The UK economy is disproportionately exposed to stranded fossil fuel assets, with potential losses for UK pension savers reaching tens of billions of pounds by 2040, according to the latest report from the UK Sustainable Investment and Finance Association (UKSIF), in collaboration with Transition Risk Exeter (TREX).
The analysis – Stranding: Modelling the UK’s Exposure to At-Risk Fossil Fuel Assets – traces the complex web of financial ownership of fossil fuel assets and tracks the exposure of end beneficiaries – such as individual investors, pension funds and governments – to the risk of these assets becoming ‘stranded’. This refers to oil, gas and coal reserves, along with associated infrastructure and investments, that lose economic viability before their expected operational lifetimes as a result of climate policies, technological changes, or shifting market conditions.
Based on current green transition policies, mid-term action plans to cut emissions and long-term net zero targets, the report found global economic exposure to fossil fuel asset stranding risk amounts to $2.28trn by 2040 – of which the UK’s exposure is calculated at $141bn.
Also read: Are investors ‘playing both sides’ by not forming exit strategies from fossil fuels?
UK pension funds are significantly exposed to asset stranding risk. Of the approximately £88bn in fossil fuel assets held by UK pension funds, around £15.2bn ($19bn) is at risk of stranding by 2040 if current policies and pledges are fulfilled. As a proportion of the total £3trn UK pension pot, this amounts to a 0.5% stranding. However, as a proportion of the UK’s projected £113bn ($141bn) economic loss, this constitutes a 13% share.
TREX and UKSIF’s modelling also shows the UK financial system overall faces a disproportionately high exposure to stranded asset risk, relative to the country’s global GDP share and population size, coming in at number four in a list of the most exposed countries to stranded asset risk for ultimate owners after the US, Russia and China.
However, given as a proportion of the population, the UK is the ninth most exposed country globally – more exposed than both the US and China – and the second most exposed country in the OECD, after Norway. This means that projected losses felt by individual savers – either as devaluation of savings or as distributed impacts on the UK economy – will be more severe per person than in other countries with less exposure, equating to £2,595 per working adult.
Dr Phil Holden, senior lecturer in earth systems science at The Open University, commented: “The scientific community has long warned that fossil fuels must be rapidly phased out to avoid the most drastic impacts of climate change. But the accelerating transition, powered by increasing economic advantages of renewables, is creating a new urgency – to rapidly divest from exposure to fossil fuels.
“This report finds that global fossil fuel stranding risk has almost doubled from $1.4trn to $2.28trn over the last five years. This problem is becoming worse by the week. Oil and gas exploration may appear attractive in the short run, but the longer extraction remains misaligned with the global decarbonisation trajectory, the more dramatic the economic realignment needed.”
Mitigating stranded asset risk
In order to help mitigate this risk, UKSIF identified four priority areas in which UK asset managers, asset owners and policymakers must work together to offset stranded asset losses while continuing to drive a controlled transition away from fossil fuels.
Policymakers are urged to capture international investment by addressing systemic investment barriers around planning rules, grid connectivity and energy market reform to determine how much of the world’s increasing transition investment the UK can capitalise on. Supporting growth industries of the future, such as renewable energy, and redressing skills gaps in strategic growth areas could also allow the UK to attract greater green investment and capitalise upon its climate leadership through long-term job creation and economic growth, UKSIF argued.
Long-term sector decarbonisation strategies “can provide investors with clarity” and allow the UK government to offer targeted support for industry segments in which the UK can excel, increasing the UK’s competitiveness in global markets, the Association added. For example, the government “should deliver on its commitment to publish an ambitious long-term decarbonisation plan for freight, with a focus on HGVs and larger vehicles”.
Meanwhile, a clear and credible regulatory framework to support sustainable finance and transition finance “will be critical for an orderly green transition”. Requirements for all large financial and non-financial companies to disclose and then implement climate-related transition plans in line with the Transition Plan Taskforce’s framework “would provide essential data for all financial market participants to make more informed sustainable investment decisions”.
Additionally, asset owners and managers “should enhance not only their corporate engagement but also their engagement with wider actors”, including governments, regulators, and international standard-setting bodies, to help ensure a more enabling policy environment for net zero, UKSIF argued. As per its response to the recent UK Stewardship Code consultation, UKSIF said it believes that maintaining a robust definition of ‘stewardship’ and high-quality reporting requirements is critical to the long-term effectiveness of UK stewardship practices.
“With asset stranding presenting a material risk to the long-term health of the UK economy, including the retirement savings of millions of people, it is clear that a carefully controlled transition away from fossil fuels is both an environmental and a financial imperative. Too many oil and gas companies are betting on demand that will not materialise in a decarbonising world, and the public are at risk of paying the bill,” UKSIF chief executive, James Alexander, said.
“The surest way to offset the risk of losses posed by stranded assets is to invest in industries that will thrive as fossil fuels decline. The UK government must demonstrate global climate leadership by implementing ambitious decarbonisation policies and fostering investment in the growth industries of the future, like renewable energy. Together, the coordinated efforts of investors and policymakers can meaningfully mitigate stranded asset risk while also ensuring that the UK plays a leading role in the global green transition.”
