New Types of Stranded Asset Risks

In the aftermath of the COP21 of last December, it is felt that for the Agreement on Climate Change to bear fruits, many things need to be looked after. Numerous think-tanks, researchers and investors debated the risks related to a low-carbon world economy.  These New Types of Stranded Asset Risks are, needless to say, as real for any part of the world as can be assessed at this stage.  The MENA region although being the location of the world’s main fossil oil production and reserves grounds, does with respect to Climate Change, know similar faith.  We have already touched on the matter shortly after the end of the Conference; i.e. "Judging the COP21 outcome and what’s next for climate action . . ." , please refer. http://www.mena-forum.com/16228-2/.

Chatham House, the Royal Institute of International Affairs published this article written by Alison Hoare, Senior Research Fellow, Energy, Environment and Resources and Eleanor Glover, Website and Digital Coordinator, Energy, Environment and Resources on 11 July 2016.

Paris Climate Agreement Brings New Types of Stranded Asset Risks

Governments and companies should plan now to navigate the potential for lost investment in the forest and agriculture sectors as climate action comes into force.

As countries and businesses seek to find ways to meet the emissions targets laid down in the Paris Agreement, it’s not only the energy sector that may find itself out on a limb, struggling with the prospect of stranded assets.

Usually associated with fossil fuels, stranded assets are investments made in a commodity that at some point down the line loses its economic value.  This can occur through physical impacts, like the recent El Nino-fuelled drought in southern Africa or rising sea levels, technological advancements, such as the hydrogen car, or regulatory changes, as countries implement low-carbon policies.

With global investment in agriculture and forestry increasing, new research from Chatham House finds that while there are significant regulatory and physical stranding risks due to climate impacts (and actions to mitigate               climate change), such risks are not being considered in national low-carbon development plans − or by investors.

Mark Carney, governor of the Bank of England, has highlighted the ‘tragedy of the horizon’; referring to the short-sighted five- to 15-year timeframe most investors are unwilling to look beyond. As the United Nations meets in New York this week to discuss the progress on the Sustainable Development Goals (SDGs), to be achieved by 2030, the financial community also needs to consider the effects sustainable development policies might have on their investments further into the future.

Regulatory risks

Efforts to achieve the SDGs – particularly in relation to food security, halting deforestation and taking action to mitigate climate change – together with the Paris Agreement, will increase the regulatory risks of stranded assets in the forest and agriculture sectors.

In Brazil, where the expansion of ethanol production is part of its emission reduction strategy, land competition between biofuels and food is likely to be exacerbated by physical climate impacts. It is estimated Brazil could lose 11 million hectares of cropland over the next 15 years due to changes in rainfall patterns and soil moisture. Such land competition may lead to asset stranding for investments in biofuel production as demand for food increases. External policy initiatives like the EU’s action plan on deforestation could affect the value of other agricultural commodities in Brazil, such as soy.

In Malaysia, there are a number of policies to promote economic transformation as well as reduce greenhouse gas emissions.  However, these ambitious strategies include some potential contradictions, and so their implementation is likely to be a challenge for the government. In particular, a failure to recognize the regulatory changes that could affect the palm oil sector in the future increases the chances of stranded assets. This will have implications for investors as well as the government, which may ultimately face many of the costs of stranding.

However, the financial implications of stranding, estimated to effect $6.3 trillion to $11.2 trillion worth of agricultural investments, should not deter regulatory efforts to combat climate change. Turning back on climate commitments would only exacerbate the physical climate risks and mean more drastic losses for investors and the planet in the long run.

Physical climate risks

Even if governments stay on track to meet the two degrees target laid out in the climate agreement,  major physical climate impacts will be inevitable, including rising sea levels and increased frequency of extreme weather events.  The Paris Agreement sets out a global goal to enhance adaptive capacity and highlights the importance of addressing loss and damage associated with climate change including through more comprehensive risk assessment, insurance and pooling solutions.

However, there is little evidence that these physical climate risks have yet been considered either by investors or governments.  For example, in Malaysia, sea-level rise is expected to inundate low-lying oil palm plantations in the next 20 years.  In Liberia, climate change is already affecting agricultural productivity. Given that future investments focus on perennial crops such as palm oil and rubber, physical climate risks should be high on the agenda of investors, but they aren’t.

With consensus on climate change now widespread, further research should be undertaken to look at how future climate impacts and mitigation strategies might create stranded assets in the forests and agriculture sectors.

An understanding of these risks is essential for governments and investors to design frameworks to manage these risks and lessen their impacts.  The Paris Agreement and SDGs could act as a springboard for further thinking in this area, as awareness of climate change among governments and investors is greater than ever.

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