Managing the risk from exposure to potential stranded assets
The Stranded Assets Working Group (SAWG) was formed in December 2013 and is comprised of investment professionals from the ESG Committee to assess risks associated with potential fossil fuel asset stranding. The purpose of the group was to provide guidance and tools for investment teams to integrate the assessment of these risks into their investment decision-making and ownership practices.
The SAWG assessment of the issues concluded that the risks are real, complex and potentially material to long term investment value. However, the SAWG also recognized that there are a number of related and sometimes competing forces which will manifest themselves in different ways for individual companies. This makes blanket top-down approaches ill-equipped to predict or manage the extent and speed by which these factors may impact individual fossil fuel (or related) investments.
In such situations there are a number of ways for investors to manage the risks and opportunities this complex dynamic presents. For example it is possible to identify and reassess the investment case for those companies who would be least resilient to changes in regulation or market demand. This would include companies who sit further up the cost curve and/or who lack the flexibility to transition their businesses to grow in a changing environment.
Stranded assets toolkit
To assist investment teams, the SAWG developed a framework for assessing company exposure to the issue and documented our assessment of best practice management based on a series of questions sent to a number of our fossil fuel holdings. Lastly we considered potential avenues and issues for engagement.
A key question for investors is which companies and assets will perform best over time? Our view is that the lowest cost operators with most operational and strategic flexibility are likely to be the most resilient.
In considering the likelihood and impact of these risks to the value of different fossil fuel assets, the SAWG developed a risk assessment toolkit to help analysts identify companies which are most exposed. The assessment process includes:
- Determination of the company’s baseline position both on the cost curve and in terms of relevant market and regulatory dynamics;
- Use of scenario analysis to test the company’s resilience to different emissions regimes by flexing commodity prices, costs and timelines;
- Assess the company’s approach relative to peers, including strategic management, capital allocation and incentives.
The different elements of the toolkit are highlighted in the diagram below:
Climate change and related issues will influence energy demand and use for decades to come. As stewards of our clients’ assets we have a duty to manage the risks and opportunities associated with these changes while deploying capital in line with our mandates. We believe the tool kit provides a good framework which, as the name suggests, can be incorporated in part or in full to strengthen existing investment processes.
We will continue to monitor this issue through the ESG committee will update the tool kit as the environment changes.