The end of fossil fuels

Renewed political commitment to tackling climate change, cheaper renewables technology, more costly prospecting – can fossil fuels survive this triple whammy? Simon Wilson reports.

What are stranded assets?

They are assets that are unexpectedly or prematurely devalued, written off, or converted to liabilities as the result of a sudden shift in technology, regulation or public opinion. A simple example might be public phone boxes these became all but redundant in the wake of universal mobile phone technology.

Or take the vast investments made by German utilities in nuclear power before Angela Merkel's government performed a U-turn after the 2011 Fukushima disaster, and announced that all Germany's nuclear plants would shut by 2022. Stranded assets are in the news today due to growing fears among investors on energy and climate change.

What fears are those?

In short, the concern is that big energy companies may be hugely overvalued because the market isn't properly pricing in the chance that global governments will get their act together on climate change.

If the regulatory climate changes or if renewables continue to get cheaper relative to fossil fuels then firms could be left with trillions of dollars worth of stranded assets; reserves of fossil fuels that can never be extracted and burned (either for legal reasons or because it would be uneconomic to do so).

Last week's news that the Rockefeller Brothers Fund (run on behalf of the heirs to the Rockefeller Standard Oil fortune) had decided to divest from its own investments in fossil fuels put the issue back in the headlines.

Is this just about fossil fuels?

No. Water-intensive crops, for example, along with nearby processing plants and related infrastructure, could become stranded due to extreme droughts. Conversely, facilities in areas vulnerable to flooding could be stranded by rising rivers or oceans.

"There are many environmentally unsustainable assets that will become devalued or converted to liabilities" as the result of climate change, reckons Ben Caldecott of Oxford University's Stranded Assets Programme.

"This will lead to unanticipated write-offs because of issues that are not currently being factored in by investors." The biggest issue, however, is unburnable carbon.

What are the numbers?

According to the International Energy Agency (IEA), two-thirds of current fossil-fuel reserves must remain in the ground if the world is to have even a 50% chance of limiting the global temperature rise to 2C (the agreed critical level).

A report by Carbon Tracker and the London School of Economics' Grantham Institute ("Unburnable Carbon 2013") has a similar finding. To stay within the 2C limit, 60% to 80% of the oil and gas reserves of publicly listed companies are unburnable.

In other words, burning known reserves is incompatible even with meeting already-agreed climate-change targets let alone any more stringent future ones.

John Fullerton, a former managing director at JPMorgan, says: "if you paid attention to the scientists and kept 80% of it underground, you'd be writing off $20 trillion in assets."

Could this all be a load of hot air?

Perhaps, but investors and analysts seem to be moving in the direction of taking the issue much more seriously. Either the world will abandon its pledge to keep emissions below the level that will produce a 2C rise (that's what Shell and Exxon Mobil say they expect) or fossil-fuel firms really are holding stranded assets and investing heavily in unusable ones. Currently, markets are implicitly betting on the former.

What's more, oil firms are investing heavily (to the tune of $1.1trn over the next decade, according to Carbon Tracker) in higher-risk projects such as tar sands, deepwater, the Arctic that require an oil price of $95 or above to break even. This makes a recent report by Paris-based brokerage and research firm Kepler Cheuvreux worrying reading.

What does it say?

It argues that oil industry assets will become unprofitable to exploit, even if prices remain high. That's because the condition needed to stimulate more investment in oil supplies ie, high oil prices is also the condition that will accelerate a global shift from fossil fuels to renewables, not least because renewable costs will continue to fall, in contrast to those of the oil industry.

Staggering gains in solar power, and perhaps soon battery storage technology, threaten to undercut oil and coal, while a coming generation of molten salt reactors would cut the costs of nuclear.

This means, says report author Mark Lewis, that "renewables are competitive with marginal new oil projects, and with renewables set to see further cost reductions over the next two decades, higher long-term oil prices will be no guarantee against asset-stranding beyond 2025 for marginal new projects".

Markets wake up to climate change

Under pressure from investors, Exxon Mobil this year published a "Carbon Asset Risk" report, in which it rejected the idea that its assets could become stranded. But the fact that it was forced to take even this limited step was significant, says Jonathan Koomey, a research fellow in energy at Stanford.

"Once markets realise there's an arbitrage opportunity, they relentlessly chip away at it until it is eliminated," he says.

"The stranded fossil asset arbitrage opportunity is... worth many trillions of dollars". That means pressure to address it will build, which will in turn draw more attention to the issue, and "that attention will become a flood very rapidly. It's the beginning of the end of the fossil-fuel economy, but the big players just don't realise it yet (or if they realise it, they're not admitting it)."

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