Stranded Assets and Compensation in Upstream Projects: Conceptual and Practical Issues

Abstract

In the context of strict remaining carbon budgets and the consequent need to raise the ambition to phase down oil and gas production through the reduction or even cessation of exploration and production (E&P) projects, this perspective discusses the definition of stranded assets and its misleading interpretations regarding asset compensation. The compensation here pertains to a situation in which oil and gas upstream activities (exploration, development, or extraction) are stopped without pre-existing provisions for that in contracts. Speculatively speaking and considering an accurate concept of stranded assets, this halt is justified due to the imperative to decarbonize the economy. Compensation methodologies based on valuation approaches and applied to upstream operators (owners of E&P rights) are presented and discussed: (i) market-based, (ii) income-based and (iii) asset-based. While the market-based approach presents challenges to compensating E&P assets due to the difficulty to find benchmark projects and transactions that allow the definition of the “fair market value”, the income-based approach (using the discounted cash flow technique) is more suitable for compensating assets in the production phase because they have proven performance track record. In the case of assets in the exploration and development phases, the asset-based approach would be better applied since its valuation is grounded on the investor expenses and there are no metrics to ensure the performance at these stages of the project.

Keywords: oil and gas, upstream, stranded assets, compensation, valuation, climate change.