The strong and growing pressure on oil and gas companies to dramatically reconfigure their core businesses to accept a lower-carbon agenda could soon lead to irreversible changes in the energy commodity markets.
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Investors and policymakers worldwide are rapidly increasing their focus on environmental, social and governance, or ESG, factors. Oil and gas companies risk losing billions of dollars in investor capital if they do not adapt.
The stakes are high, especially in the U.S., because any cuts in investor capital could materially impact the supply of oil and gas.
The European Commission passed a law aiming for net-zero emissions across the region by 2050, and shareholders of many European companies have approved legally binding resolutions demanding decarbonization.
'If you build it, they will come'
European integrated oil majors have led the charge, acknowledging the inevitability of the transition, as well as the scale of the challenge, as they face the possibility that petroleum demand could peak in the next decade. However, the majors are all moving at different paces in their efforts to reduce their carbon footprints.
"A lot of European companies had already begun to take steps to elevate ESG investor concerns into their own investment portfolios. And … I think a lot of that is reflective of where those companies' assets are," said Ken Medlock, senior director of the Center for Energy Studies at Rice University's Baker Institute for Public Policy. "Government policy and policy intent is a major influencer."
Royal Dutch Shell PLC, BP PLC, Eni SpA, Repsol SA, Equinor ASA and TOTAL SE are working to diversify and decarbonize their portfolios by turning to natural gas, electricity and renewables to meet self-imposed emissions reduction goals.
"Repsol and some other EU majors deserve high praise for setting goals, but when you look at them, there is a little bit of, 'If you build it, they will come.' You set an ambitious goal and figure out how to get there," Margaret Peloso, an environmental-focused partner at law firm Vinson & Elkins, said during a July 9 webinar hosted by S&P Global Ratings.
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"If your strategy involves investing a lot of money into lower-margin, lower-carbon segments and you think it will be supported by income coming in from more conventional activities, this pricing environment blows that thesis out of the water," she said.
The European Commission in December 2019 laid out its European Green Deal, an economy-wide strategy to reach net-zero emissions by 2050. Net-zero emissions means that all carbon would have to either be eliminated or offset.
"Climate change is a much bigger issue in Europe, and by releasing plans to reduce emissions, the [European] companies placate regulators and investors," Raymond James energy analyst Muhammed Ghulam said.
'A sea change'
U.S.-based oil and gas companies began to pay closer attention to environmental concerns in 2018 and 2019, when many began to issue yearly sustainability reports. But in most cases, their efforts were more acknowledgement of the issue than a plan for action.
"There's been a sea change in the last ... five years," Jody Freeman, who serves on the ConocoPhillips board, said at the July 9 webinar. "These issues were seen as sort of fringe interest or niche issues before, [but] they have moved to the strategic center for oil and gas."
"In the competition for capital, there will be this positioning and repositioning; I think ESG is still a part of this," Freeman said. "It's remarkable that at this really difficult time, the conversation about ESG and climate risk has not abated; if anything it's intensified."
According to Medlock, the investor community dictates the pace of change, which also dictates capital flow.
"At the end of the day, if the investment community ratchets up pressure on this front, it's going to force companies to differentiate themselves from the pack by coming up with lower-carbon solutions," Medlock said. "And that's how they'll end up winning, because they'll be able to more successfully attract more capital than their peers. And that pressure's been growing for the last couple of years and it's going to continue to grow," he said.
BlackRock Inc. CEO Larry Fink has said that the asset manager would make sustainability its "new standard for investing." In a January 2020 letter to clients, Fink promised to disinvest in coal and more closely scrutinize oil and gas companies.
"[B]y the end of 2020, we intend to provide transparent, publicly available data on sustainability characteristics — including data on controversial holdings and carbon footprint — for BlackRock mutual funds," he said.
Taking aim at intensity
Despite their slower pace, many U.S. companies have already reduced greenhouse gas emissions by some percentage in recent years through efficiencies and other internal efforts. Some have set specific percentage targets to slash greenhouse gas emissions in the future, as well as gas flaring targets.
"We are working to be part of the solution," Chevron Corp. spokesman Sean Comey said in an email, noting that the company's intensity reduction goals are linked to nearly all employees' financial compensation. "We are lowering the company's carbon intensity cost efficiently, increasing the use of renewable energy in our business and investing in future breakthrough technologies," he said.
In addition to Exxon Mobil Corp. and Occidental Petroleum Corp., Chevron is one of three U.S.-based companies in the 10-member Oil and Gas Climate Initiative that on July 16 set firm emission reduction targets for carbon and methane. The OGCI coalition pledged to cut the carbon intensity of their combined upstream operations to between 20 kilograms and 21 kg of carbon dioxide equivalent per barrel of oil equivalent by 2025. The target, which covers both CO2 and methane emissions, represents a reduction of between 36 million tons and 52 million tons of CO2e per year by 2025.
Intensity-based targets measure the amount of emissions released into the atmosphere divided by net hydrocarbon production. A company could maintain or even increase oil and gas production and still hit its carbon intensity targets by adding low-carbon alternatives like solar and wind farms to its portfolio.
This is a key point of criticism from environmental groups, who are clamoring for a cut in baseline emissions instead.
"This [OGCI] target is based on intensity, so it allows increases in emissions overall, and a group average may let poor performers off the hook," Andrew Grant, head of oil, gas and mining at London-based climate think tank the Carbon Tracker Initiative, said in a July 16 statement.
"Furthermore, [the OGCI target] only applies to a small proportion of emissions; a 13% reduction in upstream emissions translates to only a 2% reduction in lifecycle CO2 for oil and gas," he said.
US companies severely lagging European peers
Aside from the majors, there are no North American producers, refiners or midstream firms with net zero emissions goals yet, but it is also much harder for companies in these fossil fuel-heavy sectors to truly achieve a net-zero status.
In the midstream space, the natural gas-focused Williams Cos. Inc. is the only major pipeline player even publicly considering such goals.
"We are currently studying a net-zero initiative for Williams and developing our strategy for a responsible transition to a low-carbon future," Williams spokesman Tom Droege said, noting the firm's next sustainability report should come out by the end of July.
Net-zero goals pledged out to 2050 or so represent major progress for the energy sector, said Ben Ratner, senior director for the Environmental Defense Fund, but they could also end up being empty promises for companies that may cycle through at least five more CEOs in the next 30 years.
Upstream firms must pledge to eliminate natural gas flaring in five years, Ratner said, while midstream firms must work collaboratively with them to ensure there is enough takeaway and processing capacity so the producers can do away with flaring.
Ratner said that Midstream firms also need to eliminate emissions and avoid leaks and spills. They must also lobby for carbon pricing and carbon-capture funding.
Ensuring adequate supply through the energy transition
"In many ways, the efforts are not to move away from oil and gas, but to figure out ways to make it cleaner," Medlock said, pointing to hydrogen transformation, carbon capture and other projects being funded largely by the majors.
When these budding technologies become commercially viable, it could become easier for some companies to meet their targets.
Firm government mandates could help make those decisions a little easier, as it would directly incentivize research and development as a means to reach a collective regional goal.
"You're going to learn as you do, and hopefully that's going to lower costs," Medlock said, noting how production tax credits and investment tax credits played a key role in cutting costs for wind and solar power.
"[I]f anyone is going to figure this out, it's [the oil and gas companies themselves]," he said. "They just need the right incentives."
Starr Spencer and Jordan Blum are reporters with S&P Global Platts. S&P Global Platts, S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc. Trucost is part of S&P Global Market Intelligence.