Europe’s Stranded Assets: Cautionary Tale for Global Investors

By Emil Dimantchev

Last week Europe’s second largest utility, RWE, announced plans to close several fossil fuel-power plants, with a combined capacity of 3.1 GW. The German utility followed similar moves by rivals E.ON and EnBw, which had announced closures of fossil fuel-power capacity earlier this year. Its power plants had become unprofitable to operate due to competition from renewables - testifying to the way policies to reduce carbon emissions can leave fossil fuel assets "stranded."

Stranded assets are ones which suffer from unanticipated or premature write-offs, downward revaluations or are converted to liabilities. Traditionally, assets become stranded due to an unexpected change in their market environment. The shale gas revolution in the U.S. is one example that has affected the viability of coal mines across the country. More recently, however, an emerging risk for investments with exposure to CO2 emitting assets is the introduction of climate change legislation.

In this respect, the European Union, and Germany in particular, are a case in point. In 2008, the EU enacted legislation, which committed it to generating 20 percent of its electricity from renewable sources by 2020. In Germany, the renewable share must be 35 percent by 2020. Berlin has been offering additional support to renewable development through the implementation of feed-in-tariffs in 1990. The resulting growth in renewables has increased the overall supply of power in the German electricity market. Combined with the effects of the Europe’s financial crisis, the growth in renewables has depressed German power prices, and pushed many fossil fuel power stations out of the money.

The unprofitability of conventional power plants in a market with increasing shares of renewable energy is leaving a dent in companies’ share prices. RWE’s shares (which have also been negatively affected by Germany’s nuclear moratorium) have fallen 78 percent since their January 2008 peak. E.ON’s shares have shared largely the same faith. In comparison, the German equities index has now recovered to levels higher than its 2008 peak.

RWE’s stranded assets represent a small part of a potentially much larger “carbon bubble,” according to the Carbon Tracker Initiative. The researchers assert that oil and gas reserves are at risk of being overvalued and could become unusable if world governments ramp up climate change policies. In a global warming scenario of an increase of 2°C, 60-80 percent of fossil fuel reserves owned by publicly listed coal, oil and gas companies and their investors would become stranded.

Keeping global warming below 2°C might seem far-fetched, given that carbon pricing currently only cover 7 percent of world emissions. The energy sector, however, is already seeing assets become stranded due to competition from renewables, enhancing the case for factoring broader environmental factors in investment decisions.

Now let’s hear from you: Have you observed or been impacted by stranded assets in your industry due to climate change?

Emil Dimantchev is a carbon market analyst at Thomson Reuters Point Carbon. The views expressed in this article are his own, unless stated otherwise. Follow Emil here: https://twitter.com/EDimantchev

Image credit: Santa Cruiser, Flickr