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Oil investments and the global energy transition

Oil investments and the global energy transition

In recent years, investors have become concerned about investing in oil and gas producers. The expected energy transition away from fossil fuels, driven by the need to combat climate change, has raised concerns that the value of many oil and gas producers’ reserves is in terminal decline. From this perspective, it is only a matter of time before these companies are sitting on stranded assets, having developed significant reserves of oil and gas for which there is no commercial market.

Research by the UN Intergovernmental Panel on Climate Change says that global warming must not exceed an average of 1.5°C degrees above pre-industrial levels. Although pledges in 2015 as part of the Paris climate agreement aimed to limit global warning to well below 2°C, the UN Panel believes we are heading towards 3°C, and are calling for carbon emissions to be nearly halved by 2030.

Do oil and gas companies face an existential threat?

As with so many things, the reality around the stranded assets argument is far more complex. The truth is that fossil fuels will be needed for the foreseeable future. Renewable energy capacity is growing quickly, but it is not growing as fast as humanity’s demand for energy. In fact, the share of renewable energy in global energy usage has stayed roughly static over the past 20 years.

Without a game changing technological development in energy production, it is difficult to envisage a future without the continued use of fossil fuels, at least over the next 20-30 years. BP Chief Executive Bob Dudley in a keynote speech has highlighted the challenge of providing the world with energy of all kinds, pointing out that energy demand could rise by a third as early as 2030. While people may point to the need to hold back energy usage in developed markets, the majority of this growth will actually coming from emerging markets, with millions of people being lifted out of fuel poverty.

Many forecasters suggest that renewable energy could supply around a third of total energy demand by 2040. Dudley suggests that oil and gas has a crucial role to play in the remaining two thirds of demand. BP’s Energy Outlook suggests that 40% of energy supply will still be from oil and gas in 2040, while the International Energy Agency estimates almost 50%.

These forecasts are not from disinterested parties, but they do give an indication of the scale of the problem. It does seem extremely unlikely on current projections that existing oil reserves will be stranded assets. Many listed oil majors have proven reserves of between 8-10 years (reserves that can be extracted economicOil ally at current prices) and, ironically enough, may not actually be investing enough to meet future demand.

The transportation issue

To see the difficulty with replacing fossil fuels, you only need to look at the transport sector.  Electric vehicles are expected to account for around 14% of the global car stock by 2030, an improvement from current levels, but not enough to make a big short-term dent in oil demand. And while electric vehicles may be a solution for the lighter end of the automotive market, their adoption for heavy goods vehicle use is still some way off. Transport accounts for about half of global oil usage, heavy goods vehicles, with shipping and air transport accounting for some 45% of this. 

How are oil companies planning for the transition?

Irrespective of the pace of the energy transition, the oil majors know they have to think about their future business models as they prepare for the energy transition.

There have been some (small) moves into alternative areas such as renewable energy and recharging infrastructure. At Royal Dutch Shell, a proportion for the Chief Executive’s annual reward is to be linked to the management of the energy transition. In addition, a ‘Strong Societal Licence to Operate’, where the company tries to engage with local communities where it operates and offset any harmful impacts, is a key part of strategy. Shell is targeting a 20% reduction of the net carbon footprint of its energy products by 2035, and 50% by 2050. Activist shareholders, including the Church of England, have spoken in support of its actions.

Gas is also making up an increasing proportion of the oil majors’ portfolios. It is increasingly being used to replace coal and oil in energy generation as an efficient gas plant emits 50-60% less carbon dioxide than an equivalent coal or oil-fired generating plant.

There is also an increasing focus on the downstream businesses where oil is used to produce petrochemicals and other materials. Demand for product and petrochemicals will continue to rise as global GDP increases and electric vehicles are also expected to significantly increase the demand for light vehicle lubricants and other petrochemicals.

Conclusion

It seems the world will continue to rely on oil and gas for some time to come to meet future energy needs. On current scenarios demand will be more than sufficient to utilise even more than the major oil and gas producers’ current reserves.

Meanwhile, the oil majors are adapting to a clean, more energy efficient future while also taking into account shareholder pressure to be part of the solution in the energy transition.

The inherent difficulties of the Paris Agreement do not mean climate goals cannot be met. A significant part of the solution must be increased energy efficiency in transport, industry, construction and domestic use, carbon capture and storage (CCS), and the wider adoption of carbon pricing and changes to government policy. Despite this, it seems society and ‘Big Oil’ will need one another for some time yet.

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