Are Your Investments at Risk of Becoming Stranded Assets?

At one point or another, we have all heard the saying "out with old, in with the new." We do not need to look too far in this modern technological age to find cogent examples, including:

  • The telecommunications industry's transition from landlines to cell towers and the subsequent ubiquitous use of personal electronic devices;
  • The growing transition from large, desktop computers to lighter, smaller mobile devices;
  • The evolution in how we consume information, from physical newsprint media to the internet.

In each example, a new industry or firm establishes market leadership, typically at the expense of an industry or firm that is not able to keep pace with the times. Investments in industries and firms unable to keep pace become "stranded assets."

Creative Destruction

Former Chairman of the Federal Reserve Alan Greenspan used the term creative destruction in his 2007 memoir, The Age of Turbulence: Adventures in a New World. Originally coined in Joseph Schumpeter's Capitalism, Socialism, and Democracy (1942),¹ creative destruction denotes a "process of industrial mutation…that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one."² Mr. Greenspan expressed sympathy for the stresses and challenges that creative destruction can have on people's lives in his July 2005 US Senate testimony to the Committee on Banking, Housing, and Urban Affairs, in stating, "The problem with creative destruction is that it is destruction, and there is a very considerable amount of turmoil that goes on in the process."³

With this in mind, we are beginning to see early signs of creative destruction taking place in segments of the energy extraction industry, specifically the coal extraction and coal energy generation industries. Their structural demise may foreshadow obsolescence or nonperformance over the long-term, eventually leaving investors with stranded assets. If these assets do become obsolete or significantly impaired, companies will be required to reduce their recorded value on financial statements resulting in an accounting charge against the firm's equity reserves. This would diminish shareholder value and potentially the firm's ability to service its debt obligations. Under such a scenario a firm may become so financially impaired that its operations suffer or bankruptcy becomes the only relief.

While opining on the merits of creative destruction is outside of the scope of this piece, it is fair to expect that humankind's ongoing pursuit of technological evolution will persist alongside entrepreneurial endeavors, seeking opportunities in a highly competitive global market economy. It's akin to the continual, evolving state of nature and humankind's desire to advance. Despite its seemingly brutal outcome, some benefits have been realized, such as improved health care and enhanced standards of living.

What brutal outcome awaits the coal industry, and what benefits will arise from its creative destruction?

Factors Stranding US Coal Assets

There are five primary drivers for the decline of coal energy generation and the coal extraction industries in the US: aging and decrepit coal plants, burdensome compliance and regulatory trends, cheaper alternative sources of energy, changing consumer and supplier preferences, and the fossil fuel divestment campaign.

In 2014 there were a total of 491 coal-powered plants in US, down from 580 in operation in 2010, representing a 15% decline over the five-year period.4 Despite this decline, coal energy generation still represents a significant source of power generation in the US — approximately 33% of the country's total power source in 2015.5 It is also interesting to note that the average age of US coal power plants is 42 years with the 10 oldest, and least efficient, built between 1943 and 1949.6