Dead on arrival? Implicit stranded assets in leading IAM scenarios

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9 November 2017

Alexander Pfeiffer is a PhD candidate at the School of Geography and the Environment at the University of Oxford. His research focuses on stranded carbon assets and their effects on financial markets. His previous studies have centred on corporate finance and asset valuation; his master thesis analysed the short-term effects of short-selling bans on market liquidity and other relevant stock market measures.

This Q&A with Alexander provides a snapshot of Dead on arrival? Implicit stranded assets in leading IAM scenarios, the paper that he will be presenting at the Fifth GGKP Annual Conference on Sustainable Infrastructure, hosted by the World Bank in November 2017.


What is the focus of the research you will be presenting at the GGKP Annual Conference?

Our research adds to a growing body of literature by systematically exploring the extent of stranded assets in the electricity generation sector implied by the IPCC’s global decarbonization scenarios. It introduces a simple method that extracts the implicit amount of new fossil-fuel capacity that is added in every year to the global electricity generation capital stock in any given scenario. The derived structure, and remaining lifetime of this capital stock, then allows us to calculate the amount of capacity that would need to be stranded in each year, either via early retirement or lower utilization, for the scenario to be in line with its annual emissions and electricity generation.


What exactly is asset stranding, and why is it relevant to discussions on sustainable infrastructure?

According to the most common definition, an asset strands when it experiences an unanticipated or premature write-down, a devaluation, or a conversion to a liability. If carbon emitting physical assets, or related financial assets, are affected by this form of stranding they are typically referred to as stranded carbon assets. In the narrower context of our paper, carbon assets of the energy sector can strand when society gradually decides to stop the burning of fossil fuels in general or certain fossil fuels, e.g. coal, to generate energy. Stranding can then materialize via early retirement, underutilization, or the expensive retrofit of CCS or other efficiency enhancing technology.

Stranded (carbon) assets are highly relevant for discussions on sustainable infrastructure. Any investment in infrastructure that does not consider future developments such as decarbonization will be at risk of becoming stranded and hence a liability to its investors. Over the next decades, trillions of dollars will be invested in infrastructure, not only in the energy sector but also in all other sectors. A good understanding of stranded assets and their risk factor is therefore necessary.


Your paper introduces a new method to assess the amount of asset stranding for every given energy sector transition scenario. How can this method be applied by policymakers or contribute to knowledge-based policymaking?

Policymakers and investors on different levels can apply our methodology on local or national energy transition scenarios to identify the likely amount of stranded assets and when this will occur under different policy assumptions. In some cases, this can help to identify policies (e.g. lifetime extensions) that will minimize the stranding of assets and hence the cost of an energy transition.


What are the main policy messages or outcomes relevant to sustainable infrastructure, based on the outcomes of your study?

Our findings have important implications for policy makers and investors. The results show that most of the already existing electricity generation capacity cannot be fully utilized, even in the less-stringent policy scenarios, where global warming is likely to exceed 1.5-2°C or even reaches closer to 3°C. This underutilization will be much higher if even a small share of currently planned fossil fuel capacity comes online. In early-2017 Asian (mostly coal) and the OECD countries (mostly gas) are planning significant additions to the ‘polluting’ generation capital stock, i.e. their fossil fuel powered generation capacity. These countries are already strongly affected by future asset stranding, even without these future additions. Policy makers in these countries should re-assess their energy policies, especially the addition of further coal generation capacity, to avoid further carbon lock-in.


What are the main implications for sustainable infrastructure investment? Are these implications different for public and private sector investors?

Policy makers should carefully assess their environmental strategies with respect to planned generating capacity. Despite the lack of penalty for breaching the Paris agreement, there remains a potential economic cost to the industry through inaction, as excess generating capacity reduces overall utilization rates for the industry. Policy makers could assess capacity building in their electricity markets to ensure that the decision to build additional capacity is congruent with the long-term interest of their citizens and their own CO2 reduction pledges.

For investors and corporate decision makers, our results could be used to adjust hurdle rates and assess investment decisions. The significant asset stranding observed in most scenarios means that investments in almost all fossil fuel generators around the world are likely to suffer from falling utilization rates. While these declining utilization rates come at different times (as early as 2020-30 for coal and as late as 2030-50 for gas) they could have impacts on investment portfolios today once climate policies reveal the likely future pathways. Stress testing investment projects and portfolios of fossil fuel generation with low utilization rates at different times could reveal meaningful new information for investment decisions.


Read Alexander's paper Dead on Arrival? Implicit Stranded Assets in Leading IAM Scenarios



The opinions expressed herein are solely those of the authors and do not necessarily reflect the official views of the GGKP or its Partners.

Research Assistant, Institute for New Economic Thinking Oxford