What do we need to know about stranded assets?

A stranded asset is a company asset that loses its value, or becomes unusable, in a sudden or unexpected way. This represents a big loss for a company, as it cannot yield the profits it expected. Stranded assets existed before the need to consider the risks of climate change, like when typewriters were replaced by computers, but new situations have emerged that can cause assets to lose value earlier than envisioned.

Physically stranded

Climate change has caused an unprecedented number of natural disasters in the past few years. Last year, storms worldwide caused infrastructure damage of more than $US100 billion, and the tropical storm Doksuri caused $US25 billion of economic damage in Japan alone. The intensity and frequency of extreme weather events are expected to cause increasing damage as global warming proceeds.

Global emergencies like natural disasters or wars could literally “strand” the asset in an unreachable location. The cost of retrieving it could come close to, or even outweigh, any profit the business could make from it.

Stranded by policy & regulation

Countries have implemented new regulations in response to the threat of climate change. Because of such legislation, some assets could be rendered unusable and become stranded. For instance, some coal mines could become stranded as restrictions and bans are placed on using coal.

The implementation of ambitious climate policy by governments is essential to avoid investments in new carbon-intensive assets that might later be stranded. New regulations designed to phase out fossil fuels, shifting consumer sentiment, cheaper renewable alternatives, and pressure from shareholders also increase the threat of assets becoming stranded.

Financial stranding

Beyond changes in commodity prices and decreasing market demand, there are many other factors that could impact the economics of production – higher taxes on earnings, removal of subsidies or increases in the cost of production to name a few.

Expenditure for exploration, delays in project approvals, legal challenges and other costs of development for new fossil fuel projects could see companies and investors unable to recover their cost of capital. Sometimes, these assets decrease in value so much that they effectively become liabilities for the company that owns them.

Stranded by the energy transition

60% of oil and gas reserves and 90% of known coal reserves should remain unused in order to limit global warming to 1.5°C, the Paris Agreement target. Companies extracting oil, gas and coal may find some assets become stranded because they cannot be adapted to the low-carbon or zero-emission modes of production required to align with the Paris Agreement. Other sectors that use fossil fuels, or are energy- or carbon-intensive, like steel production, could also be impacted by this requirement as the world moves towards a net zero economy.