Stranded Assets and the Carbon Bubble

How fossil fuel reserves, power plants and other assets could lose value as the world shifts to clean energy, and why investors and regulators care.

Stranded assets are investments that lose value earlier than expected because of changes in the market, technology or regulation. Climate change and the shift to clean energy could strand many fossil fuel assets.

The carbon bubble

In 2011, the think tank Carbon Tracker argued that if the world limits warming, a large share of known fossil fuel reserves could not be burned. Companies’ valuations, however, assume these reserves will be extracted and sold. If they cannot be, the value of fossil fuel companies may be overstated, a carbon bubble. Research published in Nature in 2015 estimated that, to limit warming to 2 degrees, around a third of oil reserves, half of gas reserves and over 80 percent of coal reserves should remain unused.

What could be stranded

Oil, gas and coal reserves that cannot be burned.
Coal power plants retired early as renewables become cheaper.
Petrol car factories and supply chains as electric vehicles spread.
Property in areas exposed to flooding or sea-level rise.

Transition risk

Financial regulators describe transition risk: losses from the shift to a low-carbon economy, such as sudden policy changes or technological disruption. They also describe physical risk: losses from climate damage itself. Central banks and regulators, including through the Network for Greening the Financial System founded in 2017, have run climate stress tests to see how banks might be affected.

Disclosure

To help investors judge these risks, many countries now require or encourage companies to disclose climate-related risks, building on recommendations from the Task Force on Climate-related Financial Disclosures published in 2017. India’s securities regulator SEBI introduced business responsibility and sustainability reporting for large listed companies.

A young coal plant

A new coal power plant is built expecting to operate for 40 years. After 15 years, cheaper solar and wind, carbon prices and pollution rules make it uneconomic, and it closes early. Its remaining value is lost. Investors who assumed decades of profits face losses, and lenders may not be repaid. That is a stranded asset.

Thinking only fossil fuel companies face climate risks

Banks, insurers, pension funds, property owners and many industries are exposed to transition and physical climate risks. That is why financial regulators treat climate change as a financial stability issue.

Key takeaways

Stranded assets lose value early due to market, technology or policy changes.
The carbon bubble idea suggests fossil fuel reserves may be overvalued.
Research estimated most coal and large shares of oil and gas must stay unused to meet 2 degrees.
Regulators address transition and physical risks through stress tests and disclosure.