The Energy Transition and Oil Companies’ Hard Choices

July 09, 2019

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by Rob West and Bassam Fattouh (The Oxford Institute for Energy Studies) In this Energy Insight, we explore the challenges of the energy transition for international oil companies (IOCs). We argue that energy demand forecasts are inconsistent with meeting Paris Agreement targets using currently available and economic technologies and that, barring a radical change in tendencies, significant volumes of oil and gas will be required well after 2050. However, there will be growing political, societal and financial market pressure to accelerate decarbonization. This poses a major challenge for IOCs, whose current business models and technologies are incompatible with full decarbonization, but whose future depends on them being part of the solution. The paper analyzes a set of investment opportunities that the IOCs are pursuing within the decarbonization space and identifies some of the opportunities and risks they face.

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Indeed, there is growing realization that any company that fails to appreciate the changes induced by climate change concerns and societies’ desire for cleaner energy could lose its societal license to operate, its competitiveness, its ability to attract and keep talented personnel and even its access to capital. The wheels are already in motion. For example, we conducted a detailed survey last year, capturing institutional investors’ decreasing interest in the sector. 8 Fears over the energy transition are escalating costs of capital for investing in coal and new long-term oil projects (Figure 3.).

Institutions managing over $6trn of capital have agreed to ‘divest’ from the fossil fuel industry. Oil and gas companies are under increasing pressure from shareholders to reduce emissions from their operations and products and disclose how their strategies can meet the goals of the Paris Climate Agreement. As investors become better organised, these pressures will only intensify. IOCs are also grappling with an increasing number of liability lawsuits brought by counties and cities in the US, which are seeking damages for climate-related problems.9

The energy industry is already well into the transition, due to advances in renewables, unconventionals, digital technologies, electrification and the world’s growing desire for cleaner, lower-carbon energy. IOCs have been adapting their strategies, increasing investment in low carbon technologies, reducing the carbon intensity of their activities, and adjusting their portfolios for instance to increase the share of gas. IOCs have also been setting targets for greenhouse gas (GHG) emissions reductions and regularly monitoring progress towards achieving these targets with some companies linking executive pay to GHG emission performance. They have also been incorporating climate related risks into their
strategies including using an internal carbon price in their investment decisions. However, the pace of change is seen by investors, shareholders, governments, and society in general to be very slow and not enough to confront what some have identified to be ‘the great existential challenge of our times’.10

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It is important to stress that while investment in low carbon technologies represents a new and an expanded opportunity set, serious questions remain as to whether IOCs will be able to capture these opportunities and develop business models that ensure viability and profitability. One can think of multiple reasons why some of the big international oil and gas companies are well equipped to capture some of these opportunities. IOCs have the capital to scale up some of these technologies.

Large-scale projects are key to bringing costs down. In addition to financial strength, they have experience in managing and executing large projects and managing risk. They also have the ability to integrate the new technologies with their existing portfolios, infrastructure, and technical expertise.

They also desire to remain the world’s leading energy companies and not just wither away.

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These (carbon capture and use or storage) projects cannot be scaled up at present because they offer no returns, even with a $20-50/ton carbon price. But next-generation technologies can slash the costs, and could make CCUS economic.
If the world is going to commercialize carbon capture technologies, some IOCs may have a material technology lead, especially from their involvement in LNG, which requires reducing CO2 concentrations in the feed gas down to 50 parts per million. Some also own pipelines and have access to depleted fields where CO2 can be stored. Shell is currently commercializing new solvents, which remove 25% more CO2, for 30% less energy22. ExxonMobil has filed over 30-patents improving swing adsorption processes. But next-generation technologies go even further. A first example, Chemical Looping Combustion, burns fuel in a slurry of metal oxide, yielding energy, metal, water and
CO2, which can immediately be sequestered. The costs fall to $20/ton, for a mere around 4-10% energy penalty, offering economic returns with a $40/ton carbon price. 40 demonstration plants have been constructed so far. TOTAL is now funding the largest project yet, at 3MW, to start up in China in 2023. Another alternative, Oxycombustion, burns fuel in a pure oxygen atmosphere, outputting pure CO2. Costs are competitive with conventional power. Oxy has invested in NET Power, which started up a 25MW natural gas plant in LaPorte, Texas in May-2018.

Beyond these improvements in capture technology, finding ways to utilize and commercialize CO2 emissions is potentially the game changer. On the one hand, carbon utiliization creates a revenue stream and many more opportunities now exist that do not involve enhanced oil recovery. On the other hand, CCUS has the potential to be a negative emission technology, for instance when it involves biomass. Recent studies estimate that negative emission technologies could absorb between 7-10 GtCO2 at a cost of less than $100/tCO2. That is a significant share of current global energyrelated emissions of 37 GtCO2. If these studies proved to be correct, negative-emission CCUS could help to create a cushion for the continued use of hydrocarbons.23

Re-use and recycle: opportunities in the circular economy
Another opportunity to lower fuel use is to recycle waste products and plant materials. Numerous companies are pursuing such projects. Most vocally, Eni’s “Ecofining” draws on used cooking oils. We have also counted 70 biofuels patents from IOCs in 2018.

We see most potential in plastics. 85% of the world’s plastic is currently incinerated, dumped into landfill, or worst of all, ends up in the oceans. The challenge is that conventional, mechanical recycling can only be conducted on pure, PET and HDPE, around 21% of the market. An alternative, Plastic pyrolysis is near to commercialisation. READ MORE / MORE

Why doesn't Shell stop producing oil and gas? (The Energy Podcast)

BlackRock lost $90bn investing in fossil fuel companies, report finds -- World’s biggest fund manager urged to invest in clean energy for good of the climate and its investors (The Guardian)

Climate change poses new threat to US cities' long-term creditworthiness (S&P Global)

How Climate Change Could Trigger the Next Global Financial Crisis -- The Federal Reserve should act aggressively to reduce that risk, a leading economic historian argues. (The Atlantic)

Chevron starts burying CO2 off Australia at huge Gorgon storage project (Reuters)

Big Tech's eco-pledges aren't slowing its pursuit of Big Oil (ABC News)

Goldman Sachs Will Not Fund Arctic Drilling, Pledges $750B to Fight Climate Change (Our Daily Planet)

Is This The Beginning Of The End For Fossil Fuels? (Yahoo! Finance/OilPrice.com)

Excerpt from S&P Global: The analysts say, "We're rating your bonds, and are you going to be able to pay them back given what's occurring in your city?" Honolulu Mayor Kirk Caldwell said July 17 during a hearing held by the U.S. Senate Democrats' Special Committee on the Climate Risks. Hawaii's Climate Change Mitigation & Adaptation Committee estimated in 2017 that if unaddressed, frequent flooding in the state caused by rising sea levels could result in $19 billion in economic losses, with the greatest potential loss in Honolulu.

An official of another city struggling with sea-level rise, Miami Beach, Fla., Assistant City Manager and Chief Resiliency Officer Susanne Torriente, said during a March climate conference in Baltimore that she is becoming increasingly aware of the need to communicate to investors and bond rating analysts the proactive steps her city is making to adapt to climate change.

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Moody's Vice President Michael Wertz said that while climate change is rarely the main reason behind a credit downgrade, a city could struggle to pay back its bonds if it is dependent on one source of tax revenues, such as beach tourism, that could be disrupted by climate change. Cities may have similar trouble if a large number of its residents and businesses decide not to rebuild or relocate after repeated disasters blamed on climate change.

Given Moody's Corp.'s increasing focus on climate issues, the firm recently bought a majority stake in climate-risk data provider Four Twenty Seven Inc.

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Moreover, flooding in U.S. coastal cities that decades ago happened only during a major storm can now occur on sunny days when a steady breeze or a change in coastal currents overlap with a high tide and rising sea levels. Such "nuisance" flooding is contributing to overwash and beach erosion, overwhelming stormwater systems, disrupting harbor operations, closing roadways, degrading subsurface infrastructures such as pipelines, and hurting property values, the U.S. National Oceanic and Atmospheric Administration, or NOAA, said in a July report.

The NOAA found that the annual rate of high-tide flooding is rapidly increasing in more than 40 locations. Washington, D.C., for example, could see the average annual number of flood days increase from three in 2000 to 120 by 2050, the NOAA forecast. Similarly, Miami could experience 55 more high-tide flood days by 2050 compared to 2000. And Morgans Point, Texas, just south of Houston, could see as many as 215 flood days annually by 2050, compared to its average of four flood days in 2000.

Federal funding is not sure thing

City officials and investors typically assume that the federal government, largely through the Federal Emergency Management Agency, will step up to fund recovery from a disaster, experts said. But FEMA may not always be willing to back recovery for projects in areas that were already known to be vulnerable and where the city could have prevented the damage, leaving the city or state to foot the bill.

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The federal government is in the early stages of creating programs and funds tied to adaptation efforts, said Laura Lightbody, a project director at The Pew Charitable Trusts, which has studied the issue of disaster funding.

"We're really good at handing out money after disasters happen but there aren't enough available funds at all levels — local, state and federal — to do activities like buying out repeatedly flooded properties and enhancing stormwater management systems before a disaster happens or [for projects that] are not tied to a disaster happening," Lightbody said.

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The lack of pressure from the investor community means cities and localities have little to no incentive to disclose their climate-related risks. Columbia University and The Brookings Institution recently found that most local governments that depend on revenues from the coal industry are not disclosing those risks nor are they discussing how climate policies are causing declining coal production and threatening the future economic health of their local communities. READ MORE