Stranded Energy Assets: Definitions, Speculations, Fears, and Realities

Stranded Energy Assets: Definitions, Speculations, Fears, and Realities

Definitions

Stranded assets can be defined as:

“assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities.”

A stranded asset can be any asset that is underperforming or considered obsolete. Asset impairment is an inherent part of business accounting and so is always a consideration, particularly with long-term investments, technological changes, and fluctuating markets.

The International Energy Agency (IEA) has defined stranded assets as:

“those investments which are made but which, at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return, as a result of changes in the market and regulatory environment.”

With the advent of myriad 'disruptions' in many industries it has been demonstrated that various 'formats,' 'platforms,' and ways of doing things may be unstable if new technologies come along that are more efficient, more applicable, and favored by customers. In energy it is not so simple since most methods of producing it have long been R & D'd extensively. With the specter of carbon pricing looming and the incremental improvements in renewable energy and energy storage technologies it is only a matter of time before various forms of parity or near-parity with fossil fuels is attained.

However, the biggest question is how much time it will take until parity is attained with limited subsidy. It may take several decades. Indeed, time frames are the major factor in determining viability and reducing the possibility of an asset becoming stranded. In terms of large new offshore drilling projects the time-frame is typically a decade. Such projects could become stranded if they are no longer needed due to supply of other energy sources or no longer economic due to increased carbon prices. Grid transmission lines are another potential source of stranded assets if utilities build them and they end up not needed due to less demand than anticipated. Such demand reduction could be caused by efficiency increases at all levels, unforeseen increases in renewable and other distributed generation, or less usage due to higher electric prices. Over-build of gas and oil pipeline systems is another potential source of stranded assets.

The Carbon Bubble and Hedging Against Stranded Assets

As mentioned above in the IEA definition – both the market and regulations can influence stranded assets. There may also be political and geopolitical factors. Environmentalists may often refer to the idea of the “carbon bubble” where high carbon energy sources are overvalued because their carbon emissions liabilities have not been taken into account. This could devalue fossil fuel companies considerably since carbon pricing would make them less competitive. Such overvaluation could also threaten economies. However, this is not likely until clean energy sources, battery storage, and grid integration of those sources achieve parity with fossil fuels and do so with less subsidization. Environmentalists, like the more radical Bill McKibben (who promoted the idea), often site the carbon bubble as a reason to keep fossil fuels in the ground. What they don’t seem to get is that identified fossil fuel reserves are graded by economic viability and that economic recoverability is dependent on price. The amount of economically recoverable reserves are always shifting as prices shift. If clean energy does eventually become cost competitive the economically recoverable fossil fuel reserves will shift to those that are cheapest to produce. While there may be significant devaluation of some amount of fossil fuel companies at some point in the future it is not likely to happen all at once and deflate the economy. Big energy companies have long been aware of the stranded assets issue and can hedge against it in various ways: by investing in clean energy (France’s TOTAL just invested in battery maker Saft after investing in SunPower back in 2011), by avoiding and reducing investments in long-term and/or marginal projects, and by planning for the effects of carbon pricing. While TOTAL’s recent investment was branded as a means “to diversify the company’s revenue away from highly volatile oil prices,” it could also be seen as a way to hedge against the possibility of future low oil prices caused by decreasing demand due to efficiency, more renewables and future carbon pricing. Oddly enough, this hints that Big Energy companies and other fossil fuel companies could shift towards investments in renewable energy technologies as they become more viable and economic as a hedge against stranded assets. Thus, just as TOTAL had a controlling interest in SunPower, oil companies could come to control more green energy companies. In the past, most oil company involvement in green energy was with research and development and this has been cut back as those technologies have not yet become anywhere near economically viable. Several Big Oil companies have called for carbon pricing as a way to increase predictability in future markets. This would better define what assets they have are likely to become stranded, allow them to do better long-term planning, and adjust their business models accordingly. 

Delayed or Temporarily Stranded Assets

Midstream oil and gas build-out, for big pipelines  is typically a 2-4 yr deal but these days has been closer to the longer end of the range due to organized public opposition and more environmental scrutiny on the regulatory side. This could lead to temporary local gas shortages with corresponding price spikes. This would be an example of a temporarily stranded asset that is temporarily undervalued as has been the case for about 4 or 5 years with Appalachian natural gas. In the case of Appalachian gas the infrastructure upgrades are in process to relieve the gas glut so the gas is expected to increase in value as market access increases demand. Thus, these assets are not stranded, just delayed from being fully sold. Another example of temporarily stranded energy assets might be oil, gas, or coal reserve write-downs due to low prices. With the knowledge of cyclicity, supply and demand, and predicted higher future prices, such write-downs are typically seen as temporary.

Coal Power Plants: A Big Stranded Asset Liability Now 

Coal-burning power plants are probably the biggest stranded energy asset liability since they are the most carbon intensive power project and in addition they take longer to build (~4-5 years) than a gas power plant (~3 years). The World Bank no longer participates in their financing nor does the U. S. government. However, carbon sequestration projects in existing coal plants that are not slated for near-term shut-down could extend the lives of some of the current coal plant assets. While cheap coal is still quite competitive in Southeast Asia and there are still plants being planned and built this growth is not likely to continue long-term.

Upgrades, Payouts, and Predicting Future Technologies

In another sense, the stranded asset problem is similar to the upgrade issue: as a product or process is upgraded to become cheaper, more efficient, more useful, and less polluting/CO2 emitting, that leaves existing systems stranded. Thus there is a risk in improper timing of implementation of a system in stranding it. I know of one case where a power system operator of a university-sized power system favored a transition from coal to gas turbines without adding combined heat and power (CHP)/cogeneration because he thought that the added costs would amount to a stranded asset as improvements in renewable energy became available in the coming years. CHP can be very efficient when sized properly and lead to significant additional decreases in greenhouse gas emissions and pollutants. However, the payout would have been longer than the system chosen. Though I don’t know the details I suspect he would have been better off with the CHP system but was tainted with clean energy hopes and anti-fossil fuel bias. Time will tell. I know of another university project with similar circumstances where CHP was chosen so perhaps the data of these two should be compared over the next decade.

In terms of products, stranded assets means less efficient use of the product as it is discarded prematurely for a newer and better product. Thus the risk of stranding assets can be thought of as a fairly common business risk. However, in terms of multi-billion dollar energy projects this can be catastrophic. I think one of the reasons Shell abandoned Arctic exploration was to cut their losses amid the possibility of a major stranded energy asset. In that case part of the stranding would have been political in addition to the overall cost and very poor market conditions at the time. Thus political and geopolitical factors also need to be considered in preventing a stranded asset.

Investors are currently quite aware of the possibility of stranded assets and so may be wary of investing in certain projects where that is a risk. Stranded assets have thus been tagged as significant investment risks, particularly for multi-billion dollar long-term energy projects. Thus stranded asset potential analysis has become a standard part of evaluation of such projects.

The Possibility of Stranded Liabilities

Another type of stranded asset, though not an asset in the strict sense, would be the risk of stranding a ‘brownfield” cleanup project. In energy this would refer to companies going bankrupt and abandoning responsibilities for cleanup, mine reclamation, plugging of abandoned wells, etc. In terms of environmental value a reclaimed energy site would be considered to have ecosystem value over and above one that is not reclaimed. Thus it would also be considered an environmental/ecosystem asset. Such abandoned brownfields have also been implicated in a few catastrophic environmental events such as the failure of long-abandoned mine wastewater containment, polluting the river in Colorado recently when the EPA was working with it. Similar dangers exist with other very old mine works. From an industry perspective, reclaiming sites and plugging wells are liabilities that must be considered. States require bonding as proof of intention to deal with such liabilities. In coal mining states there is self-bonding which allows companies to post their assets as collateral on future reclamation costs. Companies are granted self-bonding status based on their financial health. There is currently some concern whether self-bonded bankrupt companies will be able to meet legal obligations for reclamation. Some of these bankrupt coal companies are among the largest in the world. Some states have been requiring replacement bonding while others have kept self-bonding and there is disagreement about whether self-bonding is fair.

References:

Concerned About Self-Bonding, Top Federal Mining Regulator Wonders about Collusion – by Benjamin Storrow, in Casper Star Tribune, May 18, 2016

Stranded Asset, entry at Wikipedia.com

Redrawing the Energy-Climate Map: World Energy Outlook Special Report – by International Energy Agency (IEA), June 10, 2013

Oil Giant TOTAL to Acquire Battery Maker Saft for $1.1 Billion – by Eric Wesoff, in Green Tech Media, May 9, 2016

Carbon Bubble, entry at Wikipedia.com