Climate-related stranded assets: What businesses need to know

Stranded assets and climate action: Commercial context

International and national climate commitments made by governments, and the legislation, guidance, policies and practices which flow from them, have inevitable economic consequences for corporates.  As well as the direct costs associated with making changes to comply with the sustainability agenda, many businesses – and especially those operating within, or heavily reliant upon, the energy sector – will experience potentially significant indirect economic impact, in connection with stranded assets.

What are ‘stranded assets’?

Stranded assets are assets which suffer devaluation as a result of unanticipated changes in their risk profile.

In a climate-focused future, they are assets which may no longer come up to scratch in terms of sustainability.  They can lose significant value, or become unsaleable, worthless, obsolete, or even represent an expensive liability.

Stranded assets are likely to become an increasingly significant consequence of climate action.  In this horizon-scanning article, Walker Morris’ Infrastructure & Energy and Commercial Dispute Resolution specialists Ben Sheppard and Nick McQueen highlight key legal and commercial considerations, and offer practical advice for businesses.

What do businesses need to know about climate-related stranded assets?

Some commentators have suggested that governments which enact climate legislation risk litigation, potentially worth trillions of dollars, being brought by businesses seeking compensation for fossil fuel-related lost revenue and stranded assets.

That might sound overly dramatic, but changes to the physical environment caused by climate change, and the international community’s response to those changes – including the speed of transition to green energy and the sustainability agenda more broadly – mean that significant asset stranding is already taking place in certain sectors.

A working paper published by the International Renewable Energy Agency [2] noted, back in 2017, that the buildings sector was already the most affected by energy transition-related stranded assets.  That’s in large part because the low turnover rate of buildings means that the vast majority of stock doesn’t meet modern sustainability standards.  Efforts and initiatives to upgrade and retrofit existing building stock from an energy efficiency perspective will not yet have reached sufficient levels to redress that situation.  (The situation will not have been improved, in recent years, by the impact of Covid and international supply chain difficulties.)  Other sectors already suffering significant climate-related stranded assets include upstream energy, power generation and industry/heavy industry.  Indications [2] are that the agriculture, transport and finance sectors are also beginning to be affected.

Various climate-related factors can lead to assets becoming stranded, including legislation and regulations which limit the use of fossil fuels, changes in consumer demand, and even litigation and/or lobbying which results in changed corporate policies, practices and products.

Climate-related stranded assets: What are the risks to businesses?

Potential commercial risks associated with stranded assets are several-fold.  Governments, regulatory bodies and/or corporates which implement climate-related legislation, regulation, policies or practices may face claims, and potentially litigation, from businesses whose assets become stranded as a result.  Businesses whose assets become devalued and/or obsolete face financial and operational impact. Investors and insurers may face consequential losses and claims.  Counterparties to affected businesses may have to source alternative energy solutions, products, practices or prices, and may seek to renegotiate or terminate contractual arrangements as a result.  Professional negligence claims may ensue where stranded asset owners believe failings in due diligence resulted in overvaluations and over- or imprudent investment.  In extreme cases, businesses may face insolvency and even entire industries or regions could become stranded, leading to wide scale impacts on investment strategies and liabilities.

It’s happening already.  For example, in 2020, Exxon reportedly wrote off up to $20 billion in natural gas holdings and its subsidiary, Imperial Oil, shelved a gas exploration/development project worth some C$1.2 billion.  A number of energy and exploration companies, including Germany’s RWE and Uniper and the UK’s Rockhopper, are suing 4 European governments over the stymying of coal, oil and gas projects. The claims, seeking compensation of around €4 billion, revolve around governments’ decisions to mandate the closure of coal power plants, prevent the development of specific projects, or require an environmental impact assessment. Another case, for an unknown sum, has been brought against Romania by Austria-based Petrochemical Holding over a petroleum development contract. In 2021, the International Institute for Sustainable Development reported that most of these types of claims are settled, for an average of $600 million, in favour of the energy company claimants.

The UN’s Global Climate Litigation Report 2023 Status Review, published on 27 July 2023, notes that climate litigation cases more than doubled from 884 in 2017 to 2,180 in 2022.  Stranded asset-related claims (which that report refers to as ‘backlash cases’) represent a significant proportion of ongoing climate litigation.  They’re one of the key types of climate claim that are expected to substantially increase in number in the short to medium horizon.

Practical advice

Businesses likely to have climate action-related stranded assets, or counterparties whose operations and/or supply chains are reliant upon those businesses, will be well-advised to start thinking about how they can mitigate any adverse economic impact.

Businesses can:

• Review their investments, operations, supply chains and contractual arrangements with a view to stress-testing for reliance on assets which could become stranded as a result of climate action and/or for other environment-related risks. (Over-reliance on counterparties with insufficient sustainability credentials could be one such risk.)

• Review insurance policies – both existing and new/future policies – to ensure that asset stranding, associated financial risk and losses, and other physical and tangential risks associated with climate change and climate action, are covered.

• Review and critically assess due diligence and professional advice associated with investment in assets which are at risk of climate-related stranding.

• Consider divestment: selling assets ahead of time and/or renegotiating contracts to incorporate termination flexibility and/or more favourable payment terms wherever there’s a potential climate action-related risk.

• Allocate future investments and contracts, and aim to engender future operational resilience, by consideration of ‘green indices’ (that is, scoring according to an index of sustainability performance metrics [3]).

• Consider lobbying (through involvement in industry bodies, committees, public hearings, consultations, and the like) to help shape the development of environmental policy. An orderly transition to a low carbon future is less likely to result in significant asset stranding than too swift a switch.

• Seek specialist advice as to the risk of climate action-related asset stranding and associated losses, the quantification of any such losses, and whether there’s scope for bringing claims to recoup.

Stranded assets and climate-related risks:  How we can help

Walker Morris is a multi-disciplinary commercial law firm, with specialist lawyers experienced in infrastructure and energy, environmental issues, commercial contracts, corporate- and climate- reporting, energy disputes, commercial dispute resolution and all aspects of the sustainability agenda.  We can work with businesses at every step of their journey to create, implement and deliver an effective sustainability strategy.  That includes advising on risks and mitigation strategies associated with climate action-related stranded assets.

In particular, we can:

• Keep clients up-to-date on legal and regulatory developments associated with climate action and other climate action-related risks

• Undertake audits and contract reviews and draft/update policies, procedures and contracts from a sustainability perspective

• Advise clients in respect of sustainability strategies and responsibilities generally, including climate-related corporate reporting

• Help clients to secure ‘green finance’ or other responsible investments

• Provide commercially-focused, cross-disciplinary advice and transactional assistance in relation to climate-related stranded assets

• Advise on the merits and quantification of stranded asset-related claims and/or other types of climate litigation

• Provide risk management and effective dispute resolution strategies in connection with any stranded asset or other infrastructure or energy-related issues or investigations.

For further information, training or tailored advice, please contact Ben Sheppard or Nick McQueen.

[1] See, for example: this France 24 bulletin; this Lloyds of London and Smith School of Enterprise and the Environment at the University of Oxford report; this nature climate change research briefing

[2] Climate Financial Risk Forum guide December 2022

[3] Such as: FTSE4 Good Index Series, Nasdaq Green Equity Indexes Series