A Third Of Fossil Fuel Assets May Soon Be Stranded

Fossil fuel companies hold vast oil, gas and coal riches that they frequently tout to the investing universe to help elevate their market values. However, not a single energy company has ever told investors about the potential effects on the environment if all their hydrocarbon reserves were burned.

And certainly few, if any, have ever told investors that a large chunk of these assets could be doomed to forever remain buried in the ground – and essentially worth nothing – should environmental regulations tighten.

Yet, the specter that these assets might one day end up stranded and theoretically worthless as the clamor for clean energy heats up looms large.

According to estimates in the Financial Times’ Lex column, nearly $900 billion worth of reserves – or about one-third of the value of big oil and gas companies – is at risk of one day becoming worthless as market and policy forces continue to undercut hydrocarbon economics due to the threat of climate change.

In effect, these companies could see a third of their value evaporate if governments aggressively attempt to restrict the rise in temperatures to 1.5C above pre-industrial levels for the rest of this century and avert catastrophic climate change as per Intergovernmental Panel on Climate Change (IPCC) estimates.

Consequently, investors are likely to increasingly price in the risk of asset writedowns by the world’s leading oil and gas companies unless a solution to the ongoing climate change is found within the next decade.

High Risk Investments

The effects of such a huge scale in writing off frozen assets – gradually at first and then at an accelerated rate – is likely to be keenly felt across the business world.

We could argue that notoriously secretive national oil companies (NOCs) and not independent oil companies (IOCs) are the biggest financial risk since they control ~$3 trillion in oil and gas assets and an estimated 90 percent of all known reserves. Nevertheless, considering that publicly traded energy companies have collectively lost $400 billion in their fundamental value over the past five years, losing anything in that ballpark over the next five could be disastrous for the sector.

A good case in point is Chevron Corp. (NYSE:CVX), which recently reported a large $10.4B shale asset writedownExxonMobil (NYSE:XOM) also recently found itself in the hot-seat over its failure to make disclosure about climate risk even as shareholder pressure for risk disclosure mounts. It was later absolved.

Here’s a rundown of the financial risk burden that fossil fuel companies carry:

  • Stranded Assets – the assets currently contributing to the market value of many fossil fuel companies that cannot actually be developed and sold will lower their overall valuations
  • Loss of market capitalization – downward pressure on energy stocks from divestiture efforts especially by institutional investors could hurt your mutual funds and stocks
  • Cost of capital – in December, we reported that Goldman Sachs had ruled out financing drilling in the Arctic as well as new thermal coal mines anywhere in the world and that other large banks were likely to follow suit. Fewer banks willing to finance fossil fuel projects will make it progressively more expensive to bring these buried assets to market
  • Scarcity of insurance – by the same token, fewer insurance companies will be willing to back such projects, thus increasing both the cost and time to get the necessary insurance to build them
  • Insufficient renewables investment – faced with this critical disruption in the well-established fossil fuel model, it would be smart to develop substantial lines of business that do not carry these risks. Yet, current investment in low carbon energy sources by fossil fuel companies is less than 1 percent, way too little to move the revenue needle for the vast majority
  • Market risk – there might be seismic changes in how the market begins to value fossil fuel reserves

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