Will the Falling Pound Cushion Brexit's Blow?

Mike Riddell | 12/01/2016


Britain's economy didn't roll over post-Brexit, but the pound has dropped in response to increasingly tough political rhetoric about a "hard" exit. Mike Riddell wonders whether a further drop in sterling might prompt the government to soften its stance.

Is Brexit Good for Britain?

Britain's economy was supposed to roll over in the aftermath of the Brexit vote. But based purely on the high-frequency UK economic data, one could make the case that Brexit looks to have been a good thing for Britain. That's a very dangerous outcome for European Union (EU) politicians desperate to avoid an EU exodus. They now have an incentive to make Brexit as painful as possible for the UK, even if it means the ultimately self-defeating prospect of wounding a country that buys the second-highest amount of euro-zone exports.

EU politicians have an incentive to make Brexit as painful as possible for the UK

Things look far less rosy for the UK if you judge its health by the foreign-exchange market. Immediately after Brexit, the pound fell 7.6 percent against the US dollar, the ninth-biggest daily move since 1862. This was actually a smaller drop than many had expected, which tells you a lot about the pound's positioning going into the vote.

Sharp Drop in Pound

Three months of pound stability followed, but the first two weeks of October saw another sharp move lower. UK Prime Minister Theresa May suggested that the UK is heading for a "hard" Brexit, with the UK giving up access to the single market in order to restrict the free movement of people. She also stated that the Brexit process is anticipated to officially start in March 2017, with the triggering of Article 50; ironically, this could mean that the UK might leave the EU two years later—on April Fool's Day, 2019.

Teresa May said the Brexit process will officially start in March 2017 with the triggering of Article 50

Brexit uncertainty is not being helped by the fractious state of British political parties. The Labour Party is failing to provide sufficient opposition to the incumbent government due to an internal division between Labour's leader, Jeremy Corbyn, and its members of parliament in the House of Commons. For its part, the House of Lords is unlikely to step outside of its historical role of refining proposed laws in order to effectively provide scrutiny over the government's plans. This dysfunction means, as HSBC has noted, that the British pound sterling is now effectively functioning as the opposition to the government.

Things look less rosy for the UK if you judge its health by the foreign-exchange market

Financial markets can signal their opposition to this state of affairs, but they cannot formulate policy. While the pound's further fall might lead May to be more attuned to the desires of the 48 percent who voted to remain—or to the 52 percent who in a recent poll revealed that they would prefer a "soft" Brexit—further political opposition will be needed to soften the government's hard Brexit goals.



Mike Riddell

Senior Fixed Income Portfolio Manager

Methane: The Next Frontier for Fossil Fuel Emissions

Marie-Sybille Connan | 12/01/2016


Carbon dioxide emissions have taken up all the air, so to speak, in discussions on climate change. But Marie-Sybille Connan says the message must also get through on methane, which is the second-biggest greenhouse gas and also valuable in its own right.

A matter of methane emissions

Ahead of COP21, the United Nations Climate Change Conference, the six largest European oil & gas companies (including Shell, BP and Total) called for a global carbon tax as a way of slowing global warming and promoting natural gas as a transition fuel to a low carbon economy. This was a welcome initiative from the European majors, which was sadly not mirrored by their US peers. However, as often, the devil is in the details. Any carbon tax should recognize the two sides of carbon: there are two major greenhouse gases, carbon dioxide (CO2) and methane (CH4) and both are carbon gases.

Any carbon tax should recognize both sides of carbon emissions: carbon dioxide (CO2) and methane (CH4)

Targeting both is critically important if we want to have a chance to limit global warming to 2°C (with an even greater ambition to reach 1.5°C) as agreed in the Paris Agreement. Identifying an upper limit in greenhouse gas emissions as soon as possible is the immediate climate concern. One can appreciate how difficult the challenge is considering that the oil majors are currently rebalancing their portfolios towards natural gas and that the US economic recovery post Lehman Brothers is related to the shale gas boom.

Methane is the second most abundant manmade greenhouse gas after carbon dioxide: CO2 accounts for about half and CH4 for about one-quarter. It is emitted during the production of coal, oil and natural gas. It also comes from solid waste stored in landfills, animal waste management systems, wastewater treatment facilities and other manmade and natural sources.

These emissions pose risks to people and the environment. Methane emitted into the atmosphere creates air pollution causing thousands of premature births every year. Methane that builds up in coal mines and oil & natural gas facilities can cause explosions that can endanger workers.

Major emitters of methane

China, the US, Russia, India, Brazil, Indonesia, Nigeria, and Mexico are estimated to be responsible for nearly half of all anthropogenic methane emissions. However the major sources of methane emissions for these countries vary greatly. For example, a key source of methane emissions in China is coal production, whereas Russia emits most of its methane from natural gas and oil systems. In the US, oil and gas systems are the largest source methane emissions (30%) according to the US Environmental Protection Agency (EPA).

Global anthropogenic methane emissions are projected to increase by 19% over the period 2010-2030 to 10,220 million metric tons of CO2 equivalent by 2030. The relative contributions of the agriculture, coal mining and landfill sectors are projected to remain relatively constant while methane emissions from wastewater treatment systems are expected to increase by nearly 19%. Oil and gas emissions are the real issue as they are expected to increase by 26% over the same period.

Carbon dioxide vs. methane

In order to address climate change, we must reduce pollution to slow the rate of climate change (notion of flows) while at the same time limiting maximum warming (notion of inventories). But, all emissions are not equal. Like CO2, methane is a gas that warms the earth by trapping heat. However, the way in which each gas interacts with the planetary climate is dramatically different. The climate is slow to respond to changes in carbon dioxide emissions and, as such, immediate reductions in CO2 emissions will take 30 to 40 years to slow warming but, critically, all emissions produced will have a warming effect on the climate that will last for hundreds of years.

On the other hand, the climate system reacts quickly to changes in methane emissions and therefore reducing them now is crucial for slowing climate change over the next 30 to 40 years. Furthermore, the methane remains in the atmosphere for only 12 years: methane emissions don’t have any lasting influence on the planetary climate system, unlike carbon dioxide emissions.

Methane and carbon dioxide emissions have very different lifetime and impact. CH4 is 84 times more powerful than CO2 over the first two decades following its release but its only 28 times more powerful over 100 years. By contrast, CO2 remains in them atmosphere much longer. Over time, CO2 has then a greater warming potential.

Hence, comparing them requires a metric that depends on a timeframe. Scientists measure the global warming of potential gases over two time periods: 100 and 20 years. It is scientifically proven that the earth is predicted to warm by 1.5°C above pre-industrial baseline within the next 15 years and by 2°C within the next 35 years given current GHG emissions.

It is also scientifically proven that a combination of emissions reductions, such as curbing CO2 from coal-fired power plants and methane from oil and gas activities, is the best way to stabilize the climate in the long term while reducing warming now. That’s why, the use of a global warming potential of 84 for the 20-year time period from the IPCC Fifth Assessment is the right approach to compare the warming consequences of methane and carbon dioxide emissions.

Hence, Robert W. Howarth from the Cornell University, Ithaca, NY, introduces the notion of a GHG footprint for fossil fuels and he shows that the GHG footprints of shale gas first and then conventional natural gas are higher than that of conventional oil and coal when methane emissions are considered over an appropriate timescale. As such, natural gas (and shale gas in particular) may lose its green credentials as the transition fuel to a low carbon economy.

Regulatory, investor and corporate initiatives

There is an urgent need to act on methane emissions. Take the massive natural gas leak at a storage well near Los Angeles in October 2015 as an example, this resulted in thousands of nearby families having to flee their homes and be temporarily relocated. After several unsuccessful attempts to plug the leak, SoCal Gas began building a relief well to capture the leaking gas. In mid-February, the leak was fixed, over three and a half months later. The Environmental Defense Fund (EDF) estimates that the amount of methane leaked had the same 20-year climate impact as burning nearly a billion gallons of gasoline. This sole gas leak will have an impact on California’s ability to meet its GHG targets this year. Aside from the environmental and reputational risk, SoCal Gas estimates financial costs of $330 million and 83 lawsuits have already been filed against the firm.

From an economic standpoint, methane has value and lost methane is essentially wasted fuel

From an economic standpoint, methane is valuable and lost methane is essentially wasted fuel. Because methane is the major component of natural gas, it can also be captured before it is emitted into the atmosphere and used to produce energy for heating, electricity and cooking. When it is captured from landfills and agricultural sites, the collection systems can reduce local water contamination. As such, all stakeholders have a vested interest in managing actively methane emissions. There are practical and cost effective solutions to minimize methane emissions, many of which can increase the 'bottom line' of the Oil & Gas industry.

Since 2004, countries around the world have been working in partnership with the Global Methane Initiative on projects to reduce emissions worldwide and to use methane emissions as a source energy source. These projects are also helping to reduce air pollution, protect people's health and improve local economies.

Methane emissions: The next frontier

In particular in the US, where financial and environmental stakes are high, the White House announced in January 2015 an ambitious national strategy to reduce oil and gas methane emissions to 40-45% below 2012 levels by 2025. However, in order to meet this target, new regulations are required that go beyond the EPA proposed methane emissions standards for new and modified oil and gas facilities (August 2015). Indeed, circa 90% of emissions in 2018 are expected to come from existing facilities. The outcome of the US presidential polls may weigh on the implementation of further regulations.

A windfall awaits oil & gas companies that can effectively recapture methane from emissions

The Environmental Pension Fund (EDF) has done great work in increasing awareness across the Civil Society, corporate and the investor sphere. In a recent study, they show that global oil and gas methane emissions represented $30 billion in wasted resources worldwide, which proves that there is a financial benefit for oil & gas companies to identify and manage methane emissions.

They also found that the disclosure on methane emissions is not up to the challenge. 28% of the 65 companies (out of which 40 oil majors and 25 large midstream companies) surveyed report methane emissions in investor facing channels. No company provides quantitative reduction targets. Only one company provided detailed information on its leak detection and repair (LDAR) program. Information provided is generally vague, qualitative and non-actionable. The EDF calls for corporate action to measure and report methane emissions in order to manage the impact on global warming.

In the wake of EDF, investors are increasingly pushing for action on methane after having targeted companies for releasing sustainability reports and disclosing their carbon dioxide emissions. They want more information on the extent of the issue and how companies are tackling it. Hence, they have filed 10 shareholder resolutions to press US energy companies before their annual meetings this year to detail plans for limiting methane leakage from wells, pipelines and other energy equipment.

Energy investors are urging companies to minimize methane emissions in a transparent manner

Lastly, investors representing $3.6 trillion commended the joint US and Canadian March 10th announcement that both countries take steps to seriously address methane emissions from the oil & gas sector. As widely diversified, long-term investors with holdings in the oil & gas industry, they share a vested interest in the industry's long-term success and think that natural gas can play a significant role in the North American energy mix, has demonstrated the potential to reduce greenhouse gas emissions while supporting economic growth. However, they are concerned that methane emissions pose a risk to their investments. They urge companies to minimize methane emissions in a transparent manner and provide investors and the public with better methane reporting.

Methane disclosure has become the new challenge for investors in oil & gas companies after the good progress achieved on carbon disclosure and stranded assets stress-testing. For the gas industry to really be part of the solution in the transition to a low-carbon economy, methane emissions must be actively and transparently managed. Investor scrutiny will only but increase.



Marie-Sybille Connan

Assistant Vice President, ESG Analyst
Ms. Connan is an ESG analyst and an assistant vice president with Allianz Global Investors, which she joined in 2008. As a member of the firm’s Environmental, Social and Governance team, she is responsible for the energy, media and telecommunications sectors. Ms. Connan was previously a fund manager and credit analyst. Before joining the firm, Ms. Connan was a senior credit analyst at Fortis Investments and Aviva Investors; before that, she worked at Natixis AM as a fund manager and equity analyst, focusing on IT and software. Ms. Connan has a master’s in finance from the ESC Montpellier Business School. She is a member of the French Society of Financial Analysts and a graduate of the Centre de Formation des Analystes Financiers.
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