Phoebe Stone, Head of Sustainable Investing
The investment community is becoming increasingly aware that our changing climate poses risks to businesses across almost every industry. Insurance companies have been pricing these types of risks for several years now, but the rest of the financial services industry is finally starting to catch up. One concept often referred to when conducting analysis of this type is that of 'stranded assets'.
Stranded assets are oil, gas and coal reserves on the balance sheets of large fossil fuel extractors, that may never be produced or burnt. This could be because doing so would contribute to exceeding national or internationally agreed environmental targets or, for commercial reasons, the assets are no longer desirable.
Last month, BP wrote off £17.5 billion of stranded assets, as the company acknowledged that the impact of the pandemic is likely to accelerate the transition to a lower-carbon economy and demands for cleaner sources of energy. The move comes in spite of the fact that, only two years ago, BP's chief executive Bob Dudley labelled investor concerns over stranded assets as 'misguided' at the 2018 Oil & Money Conference.
Should we expect more of this to come?
Whilst this is an extremely significant step, analysis indicates that adhering to the Paris Climate Change Agreement would render up to 68% of current fossil fuel reserves as unburnable. Furthermore, many believe limiting temperature increases by only 2°C will not be sufficient to limit climate damage. By targeting limits to increases in temperature to 1.5°C, 85% of fossil fuel reserves become unburnable. We are therefore likely to see more businesses acknowledge these stranded assets on their balance sheets. According to a report by Deloitte, US shale companies could write down up to $300 billion of assets this year alone.
It is undeniable that some energy companies will not be able to pivot the direction of their revenue streams fast enough to avoid being left with stranded assets. Investors must therefore take note of this external risk and be aware of its significant impact on both the energy industry and investment in these businesses.
Source: Rystad Energy, World Energy Council, IPCC, Global Carbon Project, LGT Vestra
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