Cooperative Finance to Avoid Stranded Asset Risk

Cooperative finance strategies can optimize innovation timelines and help all stakeholders eliminate stranded asset liability cost and risk.

A “stranded asset” is a facility or resource that cannot be used productively, even if the owner is willing to take significant losses to keep it running or to extend the life of a once-valuable contract. The most important detail of any stranded asset situation is the fact that the situation can only arise if the asset-holder is likely in the moment of acquisition to not understand how rapidly the value will decrease.

• Resistance to the idea that stranded assets touch their portfolios is characteristic of industries and investors holding them.
• This tendency may be more entrenched, and more dangerous the wider economy, when it is up to nation-state governments to judge the wisdom of investments that in the past have been lucrative but have a limited future.

Structural incentives—taxes, laws, regulations, infrastructure, and financial sector practices—limit how aggressively owners of stranded assets can transition away from those facilities and resources. Such structural limitations can also prolong the period during which a stranded asset appears to be market-standard or at least viable as an outdated yet competitive mode of operation. Investors have a stake in not seeing current asset-holdings lose value quickly; such a loss of invested value can strain budgets and lead to reduced credit, lower returns, and punishment in the markets.

The combined effect of structural limitations (on transition away from stranded assets) and market dynamics (resulting from investors seeking to limit the decline in the value of vested projects and industries) is the blurring of clear boundaries between epochal states of the art in a particular industry. In other words, incumbents can keep pulling in new investment long after it makes sense for investors to take such a risk.

None of this means asset-holders facing these constraints and pressures do not know they are walking into, or already irreversibly caught in, a trap.

“Accelerated depreciation” shortens the timeline for phasing out assets that will likely be stranded, and speeds investors’ journey to safety. Instead of letting these facilities or resources depreciate according to their own inherent value and market trends, over time—which can lead to a market-over-the-cliff-edge moment—a coordinated strategy allows for assessing the overall landscape of value and optimizing investment to get the best overall outcome from funding new clean technologies.

Accelerated depreciation is generally considered an accounting method, that must map to logistical realities, and which needs legal or regulatory support.

• A straight case of accelerated depreciation could see tax revenues overall decline, because stranded asset losses are being compensated sooner, rather than later.
• Some argue this must be offset by increasing costs to rate-payers, to make up the difference.

A cooperative, multistakeholder finance strategy, which leverages bond issuance in combination with regulatory recognition of the wisdom of accelerated depreciation, can achieve the better investment future for government, utilities, investors, and consumers, without an increase in costs in the short-term. They key is to structure a blended finance mechanism, operating through accelerated depreciation bonds, that meets all of the relevant needs, recognizing that the market will eventually phase out high-polluting capital-intensive systems.

Dirty energy creates hidden costs that proliferate throughout the whole economy, and erode value for everyone. It looks affordable only because we don’t account for those costs. By strategically stranding polluting facilities and resources in this way, a company, a utility, an investor group, and/or public authorities and taxpayers, can eliminate risk and maximize value, while repurposing existing funds and adding new funds to securely transition to clean practices.

Underneath this process is the question of “industrial ecology”—a sustainability concept that calls for active examination and optimization of the entire ecosystem of activities that makes up what we call a company and its supply chain. The radical fast-paced business-model innovation that must happen to allow us to transition to 100% clean energy requires industrial ecology understanding and collaborative processes like accelerated depreciation.

Technology is getting faster, lighter, and more capable of multipurpose application. Data management is allowing for detailed, remote integration of highly complex, decentralized systems. Business models and industrial ecology may evolve rapidly away from highly centralized grids dependent on heavy infrastructure.

There are more than $5.4 trillion in outstanding climate-smart finance commitments, and climate-aligned and sustainable bonds are the fastest growing area of new financial sector value creation. The opportunity connected to cooperative accelerated depreciation is unquestionable, but all relevant stakeholders need to see and understand the leadership of those who have shown these strategies can work.

Each step forward compresses the optimal innovation timeline; the best move for all stakeholders is to map out, establish, and activate a vision of the future in which these risks are replaced by system-wide operational resilience.