Stranded Assets: A New Concept but a Critical Risk
Fund managers are inherently concerned with risk. This note explores the relatively new concept of Stranded Assets and seeks to show how they are already a critical ‘hidden’ risk in almost every Global Multi-Asset and Equity portfolio and how they will become increasingly important to all asset managers in the coming decade.
Ian's introduces ASR's 'Stranded Assets' research.
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“Stranded Assets” are a relatively new concept (coming from the Economic Geography literature) and are defined as those physical assets which lose their economic value well ahead of their anticipated useful life. The academic literature highlights how environmental change is making investments over a wide range of sectors and asset classes at risk from being ‘stranded’.
Investments which depend on the natural environment, particularly those exposed to water, fossil fuels and agriculture, are increasingly at risk from such significant premature write-downs as regulation tightens, natural capital is impaired, clean technologies develop and socio-political pressures increase.
Water, energy and food systems are tightly linked. Water is needed to extract fossil fuels and generate power; energy is needed to treat and transport water; and both water and energy are needed to grow food. This energy-water-food ‘stress nexus’ will increasingly force corporates and asset managers to identify the implicit risks in their existing and planned investments.
Asset Stranding is already creating costs for corporates and reshaping Global Portfolios. Since 2011 Global corporates are estimated to have spent more than $84bn on improving water management systems as climate change and rising demand has increased water scarcity. European gas-fired power stations are already being closed prematurely, costing nearly €6bn in 2013 as the energy landscape shifts. Weather-related losses have increased four-fold since the 1980s to $200bn over the past 10 years. Water scarcity could cut China’s food production by up to 23% by 2050 vs 2000, and could put almost half of the world’s GDP ($63trn) at risk if companies persist with ‘business as usual’.
Energy companies ‘invested’ $674bn in new coal and gas projects last year, when there is a $28 trillion ‘Carbon Bubble’ of identified oil reserves which will be UNUSED if already agreed climate change targets are to be met. The shifts are already happening. Globally, half of new electricity generation in 2012 was renewables, while some asset managers are divesting carbon assets.
The scale of stranded assets will increase dramatically in the coming decades. Coal, oil and gas, along with mining and agricultural sectors are most likely to be negatively affected (US Coal sector capitalization has fallen by almost 20% since the Obama/EPA announcement in June 2014). Countries reliant on such sectors may also see their sovereign bond ratings suffer. Developed markets will be impacted by the pressure on Financials, especially Insurance, while Emerging Markets could suffer as the volatility of food prices increases.