Bank of England Assessing the Risk of Stranded Fossil Fuel Assets

Polar Bear at Sunset

By James Noble

December 11, 2014

Demand for fossil fuels could fall dramatically if the world gets serious on climate change, leaving huge, proven reserves of oil and gas in the ground. This scenario is plausible enough that the Bank of England is studying potential impacts on the economy.

Currently, the fossil fuel industry is spending as much as a trillion dollars a year on capital expenditures, much of which goes towards fossil fuel exploration and the development of new reserves.

Meanwhile, the World Bank, International Energy Agency, Intergovernmental Panel on Climate change and many others have concluded that up to 80 percent of fossil fuels will need to stay underground in order to keep global warming below 2°C.

Should the world come to a binding agreement a year from now in Paris to limit global warming to 2°C, many fossil fuel companies could be left with oil and gas reserves that will simply never be exploited, becoming so-called “stranded assets.” This reflects the fact that plans to continue fossil fuel extraction and climate policy plans are simply incompatible.

Major oil companies like Shell and Exxon, however do not think their assets will become stranded because they don’t expect the world to take the 2° degree path. However, the recent climate deal between the U.S. and China is a strong indication that there is growing world-wide support to limit global warming.

If oil prices continue their slide downward and governments push for carbon limits, companies will be hesitant to invest in new oil and gas projects, especially those that are unconventional and tend to be more expensive.

Already, Shell, Total and Statoil have cancelled oil sands projects in Alberta because of high costs and lack of access to markets. Furthermore, there have been a number of studies – including one by HSBC – warning that the market value of companies holding carbon intensive coal and oil assets could tumble if the world uses less fossil fuel energy.

Fortunately, investment options to hedge against the carbon bubble are increasingly available. Green bonds, for example, issued by private companies and public institutions are already in the order of billions of dollars.

While a climate deal could still be a long way off, the recent agreement between the U.S. and China – the world’s two biggest emitters – injected a new sense of optimism into negotiations. The ecological reality of climate change may yet come to trump the economic theory underlying the book value of fossil fuel producers.