Headlines in November were full of catchy words from COP26 such as ‘net-zero’, ‘decarbonization’, and ‘beyond oil and gas’. If you are a climate geek, your Twitter timeline must have been filled with briefs from COP26 and why the meeting was a failure or a great achievement, depending on who you are following.
During COP26, 20 countries, including Canada and the US, and five development institutions announced that they have committed to stop public financing for unabated fossil fuels except limited circumstances abroad by the end of 2022. Although there are discussions on what will be classified as an exception or why restrictions are only towards foreign projects, the statement is expected to have impacts on oil and gas projects dependent on foreign investment. If this is not cheap talk and if there will be less and less money willing to support upstream oil and gas, what will happen to the valuation of reserves on the ground?
The International Energy Agency (IEA) defines stranded assets as ‘those investments which have already been made but which, at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return as a result of changes in the market and regulatory environment brought about by climate policy’ (2013). A shorter definition used by Carbon Tracker is ‘assets that turn out to be worth less than expected as a result of changes associated with the energy transition.’
Stranded asset definition is not specific to the oil and gas industry. But they are the second largest sector exposed to stranding asset risk following buildings according to IRENA (2017). The ‘Delayed Policy Action’ scenario of IRENA is based on the assumption of continuing business-as-usual until 2030 and acceleration of renewables and energy efficiency afterward. Under this scenario, $7 trillion USD of assets of the upstream oil and gas industry is expected to be stranded until 2050.
Being on the optimistic side, we can assume more countries and universities will join the action and stop public financing for oil and gas projects abroad and at home, and the pressure on private finance to divest will also strengthen. In that scenario, we might see a greater risk of overestimation of the upstream oil and gas companies’ valuation. Consequently, this has created an investment risk for equity holders (e.g. pension funds, endowment funds, sovereign wealth funds, insurance funds exposed to fossil fuels). Hence, moving York U’s investments away from fossil fuels is not only a moral decision for the environment but also mitigation of the underperformance risk for investors.
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