The risk of policy tipping and stranded carbon assets

Abstract

If global warming is to stay below 2°C, there are four risks of assets stranding. First, substantial fossil fuel reserves will be stranded at the end of the fossil era. Second, this will be true for exploration capital too. Third, unanticipated changes in present or expected future climate policy cause instantaneous discrete jumps in today's valuation of physical and natural capital. Fourth, if timing and intensity of climate policy are uncertain, revaluation of assets occurs as uncertainty about future climate policy is resolved. E.g. abandoning climate policy plans immediately boosts scarcity rent, market capitalization, exploration investment and discoveries. To explain and quantify these four effects, we use an analytical model of investment in exploration capital with intertemporal adjustment costs, depletion of reserves and market capitalization, and calibrate it to the global oil and gas industry. Climate policy implements a carbon budget commensurate with 2°C peak warming and we allow for different instruments: immediate or delayed carbon taxes and renewable subsidies. The social welfare ranking of these instruments is inverse to that of the oil and gas industry which prefers renewable subsidy and delaying taxes for as long as possible. We also pay attention to how the legislative "risk" of tipping into policy action affects the timing of the end of the fossil era, the profitability of existing capital, and green paradox effects.

Tackling the Risk of Stranded Electricity Assets with Machine Learning and Artificial Intelligence

“…Figure 3 summarizes the regional distribution of these unburnable reserves. These figures are in line with other estimates of the stranded coal, oil, and gas assets by other experts and organizations, that must be kept in the ground, to meet the 2°C Paris commitments [5,10,74,85,86]. However, while in the end, all carbon must be phased out, less-carbon intensive energy carriers like gas might continue to operate as a "bridging fuel" to the carbon-free economy, in tandem with renewable energy.…”

“…Stranding is not just a loss in economic value but also an irreversibility of the investments. This means that if the investments wiped out is reversible and can be adjusted for other purposes such as retooling an obsolete coal power plant to be used as a hydro generation facility; then the assets have not stranded since they can be put to different profitable use [63,80,86].…”

Pigou in the 21st Century: a tribute on the occasion of the 100th anniversary of the publication of The Economics of Welfare

“…Firms and investors, on the other hand, face the problem of stranded assets. The threat is particularly relevant for owners of fossil resources who stand to lose large rents (Bauer et al 2016 ; Kalkuhl and Brecha 2013 ; van der Ploeg and Rezai 2020 )—but also for ‘brown capital’ which cannot be converted into ‘green capital’ (Kalkuhl et al 2020 ; Rozenberg et al 2020 ). Moreover, the stability of the financial system could be compromised (Carney 2016 ).…”

Climate Actions and Stranded Assets: The Role of Financial Regulation and Monetary Policy

“…Edenhofer et al, 2020;Jakob et al, 2012;Kriegler et al, 2018). To comply with the Paris Agreement goals, much of the world's fossil fuel reserves must be left "unburned" in the ground (Jakob and Hilaire, 2015;McGlade and Ekins, 2015;van der Ploeg et al, 2020). A sudden introduction of strict climate policies would swiftly devalue these reserves, with potentially disruptive effects on fossil capital stocks and fossil financial assets.…”