In a new paper, researchers have traced the equity ownership of 43,439 oil and gas production assets through a global network of 1.8 million companies to their ultimate owners. They concluded that the present value of future lost profits on those assets in the upstream oil and gas sector exceeds US$1 trillion. These are considered ‘stranded’ assets, because of the change in expectations on the present value of discounted future profit streams.
These findings pose a huge risk to institutional investors such as pension funds and financial markets - the ultimate owners of these assets according to the research - most of whom are in the OECD countries. This risk is greater than first appreciated, not only because these assets have shorter commercial life due to the transition to net zero, but also because of the liability risk their premature loss of economic value may pose to institutional investors.
Is this transition risk overstated? The International Energy Agency, for instance, suggests that the transition to net zero is proceeding too slowly to reach the 2050 net zero target. On the other hand, the transition is in many ways occurring much faster than first expected, with China connecting more offshore wind capacity to its national grid in 2021 alone than the rest of the world added in the last 5 years. Such acceleration should be of concern to institutional investors given that it will shorten the economic life of many of the ‘stranded’ assets identified in the research.
Given the increased understanding of where these high-risk assets are located combined with the current trajectory of the energy transition, climate litigation against the holders of these ‘stranded’ assets - the institutional investors in OECD countries - is likely to increase.
To date, we have seen very few, sporadic actions against institutional investors. In November 2020, a settlement was reached in the Australian case of McVeigh v. Retail Employees Superannuation Trust where a pension fund subscriber argued that the pension trustees had breached their duties in failing to sufficiently manage climate risk in their investments. Under the terms of the settlement, the trustees agreed to align their investments with the Paris Agreement and adopted a target of net zero by 2050. More recently, in an English case of McGaughey et al v Universities Superannuation Scheme Limited, members of the scheme brought a derivative claim (among other claims) against directors for allegedly failing to divest from fossil fuel investments. This was argued to be a breach of the directors’ duty to promote the success of the company given the financial risk of these investments. The court refused permission for the claim to proceed, but that decision is to be appealed.
Nevertheless, the findings of the new paper combined with the speed of the energy transition increase the risk of climate litigation against institutional investors who continue to hold or be economically exposed to assets that are potentially stranded.
We calculate that global stranded assets as present value of future lost profits in the upstream oil and gas sector exceed US$1 trillion under plausible changes in expectations about the effects of climate policy. We trace the equity risk ownership from 43,439 oil and gas production assets through a global equity network of 1.8 million companies to their ultimate owners. Most of the market risk falls on private investors, overwhelmingly in OECD countries, including substantial exposure through pension funds and financial markets.