Covid-19 prompts Oil Majors to begin dress rehearsal for stranded assets as climate risks take hold

“We do not believe that any of our proven reserves will become stranded. While the ‘stranded asset’ notion may appear to be strong and thought-through, it does have some fundamental flaws and there is a danger that some interest groups use it to trivialise the important societal issue of rising levels of CO2 in the atmosphere.” Those were the words of JJ Traynor, vice president of investor relations at Shell, in a 2014 pushback against the notion of stranded assets and its implications for oil and gas investments.

Fast-forward to 2020, in what seems to be a fulfillment of an important prophecy from analysts about the risks climate change poses to investments in fossil fuels, one after the other, major oil and gas producers have issued statements about write-downs or write-offs of some of their assets.

One of the deleterious consequences of the global pandemic is that it has led to demand destruction for fossil fuels during the lockdowns, mirroring the likely path for fossil fuel demand when the broad switch to lo-carbon alternatives kicks in. Companies in the fossil fuel industry are now revisiting long-held assumptions about high oil prices, demand for oil and gas, and continual expansion in oil reserves.

 But what exactly are stranded assets? As Ben Caldecott & Jeremy McDaniels put it in a 2014 paper, stranded assets are “assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities.” These assets cease to generate economic return before the end of their commercial life for a variety of reasons that may include changes in the regulatory environment, developments that cause relative costs/prices to take unfavourable pathways or even natural disasters that could cause physical damage resulting to economic loss.

Commonly referred to as the physical and transition risks of climate change, the more these risks materialize, the faster the downward re-evaluation of affected assets, resulting in their stranding.

The recent announcements are a clear sign that big oil is no longer tone-deaf. It is beginning to respond to the drumbeats of the battle against climate change, albeit at a slow pace. From the transcript of Q2 2020 earnings call, CEO of Total, Patrick Pouyanne, is noted to have said “… we have decided to look to and the Board has made a review of the assets to check which could be the stranded assets within our portfolio, keeping in mind our climate ambitions, that outlook to 2050.” In a press release on BP’s website, chief executive Bernard Looney was quoted as saying “… we have reset our price outlook to reflect that impact and the likelihood of greater efforts to ‘build back better’ towards a Paris-consistent world.”

Bernard Looney’s words point back to what has been said time and again. Fossil fuels companies should quit making investments in assets that would swing the world beyond the scientific thresholds of greenhouse gasses needed to forestall the dire consequences of climate change. They can save investors from the humongous loss associated with high-cost projects like oil sands, arctic exploration oil and gas, and shale production (that is particularly sensitive to demand). Redirect this capital to sustainable forms of energy generation to help accelerate the large chunks of investments needed for a low carbon future. Promote R&D in new and innovative technologies, reskill staff, and prepare them for the future ahead. The list of things that can be done “build back better” is endless.