Stranded Assets

What lies beneath

29 Dec 2017

Far from Stranded

The issues surrounding global warming are causing some investment sectors to feel the heat. According to some analysts, 80 percent of oil and gas reserves are likely to be stranded because the growing risks of climate change may render fossil fuels unusable.1

The concept of a 'stranded asset' became a major investment concern after a paper published in 2009 suggested that publicly traded fossil fuel companies should be divested because they are mispriced and will lose value in the near future.2 This was followed up by a similarly scathing analysis in 2011 by Carbon Tracker, an independent think tank, that concluded that 80 percent of fossil fuel reserves cannot be extracted – effectively stranding them.3

This of course has worrying implications for companies with a large portion of market value and future cash flows dependent on fossil fuels, who could suffer declining returns and eventual asset impairments. This has led a growing number of asset owners to consider fossil fuel divestment.4

However, we at UBS, believe these predictions to be at best, over-simplified. There are several nuances to understand about the origins and basis for the stranded assets hypothesis, so as to formulate an analytical approach towards informed investment decisions today.

The current predictions of the stranded assets hypothesis take a one-size-fits-all approach, ignoring major factors that could result in vastly different outcomes. The difference in prices of extraction, the volatility of current and future oil prices, the size of corporations in question, all challenge the idea that publicly traded oil and gas companies will suffer equally.

There is simply no room for companies to stand idle. As is the case with any market disruption, there will be winners and losers – companies unable to adjust to the prevailing price of oil will fail or decline in value, and companies whose production costs are such that they will do well despite a relatively low oil price.

There are of course, some publicly traded oil and gas companies that are unattractive from a long-term investment perspective. Yet, there is enough data to suggest that the news is not all bad. We at UBS believe that there is need for a thorough intrinsic value analysis, to assess the merits of any fossil fuel divestment decision, as it is likely that blanket divestment of the energy sector could mean sacrificing future returns.

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