By Shelburne, Vermont Financial Advisor Josh Kruk
January 21, 2021
The classic supply/demand curve is one of the first things taught in any entry-level economics class. Increasing the supply of an available good or service without an increase in consumer demand will cause the price of that good or service to decrease. in a basic sense, making more of something that nobody wants more of is probably a bad business strategy.
Companies and politicians backing fossil fuel development are being presented with more frequent examples of this principle in action. In 2011, two Japanese firms, Sumitomo and Kansai, purchased a new coal-fired power station in Australia. The total debt and equity value of the purchase was $1.2 billion. Recently, the companies elected to write down the value of the investment to zero1. In less than a decade, the entire investment had become essentially worthless.
The downfall of the project was accelerated when the banks who provided the initial debt financing chose not to refinance the loans. Rather than throwing good money after bad, they instead chose to realize a loss and walk away. The speed with which this project unraveled has clear implications for lenders and investors. Most fossil fuel projects involve buildings, equipment and other assets designed to have useful lives that are decades long. These assets are typically funded at least in part by borrowing.
If demand falls precipitously before the useful life of the asset has expired, the asset is likely to become “stranded”, no longer producing enough revenue to support itself. Lenders who understand basic supply and demand principles and who are interested in staying in business try to avoid making loans that might not be paid back.
Granted, this example may be a bit extreme. The decline of coal is further along than other fossil fuels. But is it unrealistic to think that in ten years, the demand curve for oil could look something like the demand curve for coal does today? If that is even somewhat likely, one has to believe that financial institutions and investors have less risky things to do with their capital. Like financing renewable energy projects, for example.
On the topic of limited demand, the much-debated auction of drilling leases in the Alaskan Arctic National Wildlife Refuge was held earlier this month2. It did not exactly go as planned. More and more, things like this feel like wishful thinking on the part of the policymakers who want to climb into a time machine and roll back the clock thirty years.
I don't know whether Bitcoin is a bubble. But I do feel bad for this guy.
Notes
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