Stockholm (NordSIP) – Beyond the logic that climate-friendly investments are a pre-requisite for the survival of planet earth and investors’ ability to enjoy their investments’ returns, the “stranded assets” hypothesis argues fossil fuels are just bad business. As the world moves towards a carbon-neutral future, consumers, investors and other corporates will have to reconfigure their energy consumption to align with the new paradigm. The necessary fossil fuel demand shock cannot avoid but depress valuations in legacy industries and affect the credit rating of those companies.
In a recent report, Fitch, one of the top 3 global credit rating firms, discusses which countries are exposed to “stranded asset” risk, and how it is likely to affect sovereign credit ratings. According to the report, fossil exporters face a loss of GDP, government revenue and export receipts from the transition to a lower-carbon economy over the coming decades. “For the most-exposed sovereigns and those that do not adequately prepare for it, climate change stranded-asset risk is likely to lead to rating downgrades as the effects become clearer, closer and more material,” Fitch Ratings says in the new report.
Who is at Risk and How?
Fitch warns that the energy transition will not affect all fossil-fuel dependent countries equally. “The materiality of stranded-asset risks to economies and sovereign creditworthiness will depend on the specifics, magnitude, speed and timing of the reduction in fossil fuel volumes, the evolution of prices, and sovereigns’ capacity to adapt to and mitigate the effects. These remain fundamentally uncertain,” the credit rating adds.
In a heat-map analysis of the matter, Fitch highlights the risk of stranded assets to the Republic of Congo, Kuwait, Angola, Azerbaijan and Kuwait, as the countries most dependent on fossil fuels for their exports and as a share of GDP. Of those, the Republic of Congo and Angola are singled out for the difficulties that they would face due to limited economic diversity potential. Among the Nordics, only Norway appears on the list, but is among the least affected nations by “stranded assets”.
“Excess potential global supply will weigh on prices, potentially compounding the loss from lower volumes,” the report predicts. “Coal will face a faster and fuller loss of market than oil and particularly gas. High-cost producers will be squeezed out first. Sovereigns with strong balance sheets and potential to diversify their economies are better-placed. Political instability and rising financing costs could amplify challenges.”
According to Fitch, the transition could plausibly result in a similar shock to oil revenue as occurred in 2013-2016 and again in 2018-2020, “when two oil exporters defaulted and a further three were downgraded by at least four notches”.