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 a new report from the UK Sustainable Investment and Finance Association (UKSIF) in collaboration with Transition Risk Exeter (TREX).
Their analysis 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 finds that global economic exposure to fossil fuel asset stranding risk amounts to $2.28 trillion by 2040 – of which the UK’s exposure is calculated at $141 billion. In comparison to the cost of climate inaction, this is still a much smaller loss to bear. In a warming scenario between 2.5°C and 2.9°C, climate-intensified natural disasters may lead to $12.5 trillion in economic losses by 2050.
UK pension funds are significantly exposed to asset stranding risk
UKSIF and TREX’s report highlights the contagion potential of stranded asset risk within the UK financial system, with corporate, government and investment fund exposure ultimately threatening severe implications for individual savers across the country.
As some of the largest and longest-term investors in the economy, pension funds have long led the way in the incorporation of sustainability factors into their investment strategies. However, with some funds invested directly in fossil fuels and others exposed to the contagion of risk through knock-on impacts associated with stranding, UKSIF and TREX’s research shows that they are also significantly exposed to asset stranding risk.
Of the approximately £88 billion2 in fossil fuel assets held by UK pension funds, around £15.2 billion ($19 billion) or 17% is at risk of stranding by 2040 if current policies and pledges are fulfilled. As a proportion of the total £3 trillion UK pension pot, this amounts to a 0.5% stranding. However, as a proportion of the UK’s projected £113 billion ($141 billion) economic loss, this constitutes a 13% share.
Individual savers will shoulder the cost of the UK’s outsized exposure
UKSIF and TREX’s modelling also shows that 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.
Accounting for around 2% of global GDP, the UK holds 1% of global stranding risk where only the physical fossil fuel resources and capital infrastructure are accounted for. However, the UK’s ultimate ownership of risk increases to 6% of total global losses at the individual and government level – which considers shareholders or outright owners of companies and investors in funds, including pension funds.
As a result, the UK is the fourth most exposed country to stranded asset risk for ultimate owners after the United States, Russia, and China. Given as a proportion of the population, the UK is the 9th most exposed country globally – more exposed than both the United States 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. With the UK’s total stranded asset risk exposure calculated at $141 billion (£113 billion) by 2040, this equates to $3,279 (£2,595) per working adult.
Mitigating stranded asset risk requires concerted action by both public and private stakeholders In order to help mitigate this risk, UKSIF has 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:
- Capturing international investment: Actions taken by policymakers now, including addressing systemic investment barriers (e.g. planning rules, grid connectivity, and energy market reform)
will determine how much of the world’s increasing transition investment the UK can capitalise
on domestically. Supporting growth industries of the future, like renewable energy, and
redressing skills gaps in strategic growth areas will also allow the UK to attract greater green
investment and capitalise upon its climate leadership through long-term job creation and
economic growth. - Industrial decarbonisation strategies: 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.
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. - Mandatory transition plans: 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 (TPT)’s framework would provide
essential data for all financial market participants to make more informed sustainable
investment decisions. - Investment stewardship: 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. As detailed in its response to the Financial Reporting Council (FRC)’s recent UK
Stewardship Code consultation, UKSIF also believes that maintaining a robust definition of
‘stewardship’ and high-quality reporting requirements is critical to the long-term effectiveness
of UK stewardship practices.
Commenting on the report, James Alexander, Chief Executive of UKSIF, said: “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.
“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.”
Willemijn Verdegaal, co-CEO at TREX, commented: “Stranded assets have the potential to cause significant disruption to the global financial system, and the UK faces particularly severe exposure. The risk of oil and gas companies’ misalignment with global demand projections is not properly understood or priced in. At Trex, we are seeking to better inform professional investors on the ways in which this risk proliferates through complex ownership networks, even to ultimate owners. The sooner investor expectations realign with demand projections, the better for their risk exposure.”
Dr Phil Holden, Senior Lecturer in Earth Systems Science at The Open University, added: “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 $1.4 trillion to $2.28
trillion 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.”