Why the oil industry has less time to decarbonize than it might think

oil petrol

(Credit: Unsplash)

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Bob Orr, Partner and North America Head – Energy Practice, Oliver Wyman & Alejandro Vanags, Partner – Energy Practice, Oliver Wyman

  • To survive and thrive in a lower-emission future, oil companies require nothing less than a transformation of their business model.
  • The demand for oil is falling, as is the value of oil and gas assets.
  • Here’s how the sector’s major players can turn this existential risk into a long-term business opportunity.

There are market signs everywhere of growing impatience with the oil industry. Powerful investors are exiting high-carbon investments or limiting their exposure. As the financial sector incorporates climate risk into credit calculations, companies not prioritizing decarbonization face a higher cost of capital, according to research by environmental disclosure nonprofit CDP. A growing number of regulations worldwide restrict or tax carbon dioxide (CO2) emissions. In surveys, the public ranks climate change as one of the biggest existential threats to the planet. Recently, Google pledged to stop developing artificial intelligence tools for oil exploration. And finally, industries across the spectrum are pledging to go carbon-neutral.

Where does that leave international oil companies? Almost all are working on strategies to cut their emissions by 2050, but they are likely to find that few of their plans go far enough, fast enough to avoid the risk of asset-value erosion. Where many strategies currently revolve around incremental increases in low-carbon investments and purchases of carbon offsets, oil majors need to be aiming instead for a transformation of their business model into one based on what it will take for energy enterprises to thrive in a future threatened by climate change.

How to begin

Setting new priorities for capital allocation is one place to start. The process of reducing dependence on carbon may likely require funnelling investment capital into activities like carbon capture, utilization and storage, renewable power, and low-carbon fuels over oil and gas exploration and development — even when long-term value multiples are uncertain. That new focus is already playing out, as several oil companies have decided to shield their low-carbon investments from capital cuts affecting almost every other part of their business.

The value of oil and gas assets is also likely to head downhill. How fast is unclear, but the risk exists and grows with each passing year. As world economies gradually shift away from dependence on fossil fuels, oil and gas holdings risk the fate of coal assets, which lost more than half their value in less than a decade.

Without divesting some combustible hydrocarbons, real decarbonization for the biggest integrated oil and gas companies would necessitate an almost impossible-to-achieve level of investment in low-carbon power and fuels. Besides reducing risk, near-term divestiture of some assets is a way to capture value and provide cash for reinvestment.

Projected change in primary energy demand by fuel in 2020 relative to 2019
Projected change in primary energy demand by fuel in 2020 relative to 2019
Image: IEA Global Energy Review 2020

Turning risk into opportunity

New investment prospects in low-carbon products and technologies are how oil majors can translate decarbonization into an opportunity to make money rather than just to mitigate risk. Because of policy incentives and a willingness to pay more for clean-energy products among better-off consumers in wealthier nations, some low-carbon products, such as renewable diesel and offshore wind power generation, often realize higher margins. Besides consumer support, companies that move early to develop these new lines of business often enjoy a vibrant talent pool filled with young professionals looking for employers with strong environmental agendas.

Investors have begun to reward low-carbon companies with higher share prices and access to new sources of capital. Take the examples of German electric utility RWE and Danish energy company Ørsted, which both substantially outperformed their markets after moving towards becoming renewable energy companies. Between 2018 and this year, RWE’s shares rose by a third with the acquisition of renewable energy assets from German utility E.ON, and Ørsted’s market capitalization rose by nearly 70% after becoming a renewables-only company in late 2017. Companies entering the low-carbon market also have available a new source of capital from the expanding green bond market, which reached $255 billion in 2019.

What’s the World Economic Forum doing about the transition to clean energy?

Moving to clean energy is key to combating climate change, yet in the past five years, the energy transition has stagnated.

Energy consumption and production contribute to two-thirds of global emissions, and 81% of the global energy system is still based on fossil fuels, the same percentage as 30 years ago. Plus, improvements in the energy intensity of the global economy (the amount of energy used per unit of economic activity) are slowing. In 2018 energy intensity improved by 1.2%, the slowest rate since 2010.

Effective policies, private-sector action and public-private cooperation are needed to create a more inclusive, sustainable, affordable and secure global energy system.

Benchmarking progress is essential to a successful transition. The World Economic Forum’s Energy Transition Index, which ranks 115 economies on how well they balance energy security and access with environmental sustainability and affordability, shows that the biggest challenge facing energy transition is the lack of readiness among the world’s largest emitters, including US, China, India and Russia. The 10 countries that score the highest in terms of readiness account for only 2.6% of global annual emissions.

To future-proof the global energy system, the Forum’s Shaping the Future of Energy and Materials Platform is working on initiatives including, Systemic Efficiency, Innovation and Clean Energy and the Global Battery Alliance to encourage and enable innovative energy investments, technologies and solutions.

Is your organisation interested in working with the World Economic Forum? Find out more here.

Given the current low oil prices, we would argue that now is an opportune time for oil majors to accelerate their decarbonization plans. While investors have often tolerated higher risks in fossil hydrocarbons because of higher returns, they are less likely to accept that exposure when returns on oil and gas are almost on a par with low-carbon energies as they are now.

The industry is in the spotlight because of CO2 emissions — not just its own, but also those generated by oil and gas in the production of energy. In 2018, that amounted to 55% of the world’s total energy-related emissions, according to the International Energy Agency. In a situation like that, you don’t want your oil company to be among the last to effectively address the issue.

Oliver Wyman Senior Consultant Michael Donatti and Principal Tommaso Alderigi contributed research and insights to this article.

the sting Milestone

Featured Stings

Can we feed everyone without unleashing disaster? Read on

These campaigners want to give a quarter of the UK back to nature

How to build a more resilient and inclusive global system

Stopping antimicrobial resistance would cost just USD 2 per person a year

Cultural tolerance is a must: “No sir, I’m not inferior!”

Will Merkel ever steer the EU migration Titanic and restore her power in Germany?

Entrepreneur India Convention 2016: Bringing together Entrepreneurs, Investors, Startups and SMEs

Gains by Abyei interim force can help advance resolution of border issues between Sudan and South Sudan, UN peacekeeping chief says

How public private partnerships must evolve to create social impact

‘Transformational benefits’ of ending outdoor defecation: Why toilets matter

UN condemns Syrian ‘war on children’ as up to 30 reportedly killed in clashes

The results of Finland’s basic income experiment are in. Is it working?

COVID-19: Managing Our Mental Health

Human rights in Brussels and in Beijing: a more balanced approach needed

Syria: Why did the US-Russia brokered ceasefire collapse? What does the duo care for?

October’s EU strong digital mix: From Safe Harbour to Net Neutrality, Roaming and Snowden

To what extent can renewable energy empower women in rural communities?

Phone lines open between Ethiopia and Eritrea, and people are calling strangers

After John Lewis: 21 civil rights leaders who are shaping America

EU Border and Coast Guard: new corps of 10 000 border and coast guards by 2027

IMF: World cup and productivity

MEPs call for EU Magnitsky Act to impose sanctions on human rights abusers

Coronavirus: Commission Statement on consulting Member States on proposal to further expand State aid Temporary Framework to recapitalisation measures

What will higher education in Africa look like after COVID-19?

Societies must unite against ‘global crisis of antisemitic hatred’, Guterres urges

At UN, France’s Macron says more ‘political courage’ is needed to face global challenges

EU lawmakers vote to reintroduce visas for Americans over “reciprocity principle”

South African women’s fury at gender-based attacks spills onto the streets

Khashoggi case highlights ‘very worrying practice’ of overseas abductions, says UN expert

How can coronavirus lockdowns end safely and effectively? – WHO briefing

These 4 trends are shaping the future of your job

The Catcher in the Rice

Sweden gives all employees time off to be entrepreneurs

Draghi: Germany has to spend if Eurozone is to exit recession

These technologies are playing a major role at the Cricket World Cup

Yemen: Escalation in fighting must stop ‘before it’s too late’, Griffiths tells Security Council

EU’s unsparing question to UK: now what kind of future relations do you want?

EU continues targeting on Chinese steel imports instead of the revival of its own economy

Coronavirus: Pandemic alert should be trigger for countries to do more against COVID-19

Respect people’s peaceful assembly and fair trail rights, UN human rights wing urges Nicaragua

COVID-19 has accelerated the digital transformation of higher education

How to provide health education and thus create better health systems

Economic Outlook: Weak trade and investment threaten long-term growth

The company of the future must do well by doing good

Finance for SMEs: Alternative supply mechanisms do exist

Bill Gates: How HIV/AIDS prepared us to tackle COVID-19

We need to rethink the way we heat ourselves. Here’s why

The EU Parliament slams Commission on economic governance

How to promote Primary Healthcare to the Young Healthcare Workforce?

We should look to nature for solutions to the global water crisis. Here’s why

Children suffering ‘atrocities’ as number of countries in conflict hits new peak: UNICEF

France v Croatia: How the World Cup finalists stack up off the pitch

We must stop choking the ocean with plastic waste. Here’s how

First-ever global conference of national counter-terrorism chiefs will strengthen cooperation, build ‘resilient’ States, says top UN official

70 years on, landmark UN human rights document as important as ever

The vital role played by logistics during humanitarian crises

Intervene, don’t overthink – the new mantra of systems design

In tech-driven 21st century, achieving global development goals requires closing digital gender divide

How to create responsible supply chains in the age of globalization 4.0

An ECB banker wants to change the European social model

UN investigates systematic sexual violence across South Sudan

Matthias in Canada

It’s time to gang up: a personal conflict on discrepancies in the medical community

Postal workers in France are helping elderly people fight loneliness

More Stings?


Speak your Mind Here

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s