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January 09, 2015
The Risk to Investors of Stranded Assets
    by Robert Kropp

In a roundtable hosted by Environmental Finance, investors, analysts, and corporate managers convene to discuss the financial risks associated with stranded fossil fuel assets. First of a two-part series.


The concept of stranded fossil fuel assets as described in a 2011 analysis by Carbon Tracker Initiative (CTI) is straightforward. If we are to avoid the worst effects of climate change by limiting global temperature increases to no more than 2°C, then as much as 80% of the reserves already counted as assets by fossil fuel companies will have to stay in the ground.

Setting aside the ethical imperative of ensuring a sustainable environment for future generations, the financial implications of the concept are momentous; that is, as James Cameron, the Chairman of Climate Change Capital, recently said, if “a significant regulatory or public policy change that will alter the market conditions for the use of this commodity” finally emerges.

Cameron was participating in a recent roundtable discussion on stranded assets, convened by Environmental Finance in London. In addition to representatives of sustainable investment organizations, environmental, social, and corporate governance (ESG) analysts and corporate executives participated as well.

James Leaton started the discussion by describing the financial analysis behind the concept. With fossil fuel exploration more and more often focused on controversial and markedly more expensive unconventional methods of extraction, the price per barrel of oil required for at least a 15% rate of return increases. However, with oil prices having dropped to new lows, the likelihood of profitability decreases.

“Some of the pure-play operators in the coal or unconventional oil sectors do not have the options that the diversified mining companies or the oil majors have,” Leaton observed. “I also think they are underestimating the pace of development of alternative technologies, and how quickly the costs are coming down.”

Cameron, however, observed, “The issue is not about the cost of the alternatives; the issue is about the cost of the transition; it is the infrastructure you have to build to make the alternatives really thrive, given the power of the incumbents.”

“The view from companies is that we could be being over-optimistic on what can be done in the short term in terms of transitioning from fossil fuels into alternative energies, even though they accept that there is a need for such a transition,” Miguel Santisteve of NASDAQ added. However, “Total, the French oil & gas producer, is now the second-largest producer of solar panels in the world through the acquisition of SunPower back in 2011,” he added. “They are therefore getting ready for the transition.”

“Regulations are very slow to emerge but companies have to anticipate the shift that will happen at some point,” Schroders analyst Solange Le Jeune said. “If regulatory change comes more suddenly than they think, they would be in trouble.”

Acknowledging the inevitability of a shift to a low-carbon economy, Tomas Gärdfors of the law firm Norton Rose Fulbright listed several recent European Union regulatory actions designed to accelerate the shift, and said, “European transmission infrastructure is a long-term asset which is well suited to pension funds.” The financial returns on investment might be lower than those of equity holdings, at least until stranded fossil fuel assets have the expected impact on portfolios, but the returns will be much more stable as well.

But as Cameron pointed out, the question of who is to finance and operate the new infrastructure of a low-carbon economy is yet to be answered. “Who is going to supply the capital, operate those assets, deliver clean energy infrastructure and avoid stranded assets as a result?” he asked. “ Who is going to come across and be both the financier and operator of clean energy infrastructure?”

Next: Stranded assets: engage or divest?

 

 
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