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Harry McKay: Stranded assets: a ticking time bomb?

Harry McKay (Climate Programme Intern at CEN)

The dominance of fossil fuels is coming to an end as the world is quite rightly turning to cleaner, cheaper renewable energy. Although we will still use oil and gas for decades to come, we will use much less and their importance will diminish over time. So, what does this mean for some of the world’s largest corporations, from Saudi Aramco to Shell, whose high valuations rest on their abundant fossil fuel reserves?

In 2014, Mark Carney, the then-governor of the Bank of England, highlighted the financial danger at hand for these companies by stating at a World Bank seminar that “the vast majority of reserves are unburnable”. Meaning that if we are serious about keeping to our climate targets, large amounts of fossil fuels that currently underpin the valuations of fossil fuel companies must remain in the ground, thus risk becoming stranded assets.

Stranded assets can be defined as assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities. Essentially, it means a lower return on investment - a fate that all industries wish to avoid.

Countries around the world are now quickly decarbonising to stop global warming from exceeding 1.5 degrees, as outlined in the 2015 Paris Agreement. For this target to become a reality, a significant proportion of the world's fossil fuel reserves will need to be left untouched. Approximately £8.1tn to £10.3tn worth of assets could become ‘stranded’ as we transition to clean energy.

Without appropriate precautionary measures taken, this could lead to a long term decline in the valuation of some of the world's largest corporations. It would be wrong to believe that this is only a concern for net exporters of fossil fuels and for the boards of oil, gas and coal companies. The UK, being a worldwide centre for finance, could also be significantly exposed.

However, there are now more opportunities for environmentally conscious investment than ever before, with multiple new green bonds issued every year. By the end of 2021, the green bond market was valued at $443 billion a year, and the size of this industry is increasing year on year, with some predicting this to more than double to over $1trillion a year by the end of 2022. These bonds provide assurance to investors that their money will not go towards fossil fuels, instead it will be invested in projects such as renewable energy, clean transportation and long term water management.

Nevertheless, it would be foolish to think that investing in green investment instruments and companies is purely to satisfy an investor’s desire to support decarbonisation. They also provide significant financial opportunities with rapid growth. For example, Tesla’s stock price has increased by over 1,500% in the last five years. Oil and gas companies are not blind to the profitability of this burgeoning industry, and are attempting to diversify to future proof themselves. Demonstrated by the majority of large fossil fuel companies now declaring they will be investing significantly in new renewable technologies and infrastructure.

The government is doing its bit, encouraging investors to be aware of what they are investing in. This was set out in the government's report, Greening Finance: Roadmap to Sustainable Investing. Soon the UK will release its own ‘green taxonomy’, which will clearly set out what can be seen as sustainable to invest in. Hopefully, this will go further than the EU’s version, which has been widely discredited due to gas being labelled as a green source of energy.

The financial world has long been dominated by giant fossil fuel companies; soon, this could all change. Even before COVID and the Russian invasion of Ukraine, 95% of new energy production was renewable, showing how we are now in a new era. Those companies who invest wisely and join the renewable revolution may maintain their position at the pinnacle of global finance and industry for the foreseeable future, whereas those who fail to adapt risk stranded assets.


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