fossil fuel reserves held in publicly listed companies, could become unburnable.
From this presentation, we see that, no commercial enterprise dependent on fossil fuels can afford to ignore such factors in its financial risk management. At the forefront of its considerations must lie a calculated evaluation of the likelihood that resources invested in assets for Guyana’s oil and gas sector may be subject to “unanticipated and/or premature” write downs, devaluations, or worse, conversion to liabilities. In this sense, the discussion on LCRs and related topics is based on the expectation that cataclysmic events may follow a spate of stranded assets worldwide. However, over the medium term horizon of Guyana’s oil and gas industry coming on stream I do not believe this will materialize.
Conclusion
Following today’s topic I shall next consider the major issues raised by calls to establish a local oil refinery. Strong nationalist supporters of LCRs see this as perhaps the ultimate expression of Guyana’s autonomous development based on its extractive sector, and premised on the diction: Guyana should produce, all it can produce.