The assumption that the use of hydrocarbons will be limited by public policy to keep emissions below 450 parts per million is completely unrealistic.
The energy business is entirely familiar with the concept of stranded assets. Now, however, a new concept has been introduced: the idea that some assets, specifically hydrocarbons, will inevitably be stranded and left undeveloped as the world reduces its hydrocarbon consumption in order to avoid the risks of climate change. The question is whether investors and companies should be worried by that concept.
Across the world all sorts of resources are well identified but cannot be developed. They range from the gas underneath the Prudhoe Bay oil field in Alaska to the coal under North Yorkshire to the large reserves of shale oil in the Paris Basin. All these assets are stranded because of the costs of development, including in some cases regulatory costs imposed in pursuit of public policy goals. In the case of French shale oil and gas, all activity is banned. In some cases, people are working to find a way of bringing the resources to market. In others the only option is to give up and leave them buried.
The new concept, which was the subject of a conference in Oxford last week under the auspices of the Smith School of Enterprise and the Environment, introduces the idea that the category of stranded assets is about to be expanded dramatically as the world adjusts to limiting hydrocarbon use to levels that ensures global temperatures rise by no more than 2C. The level of danger is disputed, as is the precise amount of hydrocarbons that can be safely used — but the differences do not alter the basic thrust of the concept.
If the concept is correct, the amount of coal, oil and natural gas that can be safely used has already been discovered. Over time, through a mixture of fiscal and regulatory moves, hydrocarbons will be priced out of the market. On this analysis exploration is valueless, as are some of the resources already identified. The rest should stay buried and cannot be valued as corporate assets.
Is this logic correct? The debate is important, not just for energy policy but also for investors, because the implication is that the hydrocarbon-based businesses are entering their final decades and will soon cease to be viable as ongoing concerns. If you accept the thesis, unless the owners can swiftly produce the assets they hold, they are also overvalued.
Step back from the emotion of the debate on climate change and it is clear that this logic is correct onlyif you believe the three assumptions on which it is based.
The first is that the use of hydrocarbons will be limited by public policy action to keep total emissions within the prescribed limit.
The second is that alternative energy supplies will be available in time and at a low enough cost to enable consumers to switch away from hydrocarbons.
The third is that attempts to reduce the amount of emissions generated by the use of hydrocarbons – such as carbon capture and storage (CCS) – will not be viable on the scale required to allow continued hydrocarbon consumption. […]