Big Oil And Climate Leadership — An Oxymoron?

By Georg Kell

With the energy sector accounting for over 70% of total emissions that cause global warming, big oil has long been at the center of the climate debate. As early as 1997, Lord Browne, then CEO of BP, acknowledged that climate change was a problem. Today, more than twenty years later, evidence of the impact of global warming is growing and decarbonization and energy transformation are looming imperatives. The need to accelerate the transformation away from fossil fuels towards cleaner sources of energy is widely recognized with a few notable exceptions of policy leaders who ignore science and reason – and amazingly get away with it.

Some European oil companies have long paid attention to climate science but by and large big oil used to play a “wait and see” strategy, with some oil companies engaging in sinister fact distortion. A major change took place in 2015 on the margins of the Paris Climate Agreement. Ten oil majors from Europe, Asia and Latin America (US-based companies have not yet joined) formed the Oil and Gas Climate Initiative (OGCI). They pledged to reduce emissions and to explore new business models and technologies in alignment with the Paris Agreement’s goal to keep global warming well below 2 degrees Celsius.

But can big oil really be part of a low-carbon future? A growing number of investors think that this is indeed not possible. The divestment-from-fossil-fuel movement has seen enormous growth from just US$ 52 billion four years ago to over US$ 6 trillion today. Despite this strong signal from the divestment movement, we know that oil and gas cannot just be switched off. Our modern lives would collapse into chaos and the hopes of hundreds of million people around the world who still don’t have access to modern energy would be dashed. Even phasing out coal seems to be a tedious undertaking – hundreds of new coal-fired power plants are currently under planning or construction in Southeast Asia alone and countries such as Germany that are leading on the renewable energy front still rely on coal to generate power. The real question seems to be whether big oil will continue to play with time and carry on with business as usual, as long as this is profitable, or whether, when and to what extent they will it start to prepare for a low-carbon future by reducing emissions in their own operations and by developing transition strategies.

Shining a light on this question is clouded by several factors: a lack of transparency about oil and gas-related emissions, an absence of coherent measurement methodologies (Carnegie Oil Climate Index) and uneven progress of regulatory efforts and voluntary transparency initiatives aimed at measuring emissions. But there are good developments. Following the Task Force on Climate Related Financial Disclosure (TCFD), a handful of companies (Equinor, ENI, Total and Shell) are now spearheading the development of relevant metrics and disclosure. Growing pressure by investors, improvements by organizations such as the Carbon Disclosure Project (CDP) and the advent of big data analysis will undoubtedly lead to significant disclosure improvements.

The second problem is that projections by the International Energy Agency (IEA) and similar “linear scenario models” which are frequently used as points of reference by policymakers and executives consistently underestimate the diffusion of renewable energy and its rapidly improving cost competitiveness (see the International Renewable Energy Agency (IRENA) for an up-to-date picture of the status of renewables). These models all predict growing energy demand and high share of fossil fuels for decades to come, largely on account of population and economic growth. However, the projected scenarios are seriously flawed and don’t paint an up-to-date picture of the status of renewables. They also fail to take into account the obvious fact that the longer we delay emission reduction, the more robust and disruptive policy reactions will be once societies are forced to face the implications of global warming. We can assume beyond a reasonable doubt that such a “climate Minsky moment” as Mark Carney, Governor of the Bank of England, recently called it, is likely to happen within the not-so-distant future.

A recent study by the DNV GL is a breath of fresh air and draws a more nuanced picture. The report recognizes the inevitability of higher carbon prices and the compound diffusion of technology. Furthermore, it projects a rapid growth of electrification – especially in transport – and acknowledges the uncertainties ahead. Among its findings are that global energy demand may well peak by 2035, leading to a historic decoupling of GDP and energy growth. Moreover, the report suggests that demand for oil will peak in the mid 2020s.

Even a cursory view at the corporate level shows that there are enormous variations across big oil companies when it comes to reducing emissions within their own operations. According to a recent article in Science Magazine, the production, transport and refining of crude oils, such as gasoline and diesel, account for 15 –40% of transport fuel emissions. Within the narrower scope of upstream activities, average industry estimates are 17kg of emissions per BOE (barrel of oil equivalent), based on annual surveys of the International Association of Oil and Gas Producers. Some of the worst performing companies produce over 30kg of carbon dioxide per BOE while the best performer, Equinor, has managed to reduce that figure to 9kg and intends to bring it down even further. The picture is similar when it comes to gas flaring, the burning of surplus gas when drilling for oil and gas. Flaring continues to be a significant source of carbon dioxide and other harmful gas emissions. Efforts to reduce and end flaring were high on political agendas around the time of the Paris Agreement. But more recently such policy efforts have been reversed, cheered on by the oil and gas industries under the generic headline of deregulation.

Source: Getty

Another critical area where big oil can demonstrate climate action is the reduction of methane leakages in conjunction with gas drilling. Natural gas is often seen as a critical transition energy. The growing share of natural gas in the portfolio of big oil, now accounting for 40% or more for many companies, can itself be seen as a proxy for adapting to the changing climate context. There are clear benefits to natural gas. When combusted as methane, it generates only about half as much carbon emissions as coal. However, methane leakages along the value chain can reduce the climate benefits of natural gas. Methane is the second most important contributor to emissions that cause global warming, accounting for about 16% (carbon dioxide is leading with 65%). Methane is estimated to be 100 times more potent than carbon dioxide. If leakages were to exceed 3.2%, the climate benefits of natural gas would be offset. The good news is that with a high focus on energy optimization and extensive emission reduction programs – motivated among others by a carbon price of US$ 50 per ton – leakages can be minimized to below 0.3% as is the case with Norwegian gas. Indeed, numbers from Equinor suggest that the upstream part is less than 0.1% and that most of the remaining leaks are with local distribution and customers.

The world will continue to rely on oil and gas for years to come. It will take decades to transform the energy system. It is therefore key that big oil reduces its own emissions. This will not only signal a commitment to climate action here and now, it will also pave the way for the energy transformation by touching on regulatory questions and broader changes in the marketplace. However, present actions to reduce emissions are not sufficient. Big oil must also prepare for transition strategies beyond fossil fuel. A forthcoming study by Deutsche Bank makes this case and provides an overview of the type of investments already undertaken, such as renewable energy and utility markets. Investing in transition strategies does not come without risks and it is too early to identify winners. Such investments show how serious big oil is about its own ambitions to become a player in the new growth markets and whether they hedge against climate risks and the possibility of stranded assets. A closer look shows that European big oil is leading in terms of capital expenditure. Equinor is an early mover, already spending over 6% of its capital in offshore wind production and carbon capture and storage. They have announced plans to quadruple the share in the coming years. Others, such as Shell, Total and Repsol are spending about 3% of their capital on renewable power generation and energy retail. These figures are still modest compared to capital expended on oil and gas exploration. But they are significant overall and an indication that big oil is seriously considering to diversify. The performance and share of such investments over time will more clearly indicate to what extent big oil can be part of the solution.

Source: Getty

A massive transformation of the energy sector is under way, driven by declining costs of renewable energy, electrification of transportation (especially of road transportation), and digitalization. Finance is increasingly paying attention to climate change risks. Besides the “hard exit” as advocated by the divestment movement, there is a rapidly evolving “soft divestment” in the form of ESG investing, now covering over US$ 20 trillion and rapidly growing. Powered by big data and machine learning as advanced by the Arabesque S Ray technology, investors are gradually and progressively relocating from high carbon to low carbon investments. As climate risks become ever more tangible and as data availability to assess these risks continues to improve, finance will increasingly become a driving force for accelerating the transformation of the energy sector.

Some big oil companies are making real progress. To show true climate leadership, big oil now needs to be transparent about climate risks, disclose relevant data and double down on improving carbon efficiency. Companies must also minimize methane leakages within their own operations and scale up transition investments. And when it comes to public and government affairs, it would seem very shortsighted to be on the wrong side of history. Making the case for carbon pricing and tighter rules on emission controls, such as methane leakages, may well be in the industry’s best interest over time, if indeed they want to be part of the solution. After all, it is just a question of time when governments and people will be forced to take much bolder action to reduce emissions than we have done so far.