An Economy-wide Framework for Assessing Global Transition Risk in the Energy Production Sector

Climate change mitigation efforts, which require the transition away from carbon-intensive activities, can pose financial risks for owners of fossil fuel assets and investors that finance companies engaged in greenhouse gas-emitting activities. For instance, fossil fuel extraction may be significantly scaled-back, and coal-power plants may be idled or even phased out prematurely, thus becoming stranded assets for the shareholders. Using a global general equilibrium model with detailed energy sector and capital stock structures, we estimate the corresponding stranded assets under various emissions mitigation scenarios. Our findings reveal that, depending on the policy scenario, the global net present value of unrealized fossil fuel output through 2040 relative to a “no policy” scenario is between 14.7 to 16.9 trillion US dollars, and that of stranded assets in coal power generation is between 1.0 to 1.4 trillion US dollars. The analytical framework presented in our study complements existing research, in which macroeconomic variables required for estimating the stranded assets are often derived from models with more simplified assumptions. Therefore, individual firms and financial institutions can combine our economy-wide analysis with details on their own investment portfolios to determine their climate-related transition risk exposure.