Stranded oil assets?: Not a simple yes or no

A stranded asset is definitely an investment that is obsolete before the end of their useful life, creating a financial loss for an investor who decided to learn.

With the prospect of disruptive technologies like planet, and tougher GHG policies targeted at curbing using hydrocarbons, some reason that today’s oil reserves turn into tomorrow’s stranded assets. Is that this a realistic view?

Like all contentious questions about the near future, the answer is not a simple “yes” or “no.”

There are numerous variables at play, which suggest that inside a lower carbon scenario some oil barrels is possibly stranded C notably people with high carbon intensity, high cost and long payback periods.

Conversely, oils that are of top quality, inexpensive and also have short payback periods, are not likely to be stranded C actually, they could be advantaged and deliver attractive investment returns in the long run.

From the outlook during global warming policy, the International Energy Agency (IEA) has put forward a potential scenario (the 450 Scenario) in which the atmospheric carbon concentration is held to less than the critical 450 parts per million (ppm) C the level required to prevent a temperature rise in excess of 2 Celsius long-term.

The 450 Scenario assumes radical and quick changes in how society sources energy, together with a drastic stop by the use of coal, a slower pace of natural gas growth, more renewable energy, expanded utilization of carbon capture and storage, strict efficiency standards, along with a renaissance for nuclear power. For oil consumption, the 450 Scenario assumes that demand drops steadily by 20 per cent to 74 MMB/d by 2040.

The 450 Scenario is not the IEA’s central scenario. At this point, government policies to limit GHG emissions aren’t stringent enough to stimulate this level of change. However, for discussion purposes let’s make use of the IEA’s 450 Scenario to look at the question of stranded assets in oil investing. Would some oil reserves be “stranded” underneath the IEA’s scenario of demand reversal?

Figure 1 shows the road of global oil demand under the IEA’s 450 Scenario, which we have split into two wedges. The very first wedge, legacy oil, is oil that’s created from today’s existing oil wells and can still produce into the future at an assumed decline rate of six per cent. This oil is unlikely to be stranded since the energy production is a sunk cost, and the projects only have to cover their variable costs to keep operating.

The second wedge is all from the additional oil which must be produced to offer the IEA’s top line demand estimate. A considerable amount of new oil projects must be developed to offset the almost 80 percent reduction in legacy production by 2040. This continued need for new oil projects for the next few decades and beyond means that the majority of the worth of oil reserves on the books of public companies should be realized, and will not be “stranded”.  

While many of these reserves is going to be developed, could any portion be stranded within this scenario? The answer is surely “yes.” In almost any industry a subset of the inventory that is comprised of inferior products will be susceptible to being marginalized when there is declining demand for goods. Inside a 450 ppm world, inferior products in the oil business is going to be defined by higher cost and better carbon intensity.

A more interesting real question is whether the IEA’s 450 Scenario C if achievable C creates an opportunity for some oil producers? It appears counter-intuitive that the oil producer will have a competitive advantage in a lower carbon world, but take into account that not every crude oils are equal within their carbon intensity.

In reality, some oil types create three-to-four times less co2 within the extraction phase compared with their higher carbon counterparts. And for refining into light transportation fuels, some crude oils generate one-third as numerous GHG emissions as others.

In the 450 Scenario, the crude oils with smaller GHG footprints won’t be stranded. On the contrary, they ought to benefit from lower costs and much more demand for their products when compared with higher carbon competitors. To help separate the wide variation in different crude oils, as well as their carbon intensities, ARC Financial released a study in February – Crude Oil Buying a Carbon Constrained World C that puts forward a method for estimating the GHG footprint of any oil development.

The IEA’s 450 Scenario in Figure 1 is useful for testing strategy and reducing oil investment risk. Even just in a scenario of declining oil demand, the relentless stop by legacy production guarantees that new oil investments is going to be required to feed long-term oil consumption. Although not all oil reserves will have equal opportunity for development in a lesser carbon world.

This is the same as every other industry facing a slower pace of growth C the cheapest cost producers is going to be advantaged, and the expensive projects with inferior products are most prone to being “stranded.” The oil industry is exactly the same.

Jackie Forrest is Vice President of Energy Research at ARC Financial Corp., Canada’s largest energy-focused private equity finance manager. At ARC, Jackie accounts for actively monitoring emerging strategic trends associated with Canadian oil and gas.