Episode 14: Stranded Assets

Sustainability In Motion

Hosts:

• Matt Orsagh, Chief Content Officer at ED4S
• Nawar Alsaadi, CEO of Kanata Advisors, Chief Advisor at ED4S

Guest:

• Natasha Chaudhary, Research Fellow at The Institute for Climate Economics (I4CE)

Episode Focus: The concept of stranded assets and a shift toward "assets at risk" to better support financial institutions in navigating climate-related financial risks.

Key Takeaways:

1. Stranded Assets Explained:

   • Traditionally associated with fossil fuels, stranded assets refer to devalued resources due to regulatory, market, or physical climate changes. Current definitions often focus on oil, gas, and coal sectors, but the concept can apply across industries.

2. Reframing to "Assets at Risk":

   • Natasha advocates shifting from "stranded assets" to "assets at risk," broadening the focus to include potential asset value losses across all sectors under transition pressures. This proactive approach allows financial institutions to better anticipate risks and guide capital toward sustainable investments.

3. Proactive Risk Management:

   • "Assets at risk" encourages financial institutions to manage risks dynamically, considering the entire value chain and transition readiness of companies, thereby supporting real-economy decarbonization rather than simply divesting from risky sectors.

4. Sectoral Examples Beyond Fossil Fuels:

   • Key sectors such as real estate, agriculture, and automotive also face significant risks. For example, the EU’s building regulations for decarbonization by 2050 and the upcoming ban on internal combustion engines by 2035 present immediate risks to financial portfolios.

5. The Need for Regulatory Guidance:

   • Clear regulatory frameworks and standardized transition plans are essential to accurately assess transition readiness across sectors, helping institutions manage climate risks effectively.

Conclusion: This episode emphasizes the importance of expanding the stranded assets framework to support proactive and comprehensive risk management across sectors, highlighting the role of financial institutions in driving climate-aligned investments.

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Transcript:

Welcome to the Sustainability in Motion Podcast!

Hello, everyone! Welcome to the Sustainability in Motion podcast, brought to you by ED4S. Here, we focus on the rapidly evolving world of sustainability, helping the business community navigate environmental challenges and opportunities. I'm Matt Orsagh, Chief Content Officer at ED4S.

And I'm Nawar Alsaadi, Founder and CEO of Kanata Advisors and Senior Advisor to ED4S. Today, we’re thrilled to be speaking with Natasha Chaudhary, a Research Fellow at the Institute for Climate Economics, also known as I4CE.

Natasha recently authored the paper From Stranded Assets to Assets at Risk: Reframing the Narrative for European Private Financial Institutions. This paper takes a deep dive into the concept of stranded assets, a topic many of us have encountered but might not fully understand. Welcome to the podcast, Natasha!

Natasha Chaudhary: Thank you for having me!

Matt Orsagh: Let’s start by level-setting. Most of our audience has likely heard of stranded assets, but could you explain the concept as it’s used today? Where does it come from, and how is it applied?

Understanding Stranded Assets

Natasha: Certainly! Theoretically, the idea of stranded assets has been around for quite some time. However, it gained practical traction about a decade ago, particularly between 2012 and 2014, when pioneering research at the University of Oxford began to spotlight the issue.

The concept became especially relevant due to its link with the fossil fuel industry and global warming. Essentially, stranded assets are resources—such as oil, gas, or coal reserves—that can no longer be extracted, used, or sold due to external changes. These changes might be regulatory, such as a ban on fossil fuel extraction, or economic, driven by market shifts.

One critical idea underpinning this is the "carbon bubble," which suggests that a significant portion of fossil fuel reserves currently listed as assets by oil and gas companies may lose their value as we transition to a low-carbon economy. The issue arises because these risks are often not fully reflected in current valuations, creating a bubble.

Organizations like the Carbon Tracker Initiative have explored these risks extensively, categorizing them into three types:

1. Regulatory stranding – driven by strict policies or bans.
2. Physical stranding – resulting from climate events like floods or droughts.
3. Economic stranding – caused by market changes, such as declining demand or cost inefficiencies.

Expanding the Lens: Assets at Risk

Nawar Alsaadi: In your paper, you argue that the concept of stranded assets is too narrow, particularly when applied to financial institutions. You propose a broader framework—assets at risk. Could you elaborate on this and explain why you think it’s a better framing?

Natasha: Of course. The traditional understanding of stranded assets is heavily tied to the fossil fuel sector and focuses on quantifying losses. While this is important, it misses the broader picture. Stranding risk isn’t exclusive to fossil fuels; it can affect any sector undergoing significant decarbonization pressures.

The concept of assets at risk broadens this perspective. It acknowledges transition-driven risks across various sectors, supply chains, and financial portfolios. Instead of being reactive, it promotes proactive engagement. Financial institutions can anticipate potential risks, identify assets at risk within their portfolios, and work collaboratively with entities to mitigate these risks.

This approach shifts the focus from risk avoidance to opportunity creation. By enabling financial institutions to engage with businesses and governments, they can drive the transition from "brown to green" through strategic financing and innovation.

Proactive Risk Management in Practice

Matt: You touched on this earlier, but could you delve into what a proactive, dynamic approach to managing assets at risk looks like in practice? Do financial institutions have the capacity to implement this today?

Natasha: Great question. Financial institutions already have many tools at their disposal, such as sectoral financing policies and climate-related stress testing. However, these tools need to be more comprehensive and inclusive of non-project-based financing, which represents a significant portion of financial portfolios.

Proactive risk management involves:

1. Broadening sectoral policies – ensuring they encompass all financing activities, not just project-related ones.
2. Enhanced risk assessments – evaluating the financial soundness and transition readiness of counterparties.
3. Whole-of-economy lens – assessing risks across all sectors, supply chains, and transition timelines.

For example, in the real estate sector, energy performance certificates (EPCs) provide insight into building efficiency and potential stranding risks. In agriculture, outdated infrastructure may become stranded as regulatory pressures grow.

By identifying assets at risk early, financial institutions can actively work with stakeholders to retrofit, repurpose, or retire assets in a managed and efficient way.

Quantifying the Magnitude and Timelines

Nawar: What’s the scale of this problem beyond oil and gas? Do we have any sense of its magnitude, and are we looking at near-term or long-term impacts?

Natasha: Quantifying the magnitude is challenging due to uncertainties and varying methodologies. Even within the fossil fuel sector, estimates of stranded assets range from $1 trillion to $185 trillion, depending on assumptions about transition speed and policy actions.

However, we can gain insights from related metrics. For instance, the European Central Bank's stress test revealed that 40% of Euro-area bank loan portfolios are exposed to energy-intensive sectors, highlighting the scale of potential risks.

As for timelines, risks are both near-term and long-term. For instance, the EU's Energy Performance of Buildings Directive targets a fully decarbonized building stock by 2050, with significant milestones along the way. Similarly, the automobile sector faces a 2035 deadline for phasing out internal combustion engine vehicles.

Final Thoughts: Regulatory Reform

Matt: If you had a magic wand to propose one regulatory reform to address assets at risk, what would it be?

Natasha: It would be establishing clear regulatory guidelines for assessing the transition readiness of counterparties. This would standardize how financial institutions evaluate risks and align their portfolios with decarbonization goals.

By providing clear parameters and expectations, regulators could help banks better assess transition risks and identify opportunities to support a just and efficient transition.

Matt: Natasha, this has been a fantastic conversation. Your paper is a must-read for anyone in the financial sector.

Nawar: Agreed. Thank you for joining us, Natasha. For our listeners, you can find more about ED4S at ed4s.org. If you’d like to connect with Natasha, Matt, or me, we’re all active on LinkedIn. Thanks for tuning in!