The conversation around climate change often focuses on what could happen if we fail to address the Climate Emergency, but if we are going to remain optimistic in the pursuit of solving the climate crisis, we must also explore the risks we might face if we are successful. The transformation we are facing is unprecedented in depth and scope, and our economy and daily lives contain countless variables that are more likely to be different in 30 years than remain the same. These potential changes hold great promise, but we are naïve if we believe that such sweeping change will not also carry risk. The fact is - When you do big things, things get broken. That is not a reason not to do them, but it is a reason to plan for them and do your best to minimize and mitigate them. One of the largest such risks is posed by Stranded Assets. What are they? Why are they a risk? How can we mitigate any harmful effects they may cause to our global economy?
What Are Stranded Assets?
A stranded asset refers to an asset that was presumed to have economic value at the time of investment but loses that value prior to the full realization of the benefits of that investment. In the context of Climate Risk, examples of stranded assets might be:
- Real estate that is lost to sea-level rise before the end of its useful life
- A coal mine that finds that its market is disappearing as the world shifts to renewable energy
- A factory that produces internal combustion engines for automobiles at a time when automakers are declaring a total shift to electric vehicles
Stranded Assets, and the cascading effects of their loss in value, have the potential to wreak havoc within both financial markets and the broader economy if their risks are not proactively identified and addressed. How then can we know when an asset or market should be flagged as a risk needing intervention to avoid economic chaos? BlackRock, the world’s largest asset manager, the G20-backed Financial Stability Board, and the U.S. Commodity Futures Trading Commission have all raised red flags recently about overlooked corners of the economy where stranded asset risk could be embedded.
Coastal Real Estate: At-risk coastal real estate may only be 1% of property assets globally by value, but in a portfolio that carries 90% leverage, the loss of 1% of assets can be significant and destabilizing. Also, the most at-risk property is concentrated in particular geographies, so that it represents a much larger percentage in many local property markets. A cascading effect can then take place, where a city becomes overwhelmed, its state or national government is too weak to step in and take care of the fallout, and the entire region is subsumed in an economic crisis. Since virtually no one is currently tasked with knowing precisely how large this risk might be, no one has a good idea of what it is, or how to handle it.
Fossil Fuel Assets: Perhaps the largest category of stranded assets will be fossil fuel assets. The problem arises from the simple math of climate change. To meet the goals set in the Paris Climate Treaty, we will be forced to leave approximately 30% of oil, 50% of gas, and 80% of coal reserves in the ground. Forever. Thousands of economically significant decisions have been made based on the assumption that these resources will be fully developed, and that still more such investments will come after them. These decisions may all be based on a bad premise. A February 2021 report by analysts at Global Energy Monitor found $1 trillion at risk just from oil and gas pipelines that are currently being built and are unlikely to be viable for much of their 50+ year planned lives. That number is dwarfed, however, by other sectors of the oil, gas, and coal industries.
The risks implicit in the fossil fuel industry are like an inverse of the renewable energy revolution – they touch virtually everything, but in a way that deepens the crisis rather than helping solve it. Start with the actual oil, gas, and coal itself. One recent study by Citigroup identified the potential lost revenue from undeveloped oil and gas assets (that is, excluding coal) as high as $100 trillion! That lost revenue translates into lost valuations in investments so that the same study suggested that as much as $980.8 billion could be at risk on the balance sheets of OECD pension funds. The psychology of the wealth effect is such that losses on 401(k) statements could start materializing just as governments are asking for more and more tax dollars for climate mitigation and prevention efforts. The compounding effect of these changes could bring political and economic instability to never-before-seen levels. What exposures do your companies’ or your clients’ financial results have to fossil fuels and fossil fuel companies?
How Can We Mitigate the Risks of Stranded Assets?
Honest Risk Assessment: Many in the climate fight fear that by talking about the inevitable downsides of the renewable energy transformation, we encourage opposition to it. However, in order to grasp the full implications of what we can expect if the clean energy transformation succeeds, it is imperative that we consider the full list of consequences, both the good and the bad. It is unrealistic and unwise to simply pretend that there are no downsides to a transformation that touches so many facets of life as we know it. With a project this huge, mistakes will be made, and things will get broken. We need to be ready for that, so those detours do not risk the entire mission.
Demanding Accountability: Public companies must be required to provide meaningful disclosure about the unique ways in which climate change poses risks to their operations and financial results, through SEC-regulated disclosure and similar channels. The exercise of analyzing and quantifying these risks, when taken seriously, will help educate not only investors but also the company decision-makers responsible for the disclosure. Being forced to think seriously about these risks is the best first step in addressing them.
Climate Change poses systemic risks to virtually every sector of the economy. Risk Managers and decision-makers in every organization must begin the critical work of assessing how these risks may affect their organizations, their employees, their customers or clients, and their very existence. In our corner of the economy, New Energy Equity is helping to lead the energy transformation through the development of solar energy projects throughout the United States for public, corporate and nonprofit customers. We would love to hear from you about how we can help you to achieve your clean energy goals.
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