Future prospects for fossil fuel stocks have been long debated but curiosity among institutional investors has grown substantially in recent months, stemming from the popularisation of the stranded assets concept, a successful divestment movement among endowments and foundations and oil price movements.

This paper, Fossil Fuels: Exploring the stranded assets debate, aims to help investors begin to assess the issues and provides a framework for developing a pragmatic and proportionate strategic response to fossil fuel investment.

Proponents of the stranded assets concept argue that it will not be possible to economically exploit a large proportion of proven fossil fuel reserves if governments adhere to international agreements to constrain global warming below 2°C by 2050. Under this scenario, current valuations of fossil fuel companies could be mispriced by the market. One think-tank estimates that there is $1.1 trillion of capital expenditure earmarked for high cost oil projects (such as deepwater, arctic, oil sands etc) over the next 10 years that require an oil price of at least$95 per barrel to be economic.

Various future scenarios are possible, some of which could have detrimental impacts on current investment portfolios. We have seen numerous investor responses to fossil fuel investment which we have categorised into four main groups including engagement, risk adjustment, divestment and hedging.

While we do not advocate any one particular response we do believe it is in the interest of investors with a medium to long-term investment horizon to explore the stranded assets argument in the context of their own portfolios, defining their beliefs and assessing current portfolio exposure.

February 4, 2015 (Original Publish Date)

Republished from Towers Watson.

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