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Article | 05 January 2022 | Investments
Stranded assets - what’s the big story?
Traditional energy companies are at a crossroads. Shareholders have demanded they change their business models and transition to become green energy producers. In addition, targets on greenhouse gas emissions, as well as the falling price of renewable energy, could mean the price of fossil fuels tumbles over the next decades. Reserves of hydrocarbon still in the ground might prove to be ‘unburnable’ and production infrastructure could be left high and dry. We drill down to expose the stranded assets of the energy sector.
Originally used in accountancy, the term ‘stranded asset’ describes one which no longer has a commercial value. A once promising facility can become unlikely to produce any future revenue, perhaps following a change in regulation. Against expectations, the asset has become devalued and must be moved from the positive side of a company’s balance sheet, becoming a liability instead. This is exactly how the value of production assets could be impaired by deteriorating fossil fuel markets.
So what is the scale of the problem? The undertaking of The Paris Agreement to limit global warming to 1.5 degrees means the world’s economies must adhere to a strict ‘carbon budget’. In order to achieve this, a considerable proportion of known hydrocarbon reserves would have to stay in the ground. That’s as much as a third of all oil reserves, half of the gas reserves and more than three quarters of coal reserves.
But some experts argue that, if the definition of a stranded asset is one that has suffered an unpredictable write down, then unburnable carbon does not qualify at all. Climate change has certainly been predicted for many decades. In the face of mounting evidence, perhaps the continuing investment in these assets by major energy companies could be better viewed as poor judgement. Either way the situation will need to be addressed.
And what of the longer term? The direction of travel seems clear. As EVs become the dominant mode of transport and we turn to sustainable energy sources for the majority of our power, demand for fossil fuels will naturally dwindle. In the current climate, coal could face a more rapid decline than oil or gas. As demand falls, so will prices and the viability of exploiting hydrocarbon reserves will likely diminish even further. The trend towards stranded assets in the energy sector looks set to be on the rise.