The risk that significant volumes of energy assets worldwide could become ‘stranded’ because of policies aimed at countering climate change has preoccupied experts for years. The conclusion of the Paris climate conference in December highlighted the breadth of concern about the issue, with 189 countries agreeing to take steps to ‘decarbonise’ their economies. The accord is not legally binding and not all the commitments will be met, but the direction of change is clear.
The conference reinforced issues that Bank of England Governor Mark Carney raised in a controversial speech in September. Carney tacitly endorsed the view that significant amounts of coal, oil and natural gas – while identified and in some cases valued on the extractive industry’s books – can never be used and are valueless.
The speech attracted attention because he touched on themes seldom the preserve of practising central bankers. But there are considerable grounds for thinking he has done investors a disservice by unnecessarily exaggerating transitional risks associated with new international energy policy regimes aimed at a lower carbon economy.
On the one hand, Carney was saying nothing dramatically new – the energy business is familiar with the concept of stranded assets. But the new concept to which he referred was that the world would have to adopt a ‘carbon budget’, setting a maximum amount of usable carbon. If that concept is correct, all the coal, oil and natural gas that can be safely used has already been discovered. Over time, hydrocarbons will be priced out of the market. Exploration is valueless, as are some of the resources already identified. The rest should stay buried, and cannot be valued as corporate assets.
This logic rests on three assumptions, and the likelihood that they will all hold is extremely low. They are that public policy action will curb hydrocarbon use to keep total emissions within a prescribed limit; that alternative energy supplies will be available in time and at a low enough cost to enable consumers to switch away from hydrocarbons; and that attempts to reduce emissions using techniques such as carbon capture and storage (CCS) will not be viable on the scale required to allow continued hydrocarbon use.
Most observers would agree that the third assumption is correct. Current CCS projects are minimal and there is no clear financial model to encourage companies to invest. Most current CCS projects are economic only because they support enhanced oil recovery. Matters may change but, on current trends, CCS will not make a major difference.
The second assumption has yet to be proved, but remains open. Low carbon costs are falling, other than for new nuclear developments. Solar costs have fallen dramatically. There are serious advances in storage technology that could transform the economics of intermittently producing renewables. But the big breakthroughs that would allow global deployment are still hope rather than reality.
That brings us to the assumption that policy measures will limit hydrocarbon use to keep the world within the carbon budget. This seems completely unrealistic. The reality is evident from the debates at the Paris conference. The commitments made and the resource transfers promised to change the trajectory of hydrocarbon consumption are not sufficient to prevent continued growth in the use of oil, coal and natural gas.
This means that the period of adjustment to a low-carbon economy on which the stranded assets theory is based will take a very long time. The carbon budget will be broken and climate change will begin to take effect.
The point may well come when the impacts of climate change force a radical change in policy, but we are not there yet. The issue for long-term investors is whether individual companies can explain their strategies for dealing with a very different world.
Prof. Nick Butler is a Visiting Fellow and Chair of the King’s Policy Institute at King’s College London.