Managing the Transition to Renewable Energy: Stranded Assets, Investment and the New Oligopoly
Global energy systems based on non-renewable fossil fuels (coal, oil and natural gas) are being transformed to energy systems based on renewable sources, particularly solar and wind.
This transformation is creating new economic value in renewable energy assets while simultaneously reducing and eventually eliminating economic value in existing fossil fuel assets.
The economic value of the fossil fuel industry includes the value of in-situ recoverable reserves of coal, oil and gas, plus the value of all above-ground assets built to convert in-situ reserves into useful forms of energy, particularly electricity and fuel. These reserves and physical assets are declining in value because they are becoming increasingly obsolete, both technologically and economically. Obsolete assets with no economic value are referred to as “stranded assets”.
Stranded assets are those that no longer produce an economic return. Stranded assets are recognized in international financial accounting systems as having 100% impairment, subject to ‘write-off’ and liquidation. Economic asset values may decline rapidly as markets transform fundamentally in response to changes affecting demand, supply, and technological innovation. Stranded assets represent lost or unrecoverable economic value from prior investment. Stranded assets are a source of significant financial and economic risk to both public and private sector companies.
To put it simply, fossil fuel assets of no economic value or rapidly declining value are scattered throughout Ukraine, burdening companies and communities with economic losses, and complicating the transformation to renewable energy.
The global renewable energy transformation is reducing the economic value of existing fossil fuel energy (FFE) assets, while risks associated with further investment and expansion of FFE asset capacities are increasing. The World Economic Forum estimates that “fossil fuel consumption in Europe peaked in 2006…. global coal demand peaked in 2013 and global demand for internal combustion engine vehicles likely peaked in 2017”. Looking out from today, as noted in an analysis posted by The World Economic Forum, “fossil fuel demand has collapsed and may never surpass the peaks of 2019. By the time the global economy recovers, all the growth may be met by renewable energy sources.” 
Global investment in renewable energy asset capacity and continuing innovation, particularly in solar and wind energy production and battery storage, already exceeds investment in fossil fuel energy (FFE) assets. Renewable energy production costs across a variety of sources and technologies has declined around 90% over the last 10-12 years and electricity costs based on renewables are now less than any fossil fuel source in most countries of the world .
The specific trends and factors in each country that contribute to FFE assets becoming stranded are often poorly understood. Specific transformation factors, be they technological, economic, social or political, are often mispriced into public and private risk calculations, often resulting in levels of continued investment in FFE assets that are economically unjustified. Stranded assets represent the developmental inertia and financial resistance that can slow and distort further progress in transforming Ukraine’s energy systems.
Several statistics demonstrate the pace of change and the inevitability of declining FFE asset values as the transformation to an energy system based on renewable sources continues. In 2019, 72% of global capacity expansion in the energy sector was in renewable sources. The annual growth rate in renewable energy capacity expansion in 2019 was 7.4% and extended a multi-year trend of high growth rates . The fossil fuel growth rate in recent years has, by contrast, been around 1% .
Growth is an exponential function and because expansion of renewable capacity is growing at a rate substantially higher than fossil fuel capacity (with most investment in fossil fuels going to maintain existing capacity rather than create new capacity) it is only a matter of time before renewables become the dominant source of energy for electric power generation and fuel transportation. This historic transition is no longer a question of ‘if’, it is a question of when. Most analysts expect this to occur by 2030 if not sooner. Renewable energy now accounts for one-third of global capacity.
Whereas renewable capacity is growing everywhere, fossil fuel capacity is declining almost everywhere. During the next three years, within the FFE asset category globally, new additions to electric energy generating capacity based on coal, is forecast to be zero and oil is forecast to add a trivial 2 MW, which is effectively zero. Over 99% of new fossil fuel electric energy generating capacity will be based on natural gas. Much of this new natural gas capacity does not represent an expansion of total fossil fuel capacity per se but rather represents a transfer of generating capacity from coal to gas.
Forecasts for capacity that will be decommissioned (taken out of service) over the next several years period further underscores the coming end of the fossil fuel age of power generation: 99% of all decommissioned capacity globally will be fossil fuel assets . Everywhere in the world today, renewable energy leads in sustainable growth and expansion.
Stranded Asset Values and Remaining Useful Asset Life in Ukraine
Fossil fuel assets consist of recoverable reserves plus physical assets built for coal mining, oil and gas extraction wells, pipelines, storage facilities, processing plants, dedicated transport infrastructure, thermal electric power stations and oil refineries. Ukraine’s fossil fuel energy systems have historically relied on coal and gas.
Coal is no longer economically viable in Ukraine and emits significantly higher greenhouse gas volumes than gas powered or wind and solar powered electric generation – two factors that have combined to render coal reserves and physical assets associated with exploitation of coal to become entirely stranded, an obsolete source of energy representing no economic value. In Ukraine, the cost of mining coal greatly exceeds market price even before adding transportation and processing costs incurred prior to use at thermal power stations. Barring artificially favorable pricing schemes, direct subsidization or short-term necessity, reserves of thermal coal (excluding coking coal) plus much of the physical assets used in mining and processing are already effectively stranded assets with no recoverable economic value. Once stranded, these assets must eventually either be decommissioned and liquidated or repurposed for use elsewhere as feasible. In the meantime, closed but un-reclaimed coal mines require continuous expenditures, such as pumping water, to be safely maintained. No further investment in coal mining capacity is economically justified.
Coal-powered thermal generating stations must now meet total input requirements by utilizing subsidized domestic coal or by importing coal. This situation cannot be maintained indefinitely and barring conversion (or reconversion) to operate on natural gas, will continue to decline in value and become impaired to the point of being stranded assets along with the attendant coal reserves and mining assets.
A current fair value of Ukraine’s recoverable oil and gas reserves is around $12 billion . This value will decline in the future as costs of development and extraction increase and gross profit margins decline. Based on a reasonable reading of medium to long term valuation trends, most oil and gas reserves are effectively stranded assets already.
As there are a number of countries with significantly larger oil and gas reserves and output capacities than Ukraine, and that have extraction costs much lower than Ukraine, it will be Ukraine’s reserves and output that will decline well before these other major sources. For the Ukrainian economy, a majority of the energy value and economic value represented by these oil and gas reserves will not be recovered.
Physical (built) assets required to extract, process, store and transport oil and gas reserves, and including oil refineries and electric power stations, are currently recorded on publicly available financial statements at high levels of accounting value. But, as these physical assets are tied to the underground reserves they were designed to exploit, they will also continue to decline in economic value and an increasing percentage will become stranded assets in the near future. As of 2019, physical asset values reported by the largest private and State-owned companies, and including the largest mining and extraction operations, processing plants, power stations and refineries in the oil, gas and coal fossil fuel energy sector, exceeds $26 billion ; the national total is higher than this.
Combined, there is approximately $38 billion of reserves and physical assets within the fossil fuel energy sector in Ukraine that are inexorably declining in economic value toward obsolescence as stranded assets as the renewable energy transformation accelerates over time.
An additional factor to consider is the indirect effect of electrification of transportation services on the value of oil reserves and oil refineries. As electric vehicles and batteries continue to decline in price and improve in efficiency and capacity, the increasing electrification of transportation services will accelerate and increasingly displace oil as the dominant fuel source. Declining demand and low prices will further strand oil reserves as well as the attendant physical assets, from wells to refineries, supporting oil-based fuels for transportation. Most oil refineries in Ukraine have already been shut down. Credible estimates indicate that already around $900 billion of global oil and gas reserves are effectively stranded assets, highlighting both market and policy forces as drivers .
Financial risk in the oil and gas industries over the next 5-10 years will continue to increase while expected economic returns will continue to decline, a negatively self-reinforcing cycle seen in other transitional economic sectors. Declining asset values (for both reserves and physical assets) will increasingly affect negatively the financial position of private and public fossil fuel companies and governments overly dependent upon them. Debt and equity will become less available and more costly.
This raises the issue of the efficacy of continued investment into new oil and gas capacity. As an example, the average useful life of oil and gas wells is around 40-50 years. In Ukraine, wells range from as few as 15 years to over 100 years old. The ongoing energy transformation from fossil fuels to renewables will worsen the demand, price and output parameters for oil and gas over time. Therefore, investment to develop new reserves and expand the base of required physical assets to support them becomes harder to justify economically and especially as a matter of developmental policy at the national level. In 2017, global investment in renewable energy significantly exceeded investment in coal, gas and nuclear power combined. This trend will continue and accelerate and Ukraine’s experience will mirror that of the global transition.
The dilemma for Ukraine is that its immediate and near-term need is to secure access to reliable and adequate sources of oil and gas supply. Certain geopolitical factors clearly influence the need to increase output within Ukraine and reduce import dependence. However, a full accounting of long-term capital and operating costs and benefits of new oil and gas investments within Ukraine argues against further investment in new oil and gas capacity.
Financial risk for investors in fossil fuel assets is highly significant around the world. Banks in India, as an example, face up to $38 billion in bad loan losses to the coal-based power sector because they failed to adequately factor in impairment and stranding of coal assets in valuations and risk assessment . A reasonable goal is to ensure that this situation is not replicated with the fossil fuel transformation in Ukraine.
There is a difficult balancing act that must be managed over the next decade between meeting immediate needs for energy security based on the existing FFE asset base, and the need to transform the energy sector to renewables as quickly as possible. Annual capital budgets for major oil and gas companies are very large. As just one example, in 2019 Naftogaz invested around $100 million to meet the requirements of its operating activities. But given that a typical gas or oil well has an average useful life of at least several decades, it is highly probable that new wells will become stranded assets long before the end of their useful lives.
Renewable Energy as an Instrument of Economic Reform
The structure of energy systems, as well as issues of ownership and operating methods have important consequences for Ukraine’s economic and social development. It is an instructive example to look at the current structure of power generation systems based on fossil fuels and compare that to solar energy.
The fossil fuel-based electric power industry is vertically integrated and highly concentrated by ownership and location. Fossil fuel electric power is largely dependent on a small number of large and highly centralized generating stations, embedded within a vertical supply chain of limited and highly concentrated extraction and processing sites. Electricity is made available to the economy through large and highly concentrated distribution facilities. This concentration of assets has led to an oligopolistic ownership structure in Ukraine wielding influential economic and political power. In Ukraine’s thermal power sector, around 2/3 of all capacity is under single ownership .
Solar energy, by contrast, has an entirely different structure. Solar energy is horizontally dispersed over a very large number of locations and capacities, from industrial-scale developments to micro-scale installations. The economics of fossil fuels requires large scale generation and distribution structures to be viable, solar does not. Solar is scalable. A single roof top panel array can power a single home and operate off-grid or be integrated into a smart micro-grid of homes collectively in a single neighborhood. The scale and structure of microgrids significantly reduces transmission losses associated with the current large-scale distribution system. To function effectively, microgrids need battery storage capacity of an appropriate scale to manage supply and demand both within the microgrid and between the microgrid and the large-scale distribution system.
There is effectively no limit to the vast number of smart solar micro-grids that can exist, if the government does not constrain them. Microgrids can provide for their own needs and sell excess energy to the current distribution system. This transforms former consumers of electrical energy into energy suppliers, as well as consumers, and this changes the economic dynamics of the electricity market. This type of market structure in effect disperses ownership and profitability very broadly as opposed to the fossil fuel structure which concentrates ownership and profitability into a very small number of entities.
There is nonetheless a remaining technological and economic need for large contributions to supply to come from a more limited number of industrial-scale solar energy (and wind energy) generating sites. It is however crucial that Ukraine as a matter of developmental policy not allow the renewable energy industry to become another oligopoly. Providing a high ‘green tariff’ may help develop renewables but it may also create an incentive for a few large companies to dominate the industry to secure access to this State largesse. It would be ironically self-defeating to allow renewable energy to develop into a vertically integrated, highly concentrated industry, dominated by a limited number of very large wind and solar companies.
Already, approximately 21% of Ukraine’s total renewable energy capacity, 15% of solar energy capacity and 40% of wind energy capacity is under single ownership. By contrast, solar microgrids in total provide only around 8% of national solar energy capacity . Duplicating the old fossil fuel oligopoly in the evolving renewables industry is not a technological or economic requirement, it is a purely political decision.
The energy transformation need not be a zero-sum game. New renewable capacity in solar (and wind) at micro-scale, feeding highly dispersed microgrids, can be developed to complement macro-scale sites to balance energy needs. If growth in total renewable energy at least meets or continues to increasingly exceed the growth in electricity demand, it will reduce pressure on the old fossil fuel-based assets, allowing for a more reliable and managed transition.
In any event, over the next decade, the technology, operating systems and market fundamentals of solar and wind energy is accelerating asset impairment in FFE assets, reducing the remaining useful life of FFE assets and will eventually leave assets stranded. Add to this the effect of ongoing developments in ‘smart solar’ roads linked to smart electric vehicles linked to smart, efficiently scaled, renewable power grids and the continuing transformation to renewable-based electric power is effectively locked in.
In Ukraine, economic values of fossil fuel reserves and enabling physical assets are declining and remaining useful life of assets is shortening. Stranded fossil fuel assets are now a serious financial, economic and developmental problem. Coal is dead already and oil is senescing. Gas remains an important fossil fuel energy source. However, the cost of developing new long-term gas and oil extraction capacity, as well as the cost to build and maintain fossil fuel power stations and oil refineries, is rising. Investment planning must therefore balance short-term energy needs with the risk of creating new long-term stranded fossil fuel assets. The values of currently stranded fossil fuel assets, the rate at which the energy transformation is further stranding assets in the near term, and the costs associated with decommissioning and liquidation of stranded assets, must be managed carefully to avoid further wasteful investments that simply create future stranded assets.
The Ukrainian government must support the transformation to renewable energy systems with appropriate legal and regulatory policies and reasonable financial incentives that promote decentralized and smaller-scale renewable energy supply by a large number of market participants. The government must resist attempts to recreate oligopoly in ownership and control of renewable energy through the domination of supply by a small number of vertically integrated, macro-scale systems benefiting from unreasonable green tariffs.
 World Economic Forum, Here’s What we Know and Don’t Know about the Energy Transition, 24 April 2020
 Carbon Tracker, Covid-19 and the Energy Transmission: crisis as mid-wife to the new, 07 April 2020
 International Renewable Energy Agency, Renewable Capacity Highlights, 31 March 2020
 Carbon Tracker, Covid-19 and the Energy Transmission: crisis as mid-wife to the new, 07 April 2020
 U.S. Department of Energy, Federal Energy Regulatory Commission, Office of Energy Projects, Energy Infrastructure Update, February 2020
 Cumulative total value of assets as reported in publicly available financial statements of the 14 largest companies in the fossil fuel industry in Ukraine. See bvdinfo.com/en-gb/
 Financial Times, as quoted in A Third of Fossil Fuel Assets May Soon be Stranded, 20 March 2020
 Institute for Energy Economics and Financial Analysis, Stranded Coal Assets a Major Concern for Indian Banking Sector, May 3, 2020.
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