What are stranded assets?
Containing global temperature rise to well below 2°C would require the world to keep a large proportion of existing fossil fuel reserves in the ground. According to a 2022 study in the journal Nature, an estimated 60% of oil and gas reserves and 90% of known coal reserves should remain unused in order to limit global warming to 1.5°C, the Paris Agreement target. In this scenario, we would be left with fossil fuel resources that cannot be burned and fossil fuel infrastructure (e.g. pipelines, power plants) that is no longer used and may end up as a liability before the end of its anticipated economic lifetime – these are termed ‘stranded assets’.
Companies extracting oil, gas, and coal could be affected by stranded assets as a result of the low-carbon transition, but it is not only the fossil fuel sector that is at risk. Other sectors that use fossil fuels as inputs for production, or are otherwise energy- or carbon-intensive, could also be impacted (the aviation sector, for example). As the world transitions away from high-carbon activities, all technologies and investments that cannot be adapted to low-carbon and zero-emission modes could face stranding.
How could assets become stranded?
Several factors could lead to assets becoming stranded. These include: new government regulations that limit the use of fossil fuels (like carbon pricing); a change in demand (for example, a shift towards renewable energy because of lower energy costs); or even legal action against high emitters.
Coal-fired power plants are the most exposed to the risk of becoming stranded and would have to retire 10 to 30 years earlier than they have done in the past to meet international climate goals. Under the Paris Agreement countries have to submit increasingly ambitious plans to cut their emissions (through their Nationally Determined Contributions), which could leave more assets stranded, although firms and investors may still be unsure of when and how these emissions reductions will happen.
Who is exposed to the risk of stranded assets, and how much could they lose?
The risk of stranded assets might not be fully reflected in the value of companies that extract, distribute or rely heavily on fossil fuels. If this risk were priced in, a sudden drop in value could result, presenting a risk to investors and shareholders.
Those who have invested in fossil fuel companies, including people who have purchased the companies’ stocks or bonds, are most at risk, with cascading impacts on companies that use fossil fuels. This includes a wide variety of people and institutions such as individual investors, banks, pension funds, insurance companies and universities, among others. As a result, the divestment movement encourages people to talk to their pension funds about reducing climate risk exposure. A recent study published in Nature suggests that most losses would be borne by individuals in wealthy countries through their pensions and invested savings, particularly in the UK and the US, where individuals own the majority of potentially stranded assets.
Beyond investors, the early phasing out of fossil fuel-based infrastructure could affect workers and communities that rely on the infrastructure for jobs and income, with the potential to exacerbate regional inequalities. Ensuring there is a ‘just transition’ to net zero, with people as beneficiaries, can help anticipate and manage these disruptions.
The economic impact of stranded assets could amount to trillions of dollars. However, the size of potential losses is difficult to estimate because it depends on different future scenarios and how they would affect the value of the underlying assets. For example, an oil company could diversify its portfolio to include renewable energy, or a coal company might be surprised by how quickly technology shifts towards other forms of power production. But, to get an idea of the scale, global estimates of potential stranded fossil fuel assets amount to at least $1 trillion (for example, in 2022 Semieniuk et al. estimated that around $1.4 trillion in oil and gas assets globally are at risk of becoming stranded). Other studies have tried to estimate the risks outside the fossil fuel industry, such as in the buildings and industry sectors.
Could stranded assets create a financial crisis?
While we do not have enough information to say for sure, many supervisory authorities (e.g. the ESRB, Finansinspektionen and De Nederlandsche Bank) are considering this question and concluding that there is a potential risk of an abrupt transition having destabilising effects on the financial system. This is less about the shift away from fossil fuels than about how smoothly it is done. For example, credible climate policy can help firms put long-term strategies into place for a slower and smoother adjustment that would avoid sudden shocks. However, the continuing expansion of fossil fuel infrastructure and insufficient transparency on the valuation of these assets raises concern that such risks continue to be underestimated by financial institutions.
What can be done about stranded assets?
Individuals concerned about stranded asset risk could talk to their pension funds or asset managers about reducing portfolio exposure to carbon-intensive assets, or increasing investment in low-carbon assets such as renewable energy.
For regulators and supervisory authorities who are monitoring the financial system as a whole, the main focus has been on encouraging greater disclosure of risk, so that investors are better aware of it and can make more informed decisions. This is being done by international bodies like the Financial Stability Board while coalitions like the Network for Greening the Financial System (NGFS) are supporting the transformation of the financial system. Progress has been made towards more transparent disclosure of transition risks but the levels of transparency are still insufficient. Regulators can also try to better understand the potential risks, for example by developing dedicated ‘carbon stress tests’ to test the resilience of financial institutions under different scenarios. However, transparency alone is unlikely to shift investment from high-carbon to low-carbon assets without clear regulation.
The implementation of ambitious near-term climate policy by governments is essential to avoid investments in new carbon-intensive assets that might later be stranded. To limit future disruptions from existing assets at risk of being stranded, governments will need to rapidly phase out fossil fuel-based infrastructure while developing new low-carbon alternatives in a considered way.
This Explainer was originally written by Sini Matikainen and has been updated by Eléonore Soubeyran.