Financial institutions need broader view of stranded asset risk: Researcher

This article was published by The Energy Mix on Nov. 28, 2024.

By Christopher Bonasia

Private financial institutions need to step out of the static narrative of stranded assets and use a “whole of economy lens” to evaluate assets at risk in an energy transition, suggests a financial researcher.

A recent report [pdf] from the Institute for Climate Economics in Paris aims to explain how “stranding risk is actually a transition-driven risk,” author Natasha Chaudhary told the Sustainability in Motion podcast.

Assets become stranded when the profitability of old products and industries falls below expectations—either because of disruptive policies, or when they are replaced by new technologies. For fossil fuel assets, stranding risk comes from policies to phase them out or replace them with renewable energy. A 2022 study found that private investors in rich countries stand to lose more than a trillion dollars in the transition out of fossil fuel infrastructure.

However, Chaudhary said current research uses a “static and narrow” definition of stranded assets, mainly focusing on quantifying losses without fully capturing the broader transition finance implications. She argues that stranding risk should instead be approached with a “whole of economy lens” that considers how the low-carbon transition impacts all economic sectors. Unlike the current narrative of stranded assets, this dynamic “assets-at-risk” approach would look at both direct and indirect financial exposures.

Shifting the focus from stranded assets to assets at risk “basically means that you’re looking at these risks across time horizons, across the entire value chain” of a corporate entity, Choudhary said. That includes risks throughout the “entire financial portfolio beyond the loans and borrowing that banks already account for,” and considers activities like “underwriting, securitization, advisory, facilitation of balance sheet activities—all of this other stuff that is not necessarily part of net-zero targets.”

Adam Scott, executive director of Shift Action—a Canadian charitable initiative focused on pension investments and the climate crisis—told The Energy Mix that Chaudhary’s research applies to public financial institutions like the Canadian Pension Plan Investment Board (CPPIB).

Recently, Shift Action reported that CPPIB made at least C$3.3 billion in new fossil fuel investments in 2024, even as the climate crisis worsens and makes those investments even riskier.

“As global heating increases, the economic effects of climate will worsen, limiting the overall potential for pension investment portfolios to grow and produce the compounding returns on which retirements are funded,” Scott said.

He added that CPPIB’s investments are essentially a bet against the energy transition because they will only generate returns for CPPIB if the transition fails. Like the conclusions of Chaudhary’s paper, Scott argues that CPPIB is underestimating the stranding risk linked to these investments.

“On a risk adjusted basis, the returns generated by fossil fuel investments are no longer competitive with other sectors of the economy,” he said. “CPPIB should exclude these assets from its portfolio as part of its fiduciary responsibility to its beneficiaries.”