Financial stability, stranded assets and the low‐carbon transition – A critical review of the theoretical and applied literatures

Abstract

Transitioning to a low‐carbon economy will entail sweeping transformations of energy and economic systems. A growing research body has raised concerns about the effect of such strain on financial stability. This literature on “financial transition risk” has highlighted that the conjunction of climate policy, technological change and shifts in consumption patterns may propagate to financial markets. In extreme cases, these dynamics may result in a “Climate‐Minsky” moment with systemic implications. The field has developed quickly, covering many methods and research questions. While this expansion in literature is advantageous when studying a complex issue like the low‐carbon transition, it also comes with downsides. The large number of methods hampers result comparison, and the integration of research designs. It also makes it difficult to provide a synthetic view of results in the literature as well as identify remaining uncertainties. To bridge these gaps, I propose a critical review of the literature. I examine three sub‐fields: the asset stranding literature, the direct assessment of transition risks through prospective models and the financial empirics of the low‐carbon transition. I expound their main results, critically assess underlying methodologies and propose a framework to compare results. The review ends by suggesting some avenues for future research.

Stranding Ahoy? Heterogeneous Transition Beliefs and Capital Investment Choices

“…Our treatment of transition expectations positions us close to the literature studying the 'stranding' of physical or financial assets along a low-carbon transition (Campiglio and van der Ploeg, 2022;Daumas, 2023;van der Ploeg and Rezai, 2020). To our knowledge, this paper is the first to incorporate capital stranding into a model with heterogeneous expectations, with most other contributions assuming homogeneity (see for instance Baldwin et al, 2020;Rozenberg et al, 2020).…”

Co-learning partnerships and carbon management in Denmark and Canada

“…We first need to know what those risks and opportunities are, recognizing that they will be specific to each enterprise and geographical context. Such risks have been broadly broken down in the literature into two categories: transitional and physical (Daumas, 2023; Ojea Ferreiro et al. , 2022; Sanderson and Stridsland, 2022).…”

Three tales of central banking and financial supervision for the ecological transition

“…This could be the case for investments in fossil fuel supply, as the low-carbon transition requires keeping a large share of fossil-fuel reserves in the ground. This asset stranding could lead to massive revaluation of asset portfolios and firms' defaulting on credit, ultimately posing a systemic threat (see Daumas, 2023) and leading to what Carney (2015) called "a climate Minsky moment. "…”