Free-to-air ‘don’t miss’ article! Stranded assets? Sustainable investors must understand oil, gas, coal sector cost curves…
For the last few years NGOs have been warning of the investment risks of climate policy for fossil fuel producers. The warnings have largely fallen on deaf ears amongst mainstream investment managers. As one oil analyst put it: “Aggressive carbon regulation may well cause stranded assets, but you don’t seriously think that’s likely to happen any time soon.” Investor ears should be deaf no more. Coal mining share prices have fallen by two thirds in two years. Several oil majors are seeing their lowest rating against the market for a decade. A wave of new broker research from Bernstein, Citi, Deutsche Bank, Goldman Sachs, HSBC and Morgan Stanley (listed at the foot of the article), takes a markedly bearish view of the prospects for these sectors, pointing to serious difficulties with their economics, and even, in some cases, suggesting they could be about to go into ‘terminal decline’. An Economist front cover (Aug 3rd) summed it up, showing a dinosaur at a gasoline pump headlined ‘Yesterday’s fuel.’ This bearish turn in investor sentiment dramatically changes the debate about stranded assets, and could offer the most important ESG integration and engagement opportunity for a long time.
Carbon Tracker, an NGO, has been extraordinarily successful in winning press coverage for its ‘unburnable carbon’ thesis. Its argument rests on a simple equation: the amount of carbon embedded in the reserves of the listed oil and coal mining companies is bigger than the amount we can safely emit to avoid dangerous climate change (a 2°C rise in temperatures). So, if governments were to regulate carbon emissions to put us on track for
2°C some reserves will become ‘unburnable’, creating the risk of stranded assets and wasted capital expenditure (cap ex). Carbon Tracker claims that these companies share prices may therefore be overvalued, creating a ‘carbon bubble’ whose bursting would hurt investors exposed to oil, gas and mining companies. The Carbon Tracker work has also been used in the US by Bill McKibben and the Fossil Free campaign to justify divestment from these companies.
The struggle for share price relevance
While I struggle to find industry analysts who buy Carbon Tracker’s more sensational claims (e.g. a carbon bubble may create systemic risks for the UK economy), there is widespread agreement about the basic stranded assets logic. Carbon regulation is a big risk for fossil fuel companies. But, as I’ve discussed on RI previously in practice it is hard to persuade oil analysts to factor these risks into their company valuations and investment decisions. The first problem is that the unburnable carbon argument is hypothetical. Only if carbon emissions regulation looks likely to move to a 2°C path will stranded assets become a material risk. Given the ongoing failure of governments to make substantial progress towards a global deal (and the climate scepticism of the entrenched Republican majority in the US House of Representatives), the probability of a 2°C path seems depressingly low and stranded assets remain a hypothetical issue. The second problem is timing.
Using standard discount rates, impacts that are 10 or 20 years ahead shrink dramatically in analyst forecasts. If
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