17 May 2020 Fossil fuel reserves: the high cost of stranded assets
What are the implications of climate change mitigation on the market value of coal, oil and gas companies?
To assess how much market value these companies might lose as governments are increasingly eager to impose stricter measures on the hydrocarbon industry, analysts must consider the reserves under threat, the type of fuel involved, the global warming threshold scenario to be met, as well as they must take a stab at how stock markets value reserves generally.
According to the International Energy Agency (IEA), coal contains the largest proportion of carbon of the fossil fuels accounting for two-thirds of potential carbon emissions held in reserve and holding by weight twice the carbon as natural gas and half as much as crude oil.
In a scenario of a global warming rise of 2C by the end of the century as agreed in the 2015 Paris climate deal, 59% of fossil fuel reserves would have to be stranded. If governments impose a tougher threshold of 1.5C, 84% of fossil fuels held in reserves will remain untouched in the ground. Vice versa, in the unlikely event that the warming target was revised up to 3C, only 4% of the remaining carbon stock would be left untouched.
Stock markets have priced in the likelihood of a 2C scenario, where less than a quarter of coal reserves could be exploited. The market has already moved away from coal. Bloomberg’s index of global coal miners, the largest of which are in China, has dropped fast as 75% from its peak in early 2011 adding up to $300bn of market value.
As far as oil and gas companies’ market value is concerned, a 2C scenario means that 71% of oil reserves and 92% of gas reserves could be burnt, which will have relatively little economic impact on the producers. Compared to coal miners, oil and gas companies’ market value have fallen half since their own decade peak in 2011.
Traditionally, the market has attributed a higher worth of companies with greater amounts of oil reserves. As a way of an example, for the largest listed oil companies, there is a positive relationship between enterprise value and their reported proven reserves, for assets with the highest probability of development. This relationship coupled with the 2C scenario leaves 29% of oil reserves untouched in the ground and adds up to something like $360bn in value loss of the top 13 IOCs by reserves. In the case of a stricter warming target of 1.5C that figure would more than double to nearly $890bn.
In the case that policymakers pay attention to the growing public demand for environmental policies, the drop in asset value for all oil and gas stocks will be dramatic especially for those companies with long reserve lives. According to Bernstein Research, IOCs like Rosneft, ExxonMobil, PetroChina and BP which have long reserve lives and high carbon intensity are exposed to the biggest potential drops.
However, those more likely to be hit by the biggest drops are NOCs like the members of the Opec cartel which control roughly 71% of the oil in the ground but have. These countries would need 68 years to exhaust their reserves, while the 50 largest listed IOCs have sufficient reserves to last from 10 to 20 years. On a top-50 oil and gas company rank, 65% of companies are controlled by national organisations, which means that in a 2C scenario the carbon budget left to NOCs is 281GT. But that means nearly half of sovereign oil reserves would be left untouched in the ground.
Of course, the drop for countries which can resist public pressure to change their environmental commitment might be less dramatic than that for listed oil and gas companies, but in the end a major depreciation of stranded assets would echo across the business world.
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