This chapter reviewed the literature on stranded assets. Section 2.1 presented a number of definitions of stranded assets. Section 2.2 looked at the reserve and capital assets at risk of stranding. It pointed out that keeping global temperature increases to within a 1.5 - 2°C threshold will place fossil fuel assets at risk of stranding, and that additional assets will be at risk of stranding if firms and governments incorrectly estimate the demand trajectory for fossil fuels, or if they attempt to transition too quickly. Section 2.3 argued that the long lifespans of some of the assets in the fossil fuel sector puts these assets at risk of stranding due to unexpected changes in market conditions. The section presented five factors that might cause market conditions to change: economic conditions, energy innovations, regulations and policy, financing conditions, and social norms. Section 2.4 discussed the potential theoretical and empirical effects from stranding. It was argued that asset stranding would affect both the firms whose assets are stranded and those that invest in and lend to these firms, as well as the economies where the assets are located and the economies where the affected firms raise their capital. Section 2.5 summarised the main claims of the stranded assets literature.
Although there is a large and varied literature on stranded assets, only a small number of papers have looked at the stranded assets issue using an economic model. In fact, as far as I am aware, as of May 2018, there are only four papers that present macroeconomic models that include stranded assets (Comerford and Spiganti [2017], Ploeg and Rezai [2016], and Rozenberg et al. [2014, 2017]). However, these papers do not investigate the economic effects of stranding that are discussed in much of the rest of the stranded assets literature – i.e. those parts that suggest that stranding will primarily affect the economy via its effects on the value of financial assets issued by fossil fuel firms (see Section 2.4). Neither Ploeg and Rezai (2016) (who use a general equilibrium model) nor
Rozenberg et al. (2014, 2017) (both using a Ramsey model) include any financial assets in their models. Instead, these papers utilise models that focus on the ‘real’ effects of stranding.
Comerford and Spiganti (2017) (who use a financial accelerator model based on Kiyotaki and Moore [1997]) do include a financial asset in their model. However, this asset is bank loans rather than equities or bonds. Thus, rather than stranding affecting the economy via its effect on equity or bond values, instead stranding is hypothesized to affect the economy via collateral values, which then limit the amount entrepreneurs’ can borrow (to finance green investment). While this is an interesting hypothesis, it is perhaps telling that this mechanism is not discussed elsewhere in the stranded assets literature. As a result, the models that have been used to investigate the effects of stranded assets (Comerford and Spiganti [2017], Ploeg and Rezai [2016], and Rozenberg et al. [2014, 2017]) do not investigate the main mechanism by which stranding is hypothesised to affect the
economy (as argued in the rest of the stranded assets literature) – that is, via their effects on companies’ market values.
There was also a stock-flow consistent (SFC) model on stranded assets being developed by Godin et al. (2017). However, I recently learned from one of the authors that there are some problems with the model that have significantly altered their results (this is why the paper is not discussed in this chapter). As such, the economic modelling of the causes and the macroeconomic and financial implications of stranded assets remains something of a gap in the literature. Filling this gap is the primary motivation for the research in this dissertation.
More specifically, the aim of this dissertation is to investigate the validity of the claims made by various parts of the stranded assets literature (as outlined in section 2.5) using an SFC model (see Chapter 3 for an introduction to SFC models). The claims from Section 2.5 can be distilled into a number of research questions, which can be further subdivided into three groups: i) research questions that relate to a transition to a low carbon economy; ii) research questions that relate to a change in market conditions; and iii) research questions that relate to both a transition to a low carbon economy and a change in market conditions. These groupings reflect the distinction in the literature between asset stranding that is caused by a transition to a low carbon economy versus asset stranding that is caused by a change in market conditions.
2.6.1 Research questions related to a transition to a low carbon economy
The stranded assets literature argues that asset stranding is likely to be influenced by the speed and the degree to which a transition to a low carbon economy is anticipated (see Section 2.2). As such, the research questions relating to different types of transition to a low carbon economy are as follows:
(i) Does the extent to which a transition to a low carbon economy is anticipated by fossil fuel firms affect the level of capital asset stranding that takes place?
(ii) Does the speed of a transition to a low carbon economy affect the level of capital asset stranding that takes place?
(iii) What are the economic and financial effects of different types of transitions to a low carbon economy and the stranding of capital assets these transitions bring about?
2.6.2 Research questions related to unexpected changes in market conditions
The stranded assets literature argues that the long lifespans of fossil fuel assets exposes these assets to risks from unexpected changes in market conditions, which can then lead to asset stranding. InSection 2.3 the various factors that might lead to a change in market conditions are categorised under five headings: economic conditions, energy innovation, government policy and regulation, financing conditions, and social norms. As such, the research questions that relate to changes in market conditions are as follows:
(iv) To what extent is the introduction of a carbon tax (i.e. a change in policy) likely to lead to the stranding of capital?
(v) To what extent is a change in agents’ preferences for purchasing securities from the fossil fuel sector (i.e. a change in financing conditions) likely to lead to the stranding of capital? (vi) To what extent is a change in banks’ preferences regarding the interest rate they charge
energy firms (i.e. a change in financing conditions) likely to lead to the stranding of capital? (vii) To what extent is an increase in the energy return on energy invested (EROEI) (i.e. a change
in energy innovation) in the renewables sector likely to lead the stranding of capital? (viii) To what extent is a change in households’ preferences for purchasing goods from the fossil
fuel sector (i.e. a change in social norms) likely to lead to the stranding of capital assets? (ix) What are the economic and financial implications of these changes in market conditions
and the stranding of capital assets these changes bring about?
2.6.3 Research questions related to a transition to a low carbon economy and a
change in market conditions
The stranded assets literature argues that an energy innovation (e.g. an improvement in storage technology) could lead to asset stranding by increasing the uses to which renewable energy could be put and the times at which renewable energy could be supplied (see Section 2.3). In addition, the stranded assets literature argues that asset stranding is likely to influence the broader economy through financial markets (see Chapter 2, Section 2.4). Given these arguments, it will be interesting to see how sensitive the answers to research questions (i) to (ix) are to different assumptions regarding: i) the ease of substitution between renewable and fossil fuel energy; and ii) the sensitivity of agents to the relative returns on financial assets. As such, the research questions that relate to both a transition to a low carbon economy and a change in market conditions are as follows:
(x) To what extent are the answers to research questions (i) to (ix) sensitive to assumptions about the degree of substitutability between different sources of energy?
(xi) To what extent are the answers to research questions (i) to (ix) sensitive to assumptions about the responsiveness of agents to the returns on financial assets?