The Energy Transition is upon us and one of the key challenges facing today’s oil and gas companies is: how do they address the fundamental changes that are needed in their business to adapt to, take part in and thrive in this radically new environment for energy companies? Governments and increasing numbers of shareholders are pressing for clarity on the implication of the Energy Transition on oil and gas industry operations since the increasing social and environmental pressures on the industry prompt questions about the industry’s position in today’s society and its licence to operate. The oil and gas industry – all of which will be affected - is divided on the correct response and only time will tell which is – or was – the right approach to adopt.
What is the Energy Transition?
The Energy Transition is the global energy sector’s move from a fossil-based (oil, gas and coal) system of energy production and consumption – to one based on renewable energy sources like wind and solar as well as lithium-ion batteries for power storage. The main drivers of the Energy Transition are renewable energy’s growing share of energy production, greater electrification, better electricity storage and a desire to decarbonise the global economy. A combination of technological change and public pressure have enabled and encouraged this switch away from oil and gas – and towards renewables.
Challenges to the Energy Transition
There are a series of challenges that will need to be overcome successfully if the Energy Transition is to be successful. These include:
- The balance needed between a desire for energy for everyone and the absence of electricity supplies to around a seventh of the world’s population
- The need to cut greenhouse gas emissions and the fact that emissions reached their highest-ever levels in 2018 and 2019, although do appear to be stabilising
- The population’s expectations of a rapid Energy Transition driven by renewables while fossil fuels remain major components of the global energy system (84.3% in 2019, down just 0.5% from the 2018 level).
- Total investment in the energy sector is very substantial (about $1.9 tn), but not too much is being invested in low-carbon energy (the IEA says just $311 bn in renewable energy during 2019) and with the Covid-19 pandemic and the resulting debts that countries have taken on, there will be a temptation to go for the cheapest solutions – which may well be fossil fuels rather than renewable energy.
Impact of Covid-19 on the Energy Transition
The Covid-19 pandemic’s most obvious impact on the Energy Transition is the sharp fall in energy demand that took place in 2Q as a result of the extensive lockdowns imposed by governments. At its peak in April, the International Energy Agency calculated that 4.2 bn people (58% of the world’s population and 60% of its GDP) were locked down while much of the rest were affected by containment measures of varying degrees of severity. This fall is particularly noticeable in oil demand, estimated to fall by 8% this year largely because of a decline in transport demand. Coal demand is also forecast to decline by 8% in 2020 because of the fall in industrial activity and lower electricity demand. Gas gets off relatively lightly with just an anticipated 4% decline, mainly in developed markets and in power generation (for the same reason as coal demand declined – decreased industrial activity). Electricity demand is expected to decline by 5% globally – hence lower coal and gas demand, as well as nuclear generation. Renewable energy production, however, is expected to increase because of its low operating costs and its preferential access to many power systems.
Peak Oil – past or future?
To some people, “Peak Oil” means the maximum amount of oil ever produced in a year – I suspect it dates back to the Club of Rome and it’s 1972 publication “The Limits to Growth” when we thought we were running out of oil (and other resources) - but clearly we’re not running out of oil. Indeed, this is the first time I’ve referred to the Club of Rome since my economics class at secondary school in the mid-1970s, so much has the debate about resources moved on.
These days “Peak Oil” is more likely to refer to the consumption or demand side of the equation, rather than the supply side. Oil demand has been rising at relatively low rates in recent years, reaching 99.8 mn bbls/day in 2019 according to the IEA. That was up just 1.1% on the 2018 level. 2020 was expected to show a similar very modest increase.
In reality of course, oil demand is now forecast by the IEA to fall by more than 8 mbd this year to 91.7 mbd, taking us back to the level of 2012/2013. While there’s a sizeable increase forecast for 2021 (5.7 mbd), there are now many voices arguing that we have already seen Peak Oil and that the future is the downslope of slowly declining oil demand (with that demand replaced by renewables and other fuels) rather than the upslope of gently rising oil demand – they argue, rightly in my view, that we are “over the hill”. The Energy Transition, and the speed with which it is accomplished, is going to be key to where oil demand goes and what that means for the industry and the world economy.
Financial markets are unimpressed with the oil and gas sector these days. My friends who remain oil analysts tell me that it’s “a really hard sell, nobody’s interested in a sunset industry”. It wasn’t like that when I was an oil analyst for big (and small) investment banks of course. In my day, Brent reached $147/bbl (June 2008) and investors couldn’t get enough of the sector (fortunately for me). Even a decade ago, oil and gas was 15% of the S&P, today it’s just 3%.
Cooler heads have prevailed since then and many have asked what the future is for the oil and gas industry as we go through the Energy Transition. Which companies will come through it in best shape to take advantage of the opportunities that will be created and which, while not falling by the wayside as such (Big Oil is…well, Big), will end up being in the wrong place to seize those opportunities and may have to cede ground to smaller, more thoughtful or nimbler rivals. Back in 1975, Anthony Sampson wrote his seminal book “The Seven Sisters” about the seven giant – private-sector - oil companies which dominated the world’s oil supply in the post-Arab oil embargo world. Only four of those still exist (BP, Shell, Exxon and Chevron) while the other three erstwhile giants (Gulf, Mobil and Texaco), and many others (Amoco, Arco, BG, Burmah Castrol, Elf Aquitaine, Getty Oil, Petrofina, Standard of Ohio and Unocal to name just a few) have long since vanished through acquisitions by strategically better-placed competitors.
What of today’s oil and gas majors – how are they preparing for a future without so much oil and gas? We should remember that they’re not going out of business – oil and gas (and probably coal) as energy sources are going to be around for quite some time and the oil and gas majors didn’t get to be Big Oil without spotting good business opportunities and bad risks (or perhaps they didn’t spot them but just had very large margins).
It’s been estimated by the IEA that the major oil companies represent 12% of the world’s oil and gas reserves, 15% of production and 10% of emissions. Today, unlike the Seven Sisters era, it is the national oil companies like Saudi Aramco, PetroChina and Rosneft which control most oil and gas reserves and production. The International Energy Agency produced a large and interesting report in January on the oil and gas industry in the transition, which was rapidly overtaken by the Covid epidemic, but in it the Agency identified that oil and gas company capital investment in areas outside their core business was much less than 1% in the last five years. This includes investments in the electricity sector, the electric mobility business and in greater R&D.
While that 1% will not be a small number in absolute terms, given the size of oil companies’ balance sheets and expenditure, it feels like too small an amount for the grand vision of the Energy Transition to be realised on this amount alone. There is also no question that there is no one-size-fits-all approach across the industry and most of the companies have their own approach to the Energy Transition.
Finally, the industry’s ESG operating environment is changing. Government policies are shifting from those which promote oil and gas production and consumption to those which discourage it and instead incentivise alternative fuels – such as carbon pricing and the EU’s Emission Trading Scheme. Investors are also paying much closer attention to companies’ performance and behaviour when it comes to decarbonisation, monetising their assets within a realistic commercial timescale and net zero emissions pledges.
Big Oil’s approach to the Energy Transition
Covid-19 has not stopped the majors from announcing their preparations to respond to the challenges of the Energy Transition. There is an obvious trans-Atlantic divide, with the European majors embracing the needed changes with perhaps more enthusiasm than their US counterparts. Big Energy vs Big Oil it has been called by some. Oil, gas and power are all areas of differentiation between the two sides of the Atlantic. However, for companies both sides of the ocean, it is a major challenge to decarbonise, to invest and to remain profitable.
The Europeans are talking about net zero emissions by 2050, not a phrase heard very much in the US. I sense they are also being more proactive in shaping their companies to meet what they view as the demands of the energy transition through reorganisations, acquisitions of low-carbon assets and a ramp-up in green power generation.
BP appointed a new CEO earlier this year and has since announced bold Energy Transition targets. The company plans to decarbonise its oil and gas production, remove emissions from its own operations and remain a financially attractive investment through maintaining its - relatively high - dividend. The company is being reorganised with more of a feel of a cross-energy business rather than a series of energy silos. All of this was announced relatively swiftly after the new CEO (Bernard Looney, an internal appointment) took over and in the last two weeks the company wrote down $17.5 bn of its assets because it foresees a faster Energy Transition and lower oil prices while it heads towards its goal of net-zero emissions by 2050. The finer details of all the changes are still sketchy but there is no question that BP has nailed its colours to the mast of the Energy Transition and expects to be judged on how well it steers through it.
ENI has, like BP, reorganised itself into two divisions – natural resources and energy evolution to reflect ENI’s new focus on the Energy Transition. It plans to cut its greenhouse gas emissions by 30% by 2035 and 80% by 2050. Like Total it aims to sharply reduce its carbon intensity - by 55% by 2050. Oil output will decline as a percentage of its energy mix from 2025 onwards and gas will grow to represent 60% of upstream output by 2030 and 85% by 2050.
Shell, often viewed as the most thoughtful and strategic of the majors, may well be aiming for a portfolio resilient to changes in both the oil sector and in the renewables sector. Shell’s CEO Ben van Beurden has described Shell as an “energy transition company” although admits that he regrets not buying Dutch sustainable energy company Eneco last year when it was outbid, highlighting how conservative Big Oil remains when it comes to making bold moves in sectors outside its traditional remit and experience. In 2017, the company set a target of cutting its carbon intensity by 50% by 2050 – and recently raised this to a 65% cut, although like BP’s plans, details are scarce. It also has quite a substantial budget for its renewable and low carbon investments.
Total, where I used to work, is more explicitly aggressive with its plans, seeing oil – which was 55% of sales last year – falling to 45% by 2030 and just 20% by 2050, with a quarter of these being biofuels. Renewable power will rise from 5% of the company’s portfolio today to 40% in 2050. Gas is likely to remain around 40% of the company’s energy mix, although even here there will be decarbonisation, with the gas component being a mixture of conventional gas and green gas from biogas. Carbon intensity is set to drop by 60% and the company announced a net zero target for 2050 across all its activities – in Europe at least.
The company has substantial plans to invest in renewable power projects, although to get to its target of green power being 40% of its portfolio will require even more substantial investments in the power sector. Moving in the same lower carbon intensity direction Total plans to avoid expensive new oil projects that don’t meet its profitability targets and is publicly supportive of a high carbon price to help the entire industry decarbonise.
The European majors all seem to be shifting to an energy split of oil representing 10-20% of energy production, gas 40-55% and green power 25-45% by 2020 according to Energy Intelligence analysis. It’s not so clear that the US companies are doing the same.
Chevron is hedging its bets, using its low debt (15%) and short-development cycles for its oil to give it time (and money) to assess what’s happening with the Energy Transition. Chevron to me seems a little passive about its strategy, aiming (hoping?) for growth while accepting that the company might well shrink if prices remain low and preparing itself to survive in today’s environment. That may be an entirely rational economic response to low prices (and the company did announce a 10-15% cut in jobs), but I still haven’t heard too many companies telling their investors they’re going to shrink. The company’s CEO is on record as saying he believes the market will want more oil rather than less oil than today, disagreeing with the Peak Oil hypothesis that suggests the opposite. The concern is that, even with time in hand to work out where the industry is going, it may get there before Chevron is ready to respond to the change and the company could suffer in contrast to those companies which have prepared for a range of possible changes to their business models.
ExxonMobil seems to be focusing on maintaining its conventional oil and gas positioning through carbon capture and the development of biofuels. The company is keen on growing its oil output in the expectation that, when needed to meet the demands of the regulators, its investments in carbon capture and storage will enable it to meet its production targets. While it has delayed some growth targets, not too much else has changed. Wood Mackenzie, on the other hand noted that ExxonMobil’s cash returns were adversely affected by the large proportion of low margin assets in its portfolio.
In my view, there is a clear trans-Atlantic divide. Total may well be the industry leader in terms of its ambitions and delivery to date. BP and Shell have both expressed lofty ambitions for their Energy Transition plans which need to be explained further while Exxon – and, to some degree, Chevron – are both taking a measured approach to the whole issue of the needed changes.
The private-sector oil industry is just one part of the industry which is responding to the Energy Transition. Another important part consists of the National Oil Companies like Aramco, PetroChina and Rosneft. In a future blog I’ll take a look at these companies and see how they stack up in their response.