Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Chief Investment Strategist
Summary: Europe's fragmented energy policy has led to a national security crisis which will now be addressed by Europe at the fastest pace possible. Of all the options including coal, nuclear, solar and wind, thermal coal is by far the quickest way to convert power plants from using gas. But the gas-to-coal switch comes with a cost to the environment and our narrative in Europe about the green transformation. However, the carbon capture storage (CCS) technology is rapidly advancing and Europe could bring coal back contingent on combining it with CCS creating a new industry. We explore combining coal with CSS and highlights the different companies involved in those two industries.
All options are on the table
The last week’s developments are existential for Europe, and defence and energy policies have moved from being uncoordinated among European countries to be a supranational issue. Europe’s dependency on Russian gas and oil has weakened Europe’s military flexibility and as a result Europe’s energy policy will be totally changed in the years to come. Germany has basically said that all options are on the table including nuclear, coal, and LNG. The German Chancellor Scholz said in the Bundestag on Sunday that "We must change course to overcome our dependence on imports from individual energy suppliers".
LNG terminals and nuclear power plants are longer term solutions, and renewable energy projects such as solar and wind are medium-term solutions because scaling these projects up takes a long time. In addition increasing the mix of renewable energy sources come with extra costs in terms of energy storage to mitigate the intermittency of renewable energy production spikes.
Europe is galloping into a ‘gas crisis’ and given the recent mild weather in Europe means that Europe will likely get through this cold period, but the pressure is on for European countries to fill up natural gas storage before next winter and Russia will likely not be a helping hand here. Germany has said that it is already building up coal reserves and will extend the life of coal power plants. Many gas power plants can be switched to coal, so the rebirth of coal in the energy policy is very likely at this point in history.
Realistically the only short-term solution Europe has to its energy crisis and to change its energy security policy at the maximum speed is by focusing on coal power plants. There is plenty of coal reserves in the world with the US having 24% of the world’s coal reserves and Australia with the third largest reserves at around 14% of the world’s coal reserves. Coal is cheap, it is great for baseload electricity production, Europe can get massive amount of coal from geopolitical partners, but it is dirty which is a problem relative to climate change and the green transformation.
Combining coal power plants with carbon capture
Coal power plants are the quick and scalable solution to lower the impact from Russian natural gas, but environmental groups among voters would resist. However, one strategy could be to accelerate coal power plants with the contingency of implementing carbon capture storage (CCS) as fast as possible. Is it even possible?
First of all, it is important to notice, that when energy policy becomes a critical national security issue, the equation is no longer a free market decision; just like the green transformation is a policy decision that dilutes free market forces. The extra cost of CCS on top of coal power plant costs might just be the cost of energy independence from Russia and Europe will have to swallow that cost in the short term.
The good thing about CSS is that the technology is already here and it is coming down fast. The report Technology Readiness and Costs of CCS (March 2021) from the Global CCS Institute is a good 50 pages report providing the highlights of the technology.
CCS is basically a three-stage process of first capturing carbon emissions from industry and power plants and transport that CO2 via ships, trucks or pipelines, and the final step is the storage which requires the CO2 to be compressed to very high pressures of minimum 74 bar which can be achieved at depths of minimum 800 meters. Storage is typically done in depleted oil and gas fields or saline formations. The picture below shows the process of carbon capture in a power plant.
IEA has also some quite useful illustrations and information on CCS as it relates to power production, and the chart below shows the CCS projects that are in the pipeline in terms of million tons of CO2 extraction. According to IEA second-generation CCS could extract at a cost of $45/tCO2 which means that combining cheap thermal coal (if supply was greatly expanded) with CCS could make this solution cost effective enough to function next to nuclear power and renewable energy sources. These second generation CCS units will also come with 67% lower capital costs and 95% capture rate.
One of the key drivers that has recently made CCS possible on a scale we have not seen before is the EU Carbon Emission price which recently surged past €90/tCO2, but the rising energy and metals prices have increased input costs on top of the price for carbon emission that total costs of producing industrial goods and have reached levels where there is real demand destruction.
Companies with exposure to carbon capture and coal mining
The carbon capture industry is growing fast and maturing with lower implementation costs for CCS making the technology a viable solution to limit climate effects from carbon emissions. There are few pure plays on carbon capture, but we have tried to come up with a list of pure and partly carbon capture stocks.
The list below shows companies that extract coal or related coal mining services, and listed on a developed market exchange.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)