An economic downturn on the level of the 2008 recession is coming if we keep investing in fossil fuels, researchers say. If fossil fuel-producing countries like the US, Canada, and Russia don’t guide their economies away from oil, gas, and coal, then low-carbon technology could render at least some of those investments worthless.
With or without the US federal government, countries and regions around the world (including US states) are pursuing policies to meet the 2°C climate change goals from the Paris Agreement. At the same time, investment in fossil fuel assets continues. These assets, like drill rigs and pipelines, generally have long lifetimes, so as the world moves to low-carbon and zero-carbon technologies, we can expect that some fossil fuel assets will become valueless before the end of their projected lifetimes. Investors call these valueless assets “stranded.”
“Irrespective of whether or not new climate policies are adopted, global demand growth for fossil fuels is already slowing in the current technological transition,” the researchers from Radboud University in the Netherlands write. “The question then is whether, under the current pace of low-carbon technology diffusion, fossil fuel assets are bound to become stranded due to the trajectories in renewable-energy deployment, transport fuel efficiency, and transport electrification.”
The researchers used a computer model of the global economy and applied two scenarios: one in which low-carbon technology continues to diffuse at the rate it has been, and a more extreme scenario in which countries really do adhere to their 2°C commitments. They compared this to International Energy Agency (IEA) forecasts of fuel use out to 2040, which generally show continued growth in demand for fossil fuels and reflect how investors formulate ideas about demand.
At current rates of adoption, cleaner technology will strand billions of dollars of assets before they’d normally be retired. And if countries implement additional climate policies, the losses would be amplified.
One scenario that would exacerbate this situation would be a “sell-off,” the researchers said. If oil producers realize that demand is starting to drop off, that could induce low-cost producers to pump as much oil as they can and sell it cheaply. That way, they can maximize the use of their assets, deplete any oil reserves, and snatch up any final profits to be made from the oil market before their competitors can. That could drive fossil fuel prices down even further, which would be a death knell for higher-cost producers, particularly oil producers in Canada and the United States.
No matter what, stranded assets result in losing countries and winning countries, which are easily categorized by which countries import fossil fuels and which countries export. China and many countries in the European Union will come out as winners if the price of fossil fuels drops and the energy economy moves toward low-carbon or no-carbon alternatives. By contrast, the United States, Canada, and Russia come out as losers because they have significant investments in fossil fuel production. The Organization of Petroleum Exporting Countries (OPEC) is not expected to lose as much as the afore-mentioned countries because it produces oil so cheaply that OPEC will be able to sell off its oil and gas as fossil fuels are retired.
The worst-case scenario? If fossil fuel investment continues unchecked, policies to limit warming to 2°C are enacted, and a sell-off occurs, the global economy could stand to lose $4 trillion, the researchers write.
“For reference, the subprime mortgage market value loss that took place following the 2008 financial crisis was around US $0.25 trillion, leading to global stock market capitalization decline of about US $25 trillion,” the paper notes.
This is obviously the most extreme example, especially given that the US has reneged on its commitment to the Paris Agreement and may even continue to prop up fossil fuels for the next few years (a scenario that the researchers seem not to have considered). That might lessen the damage temporarily, but it’s a stopgap measure for a country that exports fossil fuels to a changing world.
Is there any way to win?
The researchers stress that this global fossil fuel contraction could happen with or without new climate policy, as low-carbon technology is adopted.
Instead, the researchers argue, the only way for a fuel-producing country to win is to lean into the transition—adopt climate policies that redirect investor dollars away from fossil fuel infrastructure and into renewable energy, and fewer dollars will be available to be stranded. “Further economic damage from a potential bubble burst could be avoided by decarbonizing early,” the researchers advise.
They add that any one country, no matter how big it is, would likely not be able to turn the tide of global climate policy, so “an exposed country can mitigate the impact of stranding by divesting from fossil fuels as an insurance policy against what the rest of the world does.”
Investors: Sometimes taking this seriously
The effects of this low-carbon transition are already becoming noticeable, even in the US, despite the Trump administration’s pro-fossil fuel policies. Just last week, the Energy Information Agency (EIA) released data showing that in 2017, the electric power sector used less fossil fuel than it had in any year since 1994.
In the absence of any US policy to temper the optimism of fossil fuel companies, some investors have demanded an accounting of how their investments are exposed to climate change policies and new low-carbon technologies. Exxon is the most notable: in May 2017, more than 60 percent of Exxon’s investors voted in favor of a resolution that would require the company to compile an annual report on how global climate change policies could affect business. Though the resolution was non-binding, it showed that more and more investors are becoming concerned about the problem of stranded assets.
Just today, the UK’s House of Commons Environmental Audit Committee issued a report recommending that large companies be required to report their climate change risk to shareholders. S&P Global Platts wrote that, “If enacted into law, mandatory climate risk disclosure would likely impact the long-term availability of finance to support carbon-intensive assets and businesses.”
Committee Chair and Member of Parliament Mary Creagh reportedly said, “We need to fix the incentives in our financial system that encourage short-term thinking. Long-term sustainability must be factored into financial decision-making.”
Still, climate-risk reporting remains voluntary throughout the world. Last week, Chevron shareholders rejected a resolution asking the company to disclose a plan for how it would transition to energy sources more in line with the Paris Agreement.