Stranded assets and compensation in oil and gas upstream projects: Conceptual and practical issues

Abstract

Due to the strict remaining carbon budgets, the need to raise the ambition to phase out oil and gas (O&G) production can lead to the cessation of exploration and production (E&P) projects that might become stranded. This study discusses the definition of stranded assets and its misleading interpretations regarding asset compensation. The compensation here pertains to a situation in which O&G upstream activities (exploration, development, or extraction) are stopped without pre-existing provisions for that in contracts. Speculatively speaking, this halt could be justified by the imperative to decarbonize the economy. Compensation methodologies based on valuation approaches and applied to owners of E&P rights are discussed. Findings show that resources and reserves cannot be mandatorily considered assets, as per the accounting definition. Hence, naming them stranded assets could pose a “bias threat” in the selection of a valuation model in the event of compensation. There is a wide gap difference between discounted cash flow (DCF) and asset-based valuation models to compensate for O&G phase-out. The DCF approach leads to values of such magnitude that could challenge State's capacity to promote environmental regulatory changes while asset-based compensation amounts are straighter forward and make O&G phase-out more feasible especially if cancelled at early or later stages.