A number of high-profile divestment advocates have claimed that the recent falls in energy prices are a clear signal that the world is undergoing a large-scale energy transition away from fossil fuels.

In a recent in-depth piece examining the arguments being presented, and analysing the current volatility in commodities markets, ITS Global chief economist Jeffrey Rae said he could see two problems with divestment advocates’ line of thinking that says stocks in companies dependent on fossil fuel for revenue are overvalued as they will not be able to realise the value of their reserves.

The first problem Roe identified was that this is entirely dependent upon the implementation of a global policy that will severely limit the extraction and use of fossil fuels, most likely through the pricing of carbon.

“As has been pointed out elsewhere – and clearly signalled by the most recent United Nations climate meeting in Lima – this is unlikely to happen,” Roe said in a piece published in a Sustainable Resource Investment Briefing.

The second is that much of the analysis around these so-called overvaluations relies on a conflation of the terms “proven reserves” and “probable reserves”.

Roe said US regulations required resource companies use the term “proven reserves” according to strict definitions set by the Securities and Exchange Commission, and it is upon this data that markets price assets accordingly.

Similarly, divestment advocates have argued that falling fossil fuel prices will reduce investments in fuels such as coal, and therefore reduce opportunities for these companies.

“Advocates state that decline in coal prices reflects a long-term fall in demand. It should be underlined that this is hardly the case,” Roe said.

“Global coal demand growth has fallen slightly, reflecting global weaknesses in industrial activity, particularly in China. The more recent falls in prices appear to be the result of what can be best described as a coal glut that is simply part of the cyclical nature of the industry, as well as smaller contributing factors.

“Tightening demand causes higher prices. This means investment opportunities for new mining operations.

“But time lags, delays and increased competition can result in overinvestment, leading to overcapacity and weaker prices.”

In the current cycle, Roe believes exceptional Chinese demand growth has created opportunities for miners globally over the past decade.

Infrastructure developments and therefore export capacity has increased in major coal exporting nations, such as Australia, Indonesia and Colombia, which have boosted supply in the global seaborne market.

The ability of electricity utilities to switch between fuel sources according to cost has also prompted many companies to switch fuels accordingly.

Roe noted that in the US, lower gas prices – as a result of hydraulic fracturing – saw many utilities switch to gas, which further prompted many US miners to dump coal on to the Atlantic market, which in turn prompted many European utilities to switch to coal in the face of higher European gas prices.

“Cuts to production and productivity improvements are the immediate response of most companies,” Roe said.

“In situations where prices have fallen significantly, producers with strong balance sheets are able to cut production until prices recover and/or cut costs.

“Producers currently cutting production include Peabody and Glencore and Whitehaven. One observer summarised the company situation neatly: companies have a longer memory on how to handle a bust than on how to handle a boom.

“But it is also important to note where production cuts are taking place.”

“Glencore, for example, is cutting production in South Africa. However, many analysts consider Australian coal to be an attractive option because of its proximity to Asian markets.

“Companies that are unable to maintain cash flow – for whatever reason — will be forced sell off assets or in other cases find themselves subject to a takeover.”

Roe said these are not indications of a major energy transition, but of cyclical fluctuations within the market, and the usual responses to changing market conditions.

“While some coal divestment advocates – often boosting the position of other energy sources, renewable or otherwise — maintain that this signals a long-term decline in demand, the untenable nature of these arguments have forced many advocates simply to maintain that the case is a purely moral one.

“But what should also be remembered is that coal has come off a period of exceptionally high prices and unprecedented demand growth. Historically prices remain high – significantly higher than the bottoming out of US coal prices in the 1990s, for example.”

Energy markets and commodity markets are generally cyclical in nature, as buyers and sellers adjust to new circumstances as they see appropriate. Thus major transitions take longer, and predicting the timing of the markets or of major transitions is difficult.

Based on this, Roe said there was nothing to suggest that divestment advocates have better information than most analysts.

Roe cited Pulitzer Prize-winning American author, speaker and economic researcher Daniel Yergin, co-founder and chairman of Cambridge Energy Research Associates which has now been swallowed by HIS, who summed this up: “Transitions in the energy industry unfold over decades, owing to the large scale of the industry and the size and longevity of the infrastructure involved,” he said.

“A ‘transition’ is not an abrupt change from one ‘reality’ to another but rather a shift that unfolds generationally over considerable time, and one that may lead to greater diversity in the energy marketplace.”