Stranded Assets and the Environment

Risk, Resilience and Opportunity

Ben Caldecott

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781317310532
• Edition: 1
• Topic: Economics
• Subtopic: Sustainable Development
• Index: Economics

Drawing on the work of leading researchers and practitioners from a range of disciplines, including economic geography, economics, economic history, finance, law, and public policy, this edited collection provides a comprehensive assessment of stranded assets and the environment, covering the fundamental issues and debates, including climate change and societal responses to environmental change, as well as its origins and theoretical basis.

The volume provides much needed clarity as the discourse on stranded assets gathers further momentum. In addition to drawing on scholarly contributions, there are chapters from practitioners and analysts to provide a range of critical perspectives. While chapters have been written as important standalone contributions, the book is intended to systematically take the reader through the key dimensions of stranded assets as a topic of research inquiry and practice. The work adopts a broad based social science perspective for setting out what stranded assets are, why they are relevant, and how they might inform the decision-making of firms, investors, policymakers, and regulators. The topic of stranded assets is inherently multi-disciplinary, cross-sectoral, and multi-jurisdictional and the volume reflects this diversity.This book will be of great relevance to scholars, practitioners and policymakers with an interest in include economics, business and development studies, climate policy and environmental studies in general.

1 Introduction

Stranded assets and the environment

Ben Caldecott

1. Introduction to the volume

Asset stranding caused by environmental changes, in particular physical climate change impacts and societal responses to climate change, is now a topic of significant interest to scholars and practitioners alike.

The concept of ‘stranded assets’ has been endorsed by significant international figures, including former UN Secretary-General Ban Ki-moon (McGrath 2014); US President Barack Obama (Friedman 2014); Jim Yong Kim, President of the World Bank (World Bank 2013a, 2013b); Mark Carney, governor of the Bank of England and chair of the G20 Financial Stability Board (Carney 2015); Angel Gurría, secretary-general of the OECD (Gurría 2013); Christiana Figueres, former executive secretary of the UNFCCC (Figueres 2013); Lord Stern of Brentford (London School of Economics 2013); and Ben van Beurden, CEO of Shell plc (Mufson 2014).

The idea that environment-related risk factors can result in stranded assets is directly relevant to a wide range of critically important topics that face investors, companies, policy makers, regulators, and civil society today. For example:

• Measuring and managing the exposure of investments to environment-related risks across sectors, geographies, and asset classes so that financial institutions can avoid stranded assets (for example, see Financial Stability Board 2015; Caldecott et al. 2013; Generation Foundation 2013; Carbon Tracker Initiative 2011; Caldecott 2011).
• Financial stability implications of stranded assets and what this means for macroprudential regulation, microprudential regulation, and financial conduct (for example, see Kruitwagen et al. 2016; Bank of England 2015b; Carbon Tracker Initiative 2011; Caldecott 2011).
• Reducing the negative consequences of stranded assets created as societies transition to more environmentally sustainable economic models by finding ways to effectively address unemployment, lost profits, and reduced tax income that are associated with asset stranding (for example, see Caldecott 2015a).
• Internalising the risk of stranded assets in corporate strategy and decision making, particularly in carbon intensive sectors susceptible to the effects of societal action on climate change (for example, see Rook and Caldecott 2015; Carbon Tracker Initiative 2013; Ansar et al. 2013).
• Underpinning arguments by civil society campaigns attempting to secure rapid economy-wide decarbonisation in order to reduce the scale of anthropogenic climate change (for example, see Ansar et al. 2013).
• Keeping track of progress towards emission reduction targets and understanding how ‘committed emissions’¹ should influence decarbonisation plans developed by governments, as well as companies and investors (for example, see Pfeiffer et al. 2016; Davis and Socolow 2014; Davis et al. 2010).

These are some of the most important topics in policy, investor, industry, and civil society discourses on the environment and will remain so for as long as societies continue to transition towards greater environmental sustainability.

Drawing on the work of leading researchers and practitioners from a range of disciplines, including economic geography, economics, economic history, finance, law, and public policy, this volume is an attempt to create the essential advanced primer on stranded assets and the environment by covering the fundamental issues and debates, as well as its origins and theoretical basis. The volume provides much-needed clarity as the discourse on stranded assets gathers further momentum.

We have adopted a broad-based social science perspective for setting out what stranded assets are, why they are relevant, and how they might inform the decision making of firms, investors, policy makers, and regulators. The topic of stranded assets is inherently multi-disciplinary, cross-sectoral, and multi-jurisdictional, and the volume reflects this diversity.

This introductory chapter sets out what stranded assets are and their theoretical origins, how the literature on stranded assets has developed, the rationale for work on stranded assets and the environment, and where we are in terms of ‘mainstreaming’ the topic, particularly among financial institutions.

The second chapter, Stranded assets: then and now, by Dimitri Zenghelis, Roger Fouquet, and Ralph Hippe, examines the issue of stranded assets from a macro-economic perspective. It compares past macro-economy drivers of change and rates of asset stranding with those observable today and forecasted for the future. The following questions are addressed: what pace of asset stranding can be expected normally and during economywide transitions? What could be an optimal rate of asset stranding? Could environment-related factors be generating a different rate and scale of asset stranding? Could stranded assets be seen as an opportunity – refreshing capital stocks, reducing pollution, and moving closer to technological frontiers.

The third chapter, The ‘decarbonisation identity’: stranded assets in the power generation sector, by Alexander Pfeiffer, introduces a new theoretical framework – the decarbonisation identity – to analytically describe the choices policy makers have available to avoid asset stranding caused by carbon budget constraints. These choices are (1) protecting and enhancing remaining carbon budgets (e.g. by early and decisive action on non-CO₂ pollutants); (2) retrofitting carbon capture and storage (CCS) to operating capital stock; (3) making sure that additions to the capital stock are clean (non-emitting); (4) large-scale stranding of capital stock; or (5) creating additional carbon budget through the development and implementation of net–negative-emission technologies. With the decarbonisation identity, this chapter introduces for the first time a mutually exclusive and collectively exhaustive framework that makes these choices, especially the choice to strand assets, explicit.

The fourth chapter, Stranded assets: an environmentally driven framework of sunk costs, by Elizabeth Harnett, explores the relationship and comparisons between stranded assets and sunk costs. The chapter proposes a new spatial-temporal framework through which to view stranding risk in different geographies and time horizons, building on literatures pertaining to sunk costs, relational economic geography, and behavioural finance. This could help investors recognise the immediate and long-term investment implications of stranded assets, as investors are used to dealing with risk over varied geographical and time horizons with regards to investment costs.

The fifth chapter, The stranding of upstream fossil fuel assets in the context of the transition to a low-carbon economy, by Jakob Thomä, disentangles what stranded assets mean for the different upstream fossil fuels: oil, gas, and coal. It also sets out how to distinguish the economic stranding of assets (i.e. the stranding of the fossil fuels themselves) from the financial risks (i.e. changes in valuation and credit default driven by economic risks) and what this might mean for different actors across the investment chain.

The sixth chapter, Examining stranded assets in power generation: coal, gas and nuclear, by Daniel J. Tulloch, examines stranded assets in the electricity industry, with a focus on coal, gas, and nuclear generation technologies. The chapter provides an overview of the various environment-related risk factors which can strand generation assets and some responses to stranded asset risks. This chapter aims to assist researchers in accurately identifying stranded asset risks for a specific asset. The chapter provides a flexible framework which can be applied to a variety of global electricity industries which, themselves, differ in structure, regulation and operating environments.

The seventh chapter, Understanding climate-related stranded assets in the global real estate sector, by Kevin Muldoon-Smith and Paul Greenhalgh, introduces stranded assets into the heterogeneous global real estate asset class. Real estate is taken to mean, broadly, all residential, commercial, and operational property. The chapter observes that stranded assets are not new in real estate; the changing consumer demand of occupiers has regularly rendered property assets redundant or obsolete. However, what is new is the influence and systemic reach of climate change and associated environmental policy on some property assets and related capital markets. At the same time, the global real estate sector is going through its own set of structural growing pains in response to dynamic changes in residential and business practices – potentially coalescing with and exacerbating the issue of stranded assets.

The eighth chapter, Knowing the risks: how stranded assets relate to credit risk assessment and the debt markets, by Michael Wilkins, examines how stranded assets pose a serious risk to companies’ creditworthiness – the crucial measure of their ability to meet financial obligations, service debt, or make the necessary investments to manage or respond to risks. As environmental regulation grows, the threat of cash-flow attrition due to unmitigated environmental risks becomes more acute. The chapter sets out how these risks can be reflected in credit risk assessment and how developments in disclosure and data, as well as new debt products, could help financial institutions manage their exposure to stranded asset risks.

The ninth chapter, An introduction to directors’ duties in relation to stranded asset risks, by Sarah Barker, explores the emerging liability exposures for the directors of listed, for-profit corporations who fail to adequately assess and/or disclose the impacts of climate change-related issues on corporate risk and strategy. The analysis focuses, in particular, on directors’ statutory and fiduciary duties to govern with regard to stranded asset risk exposures. The chapter proposes general principles that may act as the starting point for further detailed application in individual jurisdictions.

The tenth chapter, Climate change: what implications for central banks and financial regulators?, by Sandra Batten, Rhiannon Sowerbutts, and Misa Tanaka, outlines the ways that stranded assets impact on the financial stability objectives of central banks. It identifies areas where central banks and financial regulators could contribute in mitigating the financial risks associated with climate change and climate-related policies. These could also likely mitigate financial stability risks arising from stranded assets.

The eleventh chapter, Diversifying stranded asset risks by investing in “green”: mobilising institutional investment in green infrastructure, by Christopher R. Kaminker, reviews how institutional investors are investing in green infrastructure, how this is changing, and how this creates opportunities to manage or hedge against stranded asset risks in investor portfolios.

The twelfth chapter, Stranded assets as economic geography: the case for a disciplinary home?, argues for stranded assets to have a more explicit disciplinary basis to ensure its development and longevity as a topic of both ‘real-world’ interest and sufficient academic rigour. This chapter makes the case for economic geography. It can help stranded assets to both develop firmer foundations and also explore new areas by providing relevant ideas, concepts, and methodologies that can be usefully adapted. Importantly, economic geography is a discipline supportive of producing research that interacts with and speaks to a range of practitioner audiences and one that is suitably adaptable so as to encourage multi-disciplinary research.

The concluding chapter, Next steps for stranded assets and the environment, discusses some of the limitations in the current literature and how this should inform research priorities on stranded assets over the next decade.

2. What are stranded assets?

There are various definitions of stranded assets that have been proposed or are used in different contexts. Accountants have measures to deal with the impairment of assets (e.g. IAS16) which seek to ensure that an entity’s assets are not carried at more than their recoverable amount (Deloitte 2016). In this context, stranded assets are assets that have become obsolete or non-performing but must be recorded on the balance sheet as a loss of profit (Deloitte 2016). The term ‘stranded costs’ or ‘stranded investment’ is used by regulators to refer to ‘the decline in the value of electricity-generating assets due to restructuring of the industry’ (Congressional Budget Office 1998). This was a major topic for utilities regulators as power markets were liberalised in the United States and the United Kingdom in the 1990s.

In the context of upstream energy production and from an energy economist’s perspective the International Energy Agency (IEA) (2013) 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’ (IEA 2013, p. 98). The Carbon Tracker Initiative also use this definition of economic loss but says they are a ‘result of changes in the market and regulatory environment associated with the transition to a low-carbon economy’ (Carbon Tracker Initiative n.d.). The Generation Foundation (2013) defines a stranded asset ‘as an asset which loses economic value well ahead of its anticipated useful life, whether that is a result of changes in legislation, regulation, market forces, disruptive innovation, societal norms, or environmental shocks’ (Generation Foundation 2013, p. 21).

Different definitions for economists (‘economic loss’), accountants (‘impairment’), regulators (‘stranded costs’), and investors (‘financial loss’) make it difficult for different disciplines and professions to communicate with each other about very similar and overlapping concepts. Caldecott et al. (2013) proposed a ‘meta’ definition to encompass all of these different definitions: ‘stranded assets are assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities’ (Caldecott, Howarth, et al. 2013, p. 7). This is the definition used throughout this volume and the definition most widely used in the literature.

While the environmental discourse appropriated the term in the 2010s and is focused on the environment-related risk factors that can strand assets, asset stranding in fact occurs regularly as part and parcel of economic development. As such it is not a novel phenomenon. Schumpeter (1942) coined the term ‘creative destruction’, and implicit in his ‘essential fact about capitalism’ (Schumpeter 1942, p. 83) is the idea that value is created, as well as destroyed, and that this dynamic process drives forward innovation and economic growth. Schumpeter built on the work of Kondratiev (1926) and the idea of ‘long waves’ in the economic cycle (Perez 2010).

Neo-Schumpeterians have attempted to understand the dynamics of creative destruction, particularly how and why tec...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Lists of figures
• List of tables
• List of boxes
• List of contributors
• Foreword by Achim Steiner
• Foreword by Lord Nicholas Stern
• Preface
• Acknowledgements
• 1 Introduction: stranded assets and the environment
• 2 Stranded assets: then and now
• 3 The ‘decarbonisation identity’: stranded assets in the power generation sector
• 4 Stranded assets: an environmentally driven framework of sunk costs
• 5 The stranding of upstream fossil fuel assets in the context of the transition to a low-carbon economy
• 6 Examining stranded assets in power generation: coal, gas and nuclear
• 7 Understanding climate-related stranded assets in the global real estate sector
• 8 Knowing the risks: how stranded assets relate to credit risk assessment and the debt markets
• 9 An introduction to directors’ duties in relation to stranded asset risks
• 10 Climate change: what implications for central banks and financial regulators?
• 11 Diversifying stranded asset risks by investing in “green”: mobilising institutional investment in green infrastructure
• 12 Stranded assets as economic geography: the case for a disciplinary home?
• 13 Next steps for stranded assets and the environment
• Index