Stranded assets and regulatory risk


in Canada, Economics, Law, Politics, The environment

One of the most important economic and political points arising from climate change is uncertainty about how seriously future governments will respond to the problem. If some kind of political change makes governments serious about hitting the 1.5 – 2.0 ˚C temperature targets from the Paris Agreement, it will mean doing everything possible to rapidly reduce emissions, from imposing high carbon prices to mandating the abandonment of especially harmful technologies and practices like burning coal and using exceptionally filthy fuel for international maritime shipping. This is termed “regulatory risk”. Whenever a potential investment project has finances that rely on governments continuing to talk big but do little about climate change, the project risks becoming non-viable after all the costs of development are spent if the government subsequently starts to take climate change seriously.

When it comes to actual fossil fuel reserves, there is a related issue of “stranded assets” – fossil fuel reserves that would be economically viable to extract if they could be sold, but where the climate change and energy policies of governments either directly prohibit their extraction or add other costs like carbon taxes which make the extraction unprofitable. In such a scenario, firms that depended on the value of these reserves to justify their own market value could be in trouble, along with everyone who has invested in them.

A recent article in The Globe and Mail describes how firms are aware of these risks:

[Caisse de dépôt et placement du Québec] The Quebec-based pension fund is part of a growing tide of institutional investors – which includes giants such as Vanguard and BlackRock Inc. – pressing companies for more information on how they will manage the transition to a low-carbon economy. Companies in carbon-heavy industries such as energy and mining face the highest pressure, as investors fear being stuck holding stranded assets: companies who fail to plan for the future and whose valuations will likely plummet as a result.

“It’s a risk that we could be left holding the bag in a Minsky Moment and it could be quite costly,” says Toby Heaps, chief executive and co-founder of Corporate Knights Inc., a Toronto-based organization focused on corporate social responsibility. “I wouldn’t say we need to sound the fire alarm, but certainly it’s time to pause and take a serious look at how we can accelerate our transition to a low-carbon economy.”

The pressure has catapulted climate risk to the top of the agenda in many of Canada’s boardrooms as companies grapple with how to measure, mitigate and disclose potential liabilities. Last year, the board at Suncor Energy Inc. recommended that shareholders approve a proposal put forward by NEI Investments to enhance the company’s climate-related disclosures. Shareholders voted overwhelmingly in favour of the resolution.

There is every reason for advocates of stronger climate change mitigation policies to pressure firms to consider these risks before investing. There are ample examples of how – once a project is built and operating – it becomes politically impossible to shut down, regardless of how much harm it is causing. A classic example is coal-fired power plants in the United States that were built before the Clean Air Act and are thus exempt from the obligation to install scrubbers. Arguably, the entire bitumen sands is a massive example of a terrible idea that has become impossible to discontinue because too much has been invested, too many jobs are now at stake, and governments have become too dependent on royalties and other related revenue.

{ 17 comments… read them below or add one }

. November 22, 2017 at 12:27 pm
. July 2, 2018 at 6:15 pm

Electricity also rewards co-operation. Because renewables are intermittent, regional grids are needed to ship electricity from where it is plentiful to where it is not. This could replicate the pipeline politics that Russia engages in with its natural-gas shipments to Europe. More likely, as grids are interconnected so as to diversify supply, more interdependent countries will conclude that manipulating the market is self-defeating. After all, unlike gas, you cannot keep electricity in the ground.

An electric world is therefore desirable. But getting there will be hard, for two reasons. First, as rents dry up, authoritarian oil-dependent governments could collapse. Few will miss them, but their passing could cause social unrest and strife. Oil producers had a taste of what is to come when the price plunged in 2014-16, which led to deep, and unpopular, austerity measures. Saudi Arabia and Russia have temporarily stopped the rot by curtailing production and pushing oil prices higher, as part of an “OPEC+” agreement. They need high prices to buy time to wean their economies off oil. But the higher the oil price, the greater the incentive for energy-thirsty behemoths like China and India to invest in renewable-powered electrification to give themselves cheaper and more secure supplies. Should the producers’ alliance crumble in the face of a long-term decline in demand for oil, prices could once again tumble, this time for good.

That will lead to the second danger: the fallout for investors in oil assets. America’s frackers need only look at the country’s woebegone coalminers to catch a glimpse of their fate in a distant post-oil future. The International Energy Agency, a forecaster, reckons that, if action to limit global warming to below 2°C accelerates in coming years, $1trn of oil assets could be stranded, ie, rendered obsolete. If the transition is unexpectedly sudden, stockmarkets will be dangerously exposed.

. July 2, 2018 at 7:12 pm

AS A citizen, Dave Jones worries that climate change may imperil his two children, and theirs in turn. What exercises him, as California’s insurance commissioner, is the way in which a transition to a low-carbon economy might affect the financial health of the state’s 1,300-odd insurers. On May 8th he unveiled an examination of how well the portfolios of the 672 insurers with $100m or more in annual premiums align with the Paris climate agreement of 2015, in which world leaders vowed to keep global warming below 2°C relative to pre-industrial times.

The answer is, not very. In the next five years carbon-intensive firms in those portfolios plan to produce more internal-combustion engines and coal-fired power than the maximum the International Energy Agency (IEA) reckons is compatible with meeting the 2°C goal (see chart). Meanwhile, investment plans in renewable energy and electric vehicles lag behind the IEA’s projections of what is needed.

The results echo those of a study last year by Swiss authorities of the portfolios of pension funds and underwriters. According to the Two Degrees Investing Initiative, a think-tank that conducted climate stress tests for the Swiss and Californian regulators, global equity and corporate-bond markets also look dangerously exposed to energy-transition risk.

Such findings prompt talk of a “carbon bubble”— overvaluation of businesses that could suffer if the climate threat is tackled resolutely. A study this month in Environmental Research Letters by Alexander Pfeiffer of Oxford University and colleagues found that electricity producers would have to retire a fifth of capacity, and cancel all planned projects, if the Paris goals are to be met. Between 2009 and 2015 Moody’s cut the average credit rating of European power utilities by three notches, partly because of environmental risk.

. August 26, 2018 at 4:56 pm

A report published on August 6th by Sarasin & Partners, an asset manager in London, suggests that oil firms are assuming that decarbonisation will be limited and are thus overstating their assets. Sarasin notes that eight European oil giants all used long-term oil price assumptions of $70-80 a barrel, rising by 2% a year with inflation to $127-145 by 2050, to price their assets. But that does not appear to assume any drop in demand. The International Energy Agency predicts a price of just $60 by 2060; Oil Change International, an activist think-tank, estimates one as low as $35 (see chart). Oil firms could face a sticky mess of forced writedowns.

The picture is complicated by the fact that in Europe oil firms can choose their own long-term prices, whereas in America regulators compel firms based there to use the average price over the past year, which is nearing $70. Executives in both places have their reasons for thinking that prices will be higher than the worst forecasts, particularly as the world is set to miss the Paris goals.

Setting those aside, prices are likely to be lower anyway in the next few decades, says Adam Pilarski of Avitas, a consultancy. There will be ups and downs to do with geopolitics. Prices are up from $26 in 2016 to over $70 mainly because of Venezuela’s meltdown and better co-operation between Saudi Arabia and Russia. But the economics on the supply side are clear: plentiful reserves and the falling cost of technology for extracting oil will soften long-term prices.

. January 4, 2019 at 3:09 pm

Investors are not simply motivated by concerns about the planet. Climate change could directly affect firms: rising sea levels could damage a factory making crucial parts, say. Some fear effects on their portfolios from changes to government policies—such as higher carbon taxes, which would hit the share prices of big emitters. Mercer, a consultancy, reckoned in 2015 that average yearly returns from coal firms could fall by 26-138% over ten years. So far, though, the returns of a low-carbon portfolio are similar to those of less green ones.

. January 9, 2019 at 9:57 pm

Oil majors, despite their critics, remain a staple of investment portfolios. They pay large, reliable dividends. Shell has not cut its dividend since the second world war. Far from fleeing them, the biggest 20 institutional investors globally account for a rising proportion of their shareholders. Last year they held 27% of the majors’ shares, up from 24% in 2014.

. June 15, 2019 at 9:01 pm

“Should this bill go through in its current form, it will unfortunately cause us to step back and deeply consider any and all future major growth opportunities — it just will,” said Imperial Oil CEO Rich Kruger in an interview.

“When we see a policy like this, a bill like this, there is no balance in it. The proof will come over time, when parties quit investing.

. June 15, 2019 at 9:04 pm

The uproar over the bill came as CAPP released its annual outlook, forecasting oil production will grow by a tepid 1.4 per cent annually — less than half the pace anticipated five years ago — by 2035 with total output reaching almost 5.9 million barrels per day.

That would be an increase of almost 1.3 million bpd from current levels, but down sharply from rosy forecasts made five years ago amid high oil prices that predicted Canada’s crude output would hit 6.4 million bpd by 2030.

The industry’s concern is Bill C-69 will continue that downward trend.

Imperial, the country’s largest oil refiner, slowed down the pace of work on its new $2.6-billion Aspen oilsands project earlier this year, due to its concerns over Alberta’s oil curtailment program.

Kruger said Bill C-69, if passed without further changes, would inhibit market access, and the lack of infrastructure “would jeopardize a project like Aspen and any other follow-on projects we might have.”

. August 7, 2019 at 3:14 pm

A recent paper in Nature shows that we have little hope of preventing more than 1.5C of global heating unless we retire existing fossil fuel infrastructure. Even if no new gas or coal power plants, roads and airports are built, the carbon emissions from current installations are likely to push us past this threshold. Only by retiring some of this infrastructure before the end of its natural life could we secure a 50% chance of remaining within the temperature limit agreed in Paris in 2015. Yet, far from decommissioning this Earth-killing machine, almost everywhere governments and industry stoke its fires.

. October 7, 2019 at 7:48 pm

The investment needed to bring all this about would be unprecedented. So would the harm to sections of the fossil economy. According to Carbon Tracker, a think-tank, more than half the money the big oil companies plan to spend on new fields would be worthless in a world that halved emissions by 2030. The implications extend to geopolitics. A world in which the oil price is no longer of interest is one very different from that of the past century.

. January 28, 2020 at 1:52 pm

So far central banks have focused on the impact of climate risk on the financial system. But activists argue that, just as central bankers saved the global economy during the financial crisis, so too must they tackle the next emergency by shifting capital away from polluters and towards greener uses. Europe’s technocrats seem willing to consider the idea. Others caution that it should be a job for politicians instead.

In 2015 Mr Carney set out the channels through which climate change could threaten financial stability. Financial firms are exposed to physical risks: floods, for instance, lead to big insurance payouts and sink the value of banks’ mortgage books. Then there is “transition” risk. New government policies, such as a carbon price, could see investors dump the assets of polluting companies. Share prices could collapse, and defaults on bank loans rise. Polluters also risk climate-related litigation. Exxon, an oil company, was accused of misleading investors over the costs of climate change, though on December 10th a court in New York found it not guilty.

. February 20, 2020 at 2:07 pm

Alberta public pensions being used to prop up struggling carbon industry, union says

‘We’re afraid they’re going to use our pension savings to fund a political agenda’

. February 27, 2020 at 1:57 pm

The abrupt decision by Teck Resources to withdraw its application for the Frontier bitumen mine project reveals a truth that politicians like Jason Kenney and other industry boosters continue to deny — that investing large sums of money in Canada’s oilsands no longer makes any financial sense.

“I think it’s a huge market signal for the oilsands,” said Kathy Hipple, an analyst with the New York-based Institute for Energy Economics and Financial Analysis. “There’s a very real risk of stranded assets for oilsands projects and there’s a huge risk even for other oil and gas projects going forward, they’re not needed.”

. February 25, 2021 at 4:18 pm

Exxon Mobil Corp. erased almost every drop of oil-sands crude from its books in a sweeping revision of worldwide reserves to depths never before seen in the company’s modern history.

Exxon counted the equivalent of 15.2 billion barrels of reserves as of Dec. 31, down from 22.44 billion a year earlier, according to a regulatory filing on Wednesday. The company’s reserves of the dense, heavy crude extracted from Western Canada’s sandy bogs dropped by 98%.

In practical terms, the revision clipped Exxon’s future growth prospects until oil prices rise, costs slide or technological advances make it profitable to drill those fields. Exxon has enough reserves to sustain current production levels for 11 years, down from 15.5 years a year ago, based on Bloomberg calculations.

. February 25, 2022 at 7:05 pm

The future of coal investment, trade, and stranded assets

Coal is at a crossroads, with divestment and phase-out in the West countered by the surging growth throughout Asia. Global energy scenarios suggest that coal consumption could halve over the next decade, but the business and geopolitical implications of this profound shift remain underexplored. We investigate coal markets to 2040 using a perfect competition techno-economic model. In a well-below-2°C scenario, Europe, North America, and Australia suffer from over-capacity, with one-third of today’s mines becoming stranded assets. New mines are needed to offset retirements, but a new commodity cycle in the 2030s can be avoided. Coal prices decline as only the most competitive mines survive, and trade volumes fall to give more insular national markets. Regions stand to gain or lose tens of billions of dollars per year from reducing import bills or export revenues. Understanding and preparing for these changes could ease the transition away from coal following 150 years of dominance.

. April 11, 2022 at 11:57 pm

The most important question, though, is barely asked: what would happen if governments agreed, sooner or later, to commitments serious enough to limit global warming to 1.5-2.0°C above pre-industrial levels, as stipulated in the Paris climate agreement of 2015? This question has an answer most multinationals shy away from. It would send shock waves through their entire business models.

. April 13, 2022 at 12:31 am

World’s biggest oil and gas companies projected to spend more than €800bn on new fields by 2030

The world’s biggest oil and gas companies, including Shell, Exxon and Gazprom, are projected to spend €857 billion on new oil and gas fields by 2030.

This could grow to a staggering €1.4 trillion by 2040, says new research from Global Witness and Oil Change International.

All 20 of the companies investigated by two NGOs claim to support the Paris Agreement goal of keeping global warming below the critical 1.5C threshold.

The new analysis comes just a week after UN Secretary-General, Antonio Guterres called it “moral and economic madness” to invest in new oil and gas.

Leave a Comment

Previous post:

Next post: