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Energy’s stranded assets are a cause of financial stability concern

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Via Financial Times

Goose herds, rendered redundant by the 19th century switch from quills to metal-nibbed pens, were an early example. So were the whaling ships no longer needed when electric light replaced oil lamps.

So-called stranded assets have long existed. Today, their incarnation as coal mines, oilfields and gas reserves in an unsustainably warming world, is a growing cause of financial stability concern.

Last Thursday 500 men and women packed into London’s Guildhall to hear the Bank of England’s outgoing governor Mark Carney, and Christine Lagarde, president of the European Central Bank.

Launching the finance agenda of the UN’s COP26 climate summit, due to take place in Glasgow in November, Mr Carney and Ms Lagarde spoke of how important it is that companies — especially the banks and insurers they supervise — are transparent about their exposure to climate change risks.

As the world moves towards a target of net zero carbon emissions companies will find themselves with a range of fossil fuel assets that will never be tapped. They could face large losses as a result. But so could the banks that lend to them, the insurers that underwrite them and the asset managers that invest in them.

Analysis by the Financial Times’ Lex team concluded that meeting the terms of the UN’s Paris Agreement — to limit global warming to 2C — would leave 29 per cent of oil reserves stranded and wipe about $360bn from the value of the top 13 international oil companies by reserves. That is well over a sixth of their total enterprise value. Meeting a stricter warming target of 1.5C would more than double the figures to nearly $890bn.

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Financial regulators are most worried about the exposure of banks, which provided about $654bn in financing to fossil fuel companies in 2018, according to the latest data available from the Rainforest Action Network.

Senior Hedge Fund Managers Are Questioned By The Treasury Committee...LONDON, ENGLAND - JANUARY 27: Christopher Hohn of The Children's Investment Fund leaves Portcullis House on January 27, 2009 in London. Senior hedge fund managers appeared before the Treasury Select Committee hearing into the banking crisis. (Photo by Peter Macdiarmid/Getty Images)
Christopher Hohn, founder of The Children’s Investment Fund, has written to banks to warn over fossil fuel investments © Peter Macdiarmid/Getty Images

The pressure for change is not just coming from regulators. Sir Christopher Hohn, founder of $28bn activist hedge fund firm TCI, has written to the chairmen of Barclays, HSBC and Standard Chartered warning them of a possible legal challenge if the trio do not stop lending money to coal mining companies. Barclays has also faced pressure from some of its shareholders to stop financing fossil fuel companies. It is expected to pledge significant cuts in an appeasement effort.

Specialist funds have led the investor drive for change in corporate and bank behaviour. But drawn by public interest in buying green funds, even the world’s biggest asset managers are now joining the fold. BlackRock chief executive Larry Fink recently pledged to stop financing significant thermal coal companies.

Fossil fuel companies are themselves beginning to change, amid louder protests from campaigners and investors. BP, under new chief executive Bernard Looney, recently promised to be net zero by 2050.

Last week Norwegian oil company Equinor abandoned a A$200m ($132m) plan to drill for oil and gas in the deep waters of an Australian marine park. In Canada, Teck Resources walked away from a $15bn oil sands project. UK energy generator Drax said it would stop burning coal at Britain’s biggest power plant by 2022.

It is unclear what role financing played in any of these decisions, but certainly banks’ sharpened focus on mitigating hydrocarbon exposures won’t have helped.

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In the US, Peabody Energy and Devon Energy are among companies to have experienced or warned of the risk of shrinking access to finance.

So far financial regulators’ contribution to the pressure has been largely verbal. But bank stress testing is set to be adapted to incorporate climate risk scenarios. Some regulators are also openly debating whether bank capital rules could or should be redesigned to spur a more rapid shift away from fossil fuels — either by cutting regulatory capital risk weightings on greener finance or raising it on brown finance. Mainstream thinking holds that this is dangerous territory — using financial stability regulation for policy ends could be a slippery slope. But the argument for change will be stronger once stranded asset risk can be quantified. In time, financing fossil fuels may become taboo for mainstream regulated banks.

It would be tempting to hail this as a victory for the planet. But that would be premature. As happened across other areas of banking as new tighter regulations were imposed after the financial crisis, non-banks — encumbered by little or no regulation and scant public scrutiny — sprang up to fill the gap. Private capital investors are showing growing interest in parts of the fossil fuel industry. As long as the cash flow is attractive, they will back coal, oil and gas, whether the traditional banks and big asset managers are there or not.

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