What are climate stranded assets?
The idea of assets stranded by climate change was popularized by the Unburnable Carbon report from the Carbon Tracker Initiative in 20111. Though the report focused on fossil fuel assets, climate stranded assets can be more generally defined as any assets that suffer unanticipated or premature write-downs, devaluations, or conversions to liabilities due to climate-change-related impacts.2
Transition stranded asset risks
Energy sector assets, including coal, oil, gas reserves, and fossil fuel power generators, are the most considered potential climate stranded assets. However, other high-emitting or fossil fuel dependent sector assets, such as steel, cement, refineries, and chemicals, are at risk of stranding in a low-carbon transition.
From a lender perspective, commercial and industrial asset write-downs due to changing market conditions from the energy transition could reduce bank collateral. Corporate and industrial customers may also be at increased risk of delinquency or default if the energy transition impacts their ability to generate cash flows from product demand shifts or carbon pricing liabilities.
Physical stranded asset risks
Chronic physical impacts, such as shifting growing regions and sea level rise from climate change, have the potential to create stranded assets in the agriculture, real estate, and tourism sectors. Acute physical climate impacts may affect many sectors, such as the recent low water levels on the Rhine that impeded fuel shipping and interrupted various supply chains.3
For banks, collateral assets in the real estate and tourism sectors may suffer write-downs or devaluations if they are in areas of high risk from sea level rise. Agricultural producers who experience losses from shifting climate patterns or increased extreme weather events may be at higher risk for delinquency and default.4 Any commercial or industrial customer who faces higher costs from physical risks may lose significant revenue if their prices are no longer competitive in global markets.
Key considerations for climate stranded assets
The complexities of climate change require lenders or investors to include additional considerations of potential climate stranded assets in their due diligence. These considerations and questions include:
- Return outlook under climate scenarios
— Do the assets maintain or realize necessary returns under ambitious energy transition (e.g., the IEA Net Zero by 2050 scenario or NGFS low physical risk scenarios) or critical high-warming climate scenarios (e.g., RCP7.0, RCP8.5, or the NGFS high physical risk scenarios)?
— Could the assets become distressed or stranded due to short-term climate phenomena (acute physical risks) or other location-based risks?
— Would the counterparty or investee face significant liabilities from carbon pricing impacting its ability to repay debt or generate net revenue?
- Potential for decarbonization
— Do the assets have viable and cost-effective decarbonization pathways?
— Would the customer be lent to for short-term operations with any high-emitting assets retired, or would assets be decarbonized and a longer-term customer relationship developed?
— Would the assets be purchased for short- to medium-term cash flows to be retired or decarbonized and resold in a determined timeframe?
- Potential alignment with stated greenhouse gas (GHG) targets
— Are the assets compatible with publicly-stated GHG targets or could they present a potential reputational risk or accusations of greenwashing if viewed as incompatible with these stated targets by external stakeholders?
— How would achieving stated GHG targets affect the necessary return of the assets?
Despite recent rebounds in the returns of some high emitting assets such as fossil fuel production, the longer-term trends of climate change are likely to increase stranded asset risks.
Lenders and investors may choose to reduce stranded asset risks by incorporating the potential for assets to decarbonize within necessary timeframes and holding periods as well as their assets’ alignment with stated emissions reduction goals when assessing borrowers or potential investments. For banks, incorporating physical and transition scenario analysis into the credit review process would help ensure climate stranded asset risks to collateral are minimized for commercial and industrial lending portfolios.
1Carbon Tracker Initiative, Unburnable Carbon (August 23, 2017)
2Source: Smith School of Enterprise and the Environment, “Stranded Assets Programme” (March 2014).
3Source: Reuters web site, Brussels, Philip Blenkinsop (August 23, 2022).
4Source: Smith School of Enterprise and the Environment, “Stranded Assets Programme” (March 2014).