J. Environ. Econ. Manag. 100, 102277 (2020).

Financial investments in fossil fuel assets could be lost if climate policies limit emissions in line with climate targets. Stranded assets, as these are known, thus represent an investment risk which may not be currently accounted for by investors and company valuations.

The German climate policy Klimabeitrag — the climate levy to reduce coal-generated electricity — allowed Suphi Sen and Marie-Theres von Schickfus of University of Munich, to investigate how investors consider and price such risk of stranding on German utility companies. The policy had three stages — introduction of the levy on carbon emissions, inclusion of a compensation mechanism and regulatory compliancy checks of the compensation mechanism — and the authors tracked stock market response to each stage.

The first two stages did not result in significant reactions, whereas the third stage elicited a significant negative reaction. This pattern of reaction is suggestive that investors had priced in compensation rather than overlooked the risk of asset stranding. Thus, steep and rapid devaluation of fossil fuel companies could result from climate policy changes where compensation is not included.