Warning for investors, not just environmentalists, in fossil fuel spending: Don Pittis

It is no surprise when committed environmentalists scoff at new investments in pipelines and oilsands. But a new study indicates that self-interested investors should also be wary.

As the Canadian Association of Petroleum Producers announces a $50 billion drop in Canadian oil and gas investment, the new research raises concerns about the valuation of any future investments, saying they may not last long enough to pay off.

• Investment in Canada's oilpatch expected to plummet by $50B
• Junior oil sector hit hardest amid downturn

The report, published in the academic journal Applied Energy, does not focus directly on pipelines or oilsands development. Instead, it addresses electrical power plants driven by fossil fuels.

Extending stranded assets

The innovation of the report, however, is to extend the concept of "stranded assets" beyond fossil fuels still in the ground. It says they now include the plant and equipment used to turn those resources into energy used by our economy.

The stranded-assets concept has been widely discussed by the financial industry, including by Bank of England governor Mark Carney, in regard to the fossil fuel industry.

The idea describes how companies, and potential investors in those companies, should assess the value of corporate reserves of coal, oil and gas.

If extracting those assets would seriously damage the world — flooding trillions of dollars worth of coastal land, for instance — then it is completely unreasonable for a company to calculate the value of proven reserves in the traditional manner. It will never be permitted to extract them.

High and dry?

To clarify, it might help to move away from the oil and gas industry.

Imagine if, as well as its cash in the bank, its office buildings and its factories, a company had on its books $1 billion worth of asbestos that had not yet been mined. The company can borrow against all those assets, and the assets represent the company's future income stream.

Now imagine that changing health concerns mean that most of that asbestos may never be mined or exported. The asset still exists, it is still being mined, but for the purpose of valuations, most of that asbestos is stranded underground for the foreseeable future.

No smart investor is going to lend the company its money using that $1 billion worth of asbestos as collateral.

Coal already suffering 

The analogy to the coal industry has already become apparent. China and many other places are sharply reducing the use of coal. The world's enormous underground coal reserves have been slashed in value.

The innovation of this brand new analysis published by academics from the Oxford Martin School  and the Smith School of Enterprise and the Environment, both at Oxford University, is that it expands the stranded-assets concept to include what economists call capital. That's the human-made part of energy company assets.

"Investors putting money into new carbon-emitting infrastructure need to ask hard questions about how long those assets will operate for, and assess the risk of future shutdowns and writeoffs," says Cameron Hepburn, one of the academics involved in new study.

The hard questions investors face include whether the investments will pay off. 

The study discusses electricity generating plants but, as Hepburn says, the same thing applies to any other energy investment.

Payback time

Like power plants, pipelines and new oilsands operations take decades to earn back their initial investment costs. If the investor is sure the stream of future income is secure, the investment is well worthwhile. 

But the Oxford researchers calculate that for the world to limit climate change to 2 C as agreed at COP21 in Paris, many planned new energy developments cannot go ahead. Or, if they go ahead, other existing projects will have to be shut down.

The researchers say at the current pace, new investment will hit that cutoff level in 2017.

"If the 2 C target is to be taken seriously, then current and future assets will have to be written off before the end of their economically useful life (become stranded assets) or we will have to rely on large-scale investments down the line in carbon capture and storage technologies that are as yet unproven and expensive," says the report.

Some of the proponents of Canadian pipeline and oilsands investments reject the climate change argument. For investors considering whether to invest, whether climate change is true or not really doesn't matter.

For their own financial benefit, what investors must consider is whether the climate risk has been properly calculated into the future income stream.

If investors in power plants, pipelines and new oil development go ahead without proper regard to climate risk and find those assets stranded, they will be worth less than advertised.

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​More analysis by Don Pittis