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On Stranded Assets

Back in November, a report titled “Reframing incentives for climate policy action” found that half of the world’s fossil fuel assets will be worthless by 2036 under a net-zero transition. The report highlights the risk of producing more oil and gas than required for future demand, which is estimated to leave more than $11 million in stranded assets.

These can include infrastructure, property and investments; stranded assets are assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities (Caldecott, Howarth, and McSharry, 2013).

In this context, this refers to fossil fuel infrastructure and investments that will no longer generate economic returns due to the changes associated with decarbonisation.

The lead author, Jean-Francois Mercure told The Guardian that “In a worst-case scenario, people will keep investing in fossil fuels until suddenly the demand they expected does not materialise and they realise that what they own is worthless. Then we could see a financial crisis on the scale of 2008.” This was seen in COP26 when several oil and gas producing nations such as Russia and Saudi Arabia pledged to become net-zero by 2060.

The prediction that assets tied to the fossil fuel industry are likely to become stranded sooner rather than later, is a ‘transition risk’ that could jeopardise financial stability while reshaping our current understanding of geopolitics. While national reserves such as Saudi Arabia’s are estimated to last 70 years, international oil companies’ proven reserves range between 10 and 15 years. Which would mean it is unlikely for geopolitical relations to change anytime soon. However, according to the report, the most vulnerable assets are those in remote regions and inaccessible environments such as the Russian Arctic and the deep offshore wells in Brazil. In contrast - an implication of this transition that we are seeing EU Member States quickly realise - oil, gas and coal importers will find economic dividends as a result of this transition and the reduced demand for imported fossil fuel-derived energy. The research found that the GDP of most European nations would increase in any net-zero scenario - in the UK this could add around $700 billion to the value of the country’s GDP despite losing many of its fossil fuel assets.

Risks and returns: the role of governments?

Traditionally, high risks - such as the risk of assets becoming stranded - are associated with high returns. Indeed, the energy crisis prompted by the sharp increase in energy demand and consumption saw oil companies receiving boosted profits and investors receiving high returns. These are profits held by private organisations that have made risky investments in a volatile market. Nevertheless, in the EU, five energy groups are suing four European governments under the Energy Charter Treaty for over $4 billion over restrictions around coal, oil and gas projects: essentially asking governments to bear the risk associated with stranded assets in the fossil fuel industry as a result of climate action. This raises the question: will governments be called to bail out failing oil companies when their assets become stranded in a few years from now, as they did with the air travel industry in wake of the COVID pandemic?

The Bet on Gas

Despite the warnings that have been hailed since the early 2010s, companies and governments are making large bets on natural gas as a transition fuel. Natural gas has been the gateway to the risks that are attached to the oil industry, with several international oil companies now diversifying their operations and targeting natural gas production. The five largest oil companies saw a rise in their gas output from 39 per cent in 2007 to 44 per cent in 2019. This came as Shell announced its oil production peaked in 2019 and that it would expand its gas business. It is expected that ‘gas will become the new coal’ as a result of renewables becoming more competitive than gas-fired stations. EU plans to build several infrastructure projects such as pipelines and terminals to support its misled, transitional vision, which has a potential $104 billion stranded-asset risk according to the Global Energy Monitor.

“Gas will be a repeat of coal but quicker,” said Catharina Hillenbrand von der Neyen, head of company research at Carbon Tracker, to Bloomberg Green. “When we look at power generation, you can see that going really, really quickly.”

Despite the rhetoric behind natural gas’ role as a transition fuel, investors pushing the ESG agenda add mounting pressure on companies to remove gas from their operations.

There’s no point building assets now that will be of no use in a few years, said Frans Timmermans, the European Commission’s executive vice-president. Europe can skip the transition and go straight to clean assets by spending on the right projects now, he said.


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