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Stranded asset risk and valuation
Comment on Part A and Guidance on Part B
Comment on Part A Assignments
It was encouraging to see a generally high quality of work across the submitted assignments;
the mean and median mark was 72%.
The assignment more closely resembles the kind of open-ended projects you will asked to
complete in industry than the typical university assignment but it is more challenging. We split
it in two components to allow you to get feedback you can incorporate in the second part.
The key to addressing what seems to be an unstructured assignment is to identify or define the
major theme(s) and then explain the detail.
Identifying the theme in the assignment was relatively easy. The notion that BHP and
Woodside face rising stranded asset risk is straightforward and there are any number of media
reports that tell this story.
Assignments that presented a more detailed account of the risk(s) backed by reference to
reliable sources received higher marks.
For example, the following extract from an assignment reveals the ways in which BHP and
Woodside differ in their exposure to stranded asset risk:
“In BHP’s most recent financial statements (H1FY23), operating assets by segment
consisted of 50% copper, 31% iron ore, 13% coal, and 6% other (BHP Group, 2023a).
In Woodside’s most recent financial statements (FY22), all assets were allocated across
oil and gas encompassing LNG, pipeline gas, and crude oil with 75% of equity
production represented by natural gas (Woodside Energy Group, 2023).”
The same assignment identified and explained less obvious source of stranded asset risk.
“The emergence of green hydrogen as a cheaper alternative to green steel presents a
significant technological challenge for BHP’s numerous iron ore assets, particularly as
a producer of lower-grade iron ore, which is unsuitable for steel production using
hydrogen (Mazengarb, 2021). As a result, in the next ten years, BHP faces a serious
stranded asset risk to its iron ore operations due to the threat of insufficient resource
quality.”
Assignments attracted higher marks when their discussion provided an indication of the
economic magnitude of exposure to stranded asset risk. Two examples:
“As of 3rd April, the share price for BHP was AU$46.97. Given the fact that fossil fuels
was only 12% of the NOA, the sale of those related assets would not be a significant
hit to BHP’s operations. The EBIT it brings in for BHP is also much smaller compared
to that of Copper and Iron Ore. However, BHP stands to gain much more than that in
public perception, as they are now seen as trying to do better for the environment which
is currently popular with many environmentally conscious investors”
“Figure one [not shown here] highlights the cumulative demand for Woodside and
BHP’s commodities under different climate change scenarios. Woodside’s portfolio
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consists of oil and gas assets which are most at risk of lower market demand over the
next 30 years from a 1.5C scenario. However, BHP’s assets stand to benefit from a
1.5C scenario as their iron, copper and potash reserves will see elevated demand over
the next 30 years.”
Most assignments acknowledged that the impact of stranded asset risk was likely to grow over
longer time horizons so that the exposure over next 5 years would likely be less than over the
next 10 years and 20 years. This discussion earned more marks when the reasons for the lower
risk exposure in the short term were explained. For instance, some assignments pointed out
that countries’ energy infrastructure was still heavily dependent on oil and gas which meant
that in the short-term the demand for both was largely inelastic.
It is rarely the case that all the evidence and relevant considerations point unambiguously in
one direction. Things are more complicated. Assignments attracted higher marks when they
acknowledged different points of view, as in the example below:
“There are also contrary views on market conditions for oil and gas reserves which
argue that fossil fuels will remain an important transition energy source. This argument
suggests that the current stranded asset risk is overestimated in the short term and that
fossil fuels will account for ~60- 80% of the world’s key energy sources by 2040
(Newell et al., 2019).”
The timing of the impact of technological change and regulatory uncertainty is another issue.
The two factors are complementary to a degree. The greater the costs imposed by regulations
(and taxes) on companies that generate climate change emissions then the more investment
will be put into technological development of alternative energy sources which will heighten
stranded asset risk. Here is an example of an assignment that made a similar point and,
importantly, discussed its implications for BHP and Woodside:
“The impact of stranded asset risk over the next 10 years will depend on the uncertain
timing of government policies to limit global warming to 1.5C as outlined in the Paris
Agreement (van der Ploeg & Rezai, 2020; Firdaus & Mori, 2023). This will likely
coincide with growth in renewable technologies which will contribute to worsening
market conditions from lower demand. As government regulation is implemented in
relation to climate change, this will drive greater stranded asset risk for Woodside over
the next 10 years. Contrary to Woodside, BHP’s stranded asset risk is limited given
there are long term demand tailwinds for their commodities as outlined in figure 1 [not
shown in this extract].”
Some assignments made the relevant point that companies like BHP and Woodside can and
probably will take steps to minimise their exposure to stranded asset risk by, amongst other
things, using technology that minimises their emissions. Of course, whether such efforts will
be sufficient to make a difference remains to be seen.
Assignments attracted higher marks when they made the point and illustrated it with some
numbers that the impact of stranded asset risk in the 20-year horizon was low in part because
reasonable discount rates substantially reduced the present value of the cash flows expected in
20 years.
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Incidentally, my own view is that the development of new energy sources and regulatory
pressures are more important contributors to stranded asset risk than divestment. My view is
based on the negligible impact of divestment campaigns on the profitability of tobacco
companies. Tobacco companies remain highly profitable despite extensive and sustained
divestment campaigns against them.
In relation to second question of Part A, whether BHP timed its sale of its oil and gas assets to
Woodside well, there seemed to be a difference of opinion. Most students agreed but a
substantial minority said it was a mistake, BHP would have been better off if they had delayed the
sale given the record profits earned by oil and gas companies due to the world-wide disruption
in supply as a result of the Russian invasion of Ukraine.
It’s true that, as things turned out, BHP would have earned higher profits in the short term if it
had not sold its oil and gas assets. However, at the time of the sale, the turn of events wasn’t
known. In general, if you are facing a risk of some sort, you can’t wait until the outcome is known
before making a decision. The way to make these decisions is to identify which company is best
positioned to bear the stranded asset risk.
As discussed earlier, BHP is much less exposed to stranded asset risk than Woodside. It may
appear that BHP is better placed to bear the risk of its oil and gas assets. However, by getting rid
of its assets that are most exposed to stranded asset risk, BHP probably gains much by not being
a target of climate change activists. Woodside is already heavily exposed to stranded asset risk
and is already a target of climate change activists and so taking more oil and gas assets won’t
make much difference, if at all. Looking at the problem in this way,suggests that it was a sensible
move by BHP to divest its oil and gas assets to Woodside.
Guidance on Part 2 of the Assignment
1. Provide a brief summary of your expectations regarding stranded asset risk from Part
A in your assignment. This should include information that is related to your
expectations for stranded asset risk in the next 5-, 10-, and 20-years. (20%)
What we’re looking for here is your opinion, supported by evidence, whether you expect
stranded asset risk to be a concern for natural resources companies over the next 5-, 10-, and
20 years. You can draw on your work from Part A but you are free to modify your Part A
opinion, based on feedback and any further reading. This part of the assignment sets the
foundation for the second question of part 2, which is to assess the likely impact of stranded
asset risk on 8 specific natural resource companies.
2. List the following 8 ASX listed companies in order of the stranded asset risk to which
you expect they are exposed (40%). Which combination of companies would you go
long and which would you short in order to maximise excess risk adjusted return over
the next 5 years? (40%)
The exposure of natural resource companies to stranded asset risk depends on the mix of assets
they have (as discussed with respect to Woodside and BHP). This is why you are asked to
identify the major commodities mined by each company and the proportion of revenue from
each. Note that the proportion of revenue will change with the price of each commodity so
you need to form some expectation of future demand and supply. It would be useful to review
reports discussing future demand for each commodity. In general we can expect producers to
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more biased in forecasts than independent industry experts so think about when deciding which
reports to rely on and read more than one report.
It may be useful to classify the natural resources in terms of their exposure to stranded asset
risk (e.g., fossil fuels would probably rate high and rare earth minerals would probably rate
low). Note that there is some uncertainty as to which technologies will prevail as economies
decarbonise so a natural resource such as lithium that is essential in some renewable
technologies may not be certain to dominate in the future. You should assess this risk.
Having come to a view on the exposure of each company’s stranded asset risk, the next step is
to see if this risk is reflected in share prices. You don’t want to go short on a company with a
high stranded asset risk if the share price already reflects that risk. No one can know how
efficiently share prices reflect stranded asset risk but price/earnings ratio and book to market
ratios can be indicative. Companies that you think have exposure to stranded asset risk and
that have high price/earning ratios relative to other companies and low book to market ratio
relative to other companies are more likely to be over-valued. Think about which set of
companies are the appropriate benchmark.
Incidentally, you can be 100% long in all the companies, 100% short on all the companies or
any combination in-between.
Finally, my advice is to spend 50% of the time researching and 50% of the time writing. It is
challenging to write a concise and clear account of anything. A deservedly famous saying
amongst people who write for a living is one attributed to the French mathematician and
philosopher Blaise Pascal. He reportedly once wrote to a friend saying, “I am sorry to have
written a long letter, if I had more time it would have been shorter”.
The full question (Part 2) is copied below:
What companies in Australia have the highest stranded asset risk?
ChatGPT: Identifying companies with the highest stranded asset risk is a complex process
that requires detailed analysis of each company’s specific situation. It involves assessing
factors such as the type of minerals mined, the location of the mine, the company’s level of
debt, and the extent to which it is exposed to technological, regulatory, and market risks.
That being said, there are several factors that could increase the stranded asset risk for
mining companies operating in Australia. Some of these factors include:
1. Coal mining: As the world moves towards renewable energy, the demand for coal is
expected to decline. This could result in coal mines becoming uneconomic and stranded
assets. Therefore, companies with significant coal mining operations, such as BHP Group,
Rio Tinto, and Anglo American, could be at risk.
2. Iron ore mining: Iron ore is Australia’s biggest export, but there is a risk that demand
for it could decline if steel production becomes more sustainable. This could result in iron
ore mines becoming stranded assets. Therefore, companies with significant iron ore mining
operations, such as BHP Group, Rio Tinto, and Fortescue Metals Group, could be at risk.
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3. Regulatory changes: Regulatory changes that limit the amount of carbon emissions or
water use from mining operations could increase the stranded asset risk for mining
companies. Companies that operate in regions that are prone to drought or face stringent
environmental regulations, such as New South Wales and Western Australia, could be at
higher risk.
It’s important to note that each mining company has unique circumstances that impact their
risk of stranded assets, and the situation is constantly evolving. Therefore, it’s recommended
that investors and analysts conduct their own research and analysis to identify companies
with high stranded asset risk.
ChatGPT tells us that identifying companies with the highest stranded risk is a “complex
process”. Your lecturer is also aware that this task is not a simple one. You will notice that
ChatGPT’s answer provides a non-detailed response, one that is not useful to your employer
to assist their decision making.
Required:
2. Provide a brief summary of your expectations regarding stranded asset risk from Part
A in your assignment. This should include information that is related to your
expectations for stranded asset risk in the next 5-, 10-, and 20-years.
3. List the following 8 ASX listed companies in order of the stranded asset risk you
expect they are exposed to. Which combination of companies would you go long and
which would you short in order to maximise excess risk adjusted return over the next
5 years?
To support your answer you are required to provide the following information for each
company:
• Major commodities mined by the company.
• The proportion of revenue that comes from the major commodities in the company’s
portfolio.
• Price-to-earnings ratio
• Market-to-book ratio
Please note that is is not enough to simply list this information. It needs to relate to additional
research you have undertaken to formulate your expectations on stranded asset risk, and your
decision on the combination of assets you decide to go long or short to maximise excess risk
adjusted return over the next 5 years.
A good source of information is the companies’ annual reports.
Table 1: List of ASX mining companies

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