Last month, I penned an article entitled: ESG: Woke Capitalism or Smart Investing?
In that article, I noted that not only is ESG a voluntary investment strategy, so opposition to it based on government interference is irrational, but many of the fundamentals of this strategy are already used by funds, retirement plans and individual companies that have a fiduciary responsibility to their shareholders to assess any and all liabilities related to lack of environmental, social, and governance oversight.
To give you an example of what I’m talking about, consider the news last week that the Net-Zero Asset Owner Alliance (NZAOA), a group of institutional investors that oversees $11 trillion in assets is now advising members to halt direct funding of any new investments in fields, pipelines or power plants that are fueled by oil or gas.
Well, it has nothing to do with hugging trees, folks.
It’s all about risk management.
In its latest investor note, NZAOA reps said members that continue investing in oil and gas will probably be saddled with stranded assets.
If you’re unfamiliar, let me explain what is meant by “stranded assets.”
As the world transitions away from fossil fuels and towards renewable energy, and as new climate mitigation efforts being instituted by most of the countries in the world take hold, we’re left with a scenario where fossil fuel resources won’t be burned and fossil fuel infrastructure will no longer be needed, which makes this infrastructure a liability. This is what is meant by stranded assets.
The London School of Economics and Political Science (LSE), explains it a bit better by noting that there are several factors which could lead to assets becoming stranded. These include: new government regulations that limit the use of fossil fuels (like carbon pricing); a change in demand (for example, a shift towards renewable energy because of lower energy costs); or even legal action against high emitters.
The first two of those factors already exist, and legal action (at least in any significant way), is not far behind.
The LSE also identified who is most exposed to the risk of stranded assets, and how much they could lose.
Check it out …
The risk of stranded assets might not be fully reflected in the value of companies that extract, distribute or rely heavily on fossil fuels. If this risk were priced in, a sudden drop in value could result, presenting a risk to investors and shareholders.
Those who have invested in fossil fuel companies, including people who have purchased the companies’ stocks or bonds, are most at risk, with cascading impacts on companies that use fossil fuels. This includes a wide variety of people and institutions such as individual investors, banks, pension funds, insurance companies and universities, among others. As a result, the divestment movement encourages people to talk to their pension funds about reducing climate risk exposure. A recent study published in Nature suggests that most losses would be borne by individuals in wealthy countries through their pensions and invested savings, particularly in the UK and the US, where individuals own the majority of potentially stranded assets.
The economic impact of stranded assets could amount to trillions of dollars. However, the size of potential losses is difficult to estimate because it depends on different future scenarios and how they would affect the value of the underlying assets. For example, an oil company could diversify its portfolio to include renewable energy. But, to get an idea of the scale, global estimates of potential stranded fossil fuel assets amount to at least $1 trillion.
When the news came out that NZAOA would be eschewing new oil and gas investments, some folks were quick to call out the decision as an exercise in wokeness. But it was not. It’s simply an exercise in fiduciary responsibility. And to ignore the potential threat of stranded assets is an exercise in recklessness.
We know that this transition away from fossil fuels and towards renewable energy and vehicle electrification is happening.
We know that by 2030, more than half of all vehicles sold in the US will be electric.
We know that by 2040, nearly 70% of new vehicles sold across the globe will be electric.
And we know that by 2040, renewables will make up 51 percent of the global power mix, with natural gas demand peaking in just 7 to 8 years, according to the International Energy Association.
So yes, given what we know now about the transition of our global energy economy, which is well underway, “stranded assets” represent a very real risk to investors, and should not be trivialized.