The oil and gas industry is currently in crisis — supply exceeds demand and has resulted in oil prices falling to less than half their value of 12 months ago. According to the Financial Times in June 2015, this has led to postponement or cancellation of ca. $200 billion worth of projects worldwide (Adams, 2015). The industry is restructuring and many staff are being laid off; figures quoted in June 2015 indicate 150,000 worldwide (Eaton, 2015).
But worse may be to come. Because of increasing concerns about the effects of high carbon dioxide (CO2) emissions on the planet’s climate, the oil and gas industry will need to adapt to a future of regulated carbon usage and lower demand, as technology enables other energy sources to power traditionally oil and gas dominated sectors.
Transitioning to a low-carbon future is one of the greatest challenges of our times. Ignoring it is not an option.
by Sue Paterson, Associate.
Sue is an oil and gas professional with almost 35 years’ UK and international experience including profit/loss accountability, developed within the industry and in consulting. She has a subsurface technical background and extensive management experience. Her passions are business sustainability, and supporting people to be the best that they can be.
This paper outlines a Blueprint for Adapting to a Low-Carbon Economy after considering the risks and opportunities in a low carbon world. To read the full “Blueprint for Transition to a Low-Carbon Economy” please contact Pale Blue Dot Energy by clicking here.
2. Risks & Opportunities in a Low-Carbon World
Most oil and gas industry planning assumes that demand for fossil fuels will continue to grow due to the world’s increasing population and industrialisation. But tackling climate change by keeping below a 2°C global temperature increase requires that consumption peaks within the next decade and then reduces significantly. This means that the oil and gas industry will have to change profoundly over the next couple of decades.
It needs to minimise the risks and maximise the opportunities related to a low-carbon world, as well as build its competence to operate in a new context. To do this successfully, it needs to play to its strengths: deep understanding of the energy markets; subsurface and surface expertise and technology; and large-scale project management excellence.
Two broad areas of risk have been identified. These are (1) lower demand for fossil fuels leading to volatile prices; and (2) poor investor appetite.
Opportunities for diversification and growth exist in the areas of (1) fuel switching and (2) technology innovation.
2.1. Minimise the Risks
2.1.1 Risk of Lower Demand for Fossil Fuels
Underpinning successful oil company planning is the ability to predict future oil prices and, though notoriously difficult, it relies on understanding the overall market, especially demand and supply. As we have seen, ‘Business As Usual’ predictions assume growth in demand with an attendant rise in supply and oil price. Uncertainties in growth of major economies (like China and India), geopolitical uncertainties (especially in high producing countries in the Middle East), and new sources of fuels (for example the US fracking revolution) can have significant impacts on the balance of supply and demand, and consequently oil price, but these have tended to be temporary in the past.
Tackling climate change however will lead to long-term pressure to reduce demand, have an impact on supply and lead to increased oil price volatility.
Demand reduction can happen because of changes in (1) regulation and climate policies; (2) consumer behaviour; and (3) technology that improves efficiencies. All these are inter-related: changes in regulation and climate policies are the initial drivers and they can have a direct effect on the industry. These then later feed through to encourage consumers to change behaviours and stimulate new technology. In addition, lower demand may arise due to (4) increasing electrification using low-carbon sources; and (5) battery storage.
(1) Regulation and Climate Policies. Policymakers are already taking steps to encourage reduction of CO2 emissions. This will increase as committed GHG emission targets agreed at the 2015 UN conference in Paris take hold. Specific regulations are already being imposed to increase efficiency in many sectors (cars, buildings, electrical appliances) that is reducing demand, and this could increase. Fuel subsidies may be removed.
Policy makers have also already begun to introduce a ‘cost of carbon’ on CO2 emissions of some businesses. In future, this may include the cost of carbon on the oil and gas industry’s own footprint, which will impact downstream refineries, and high carbon exploration and production activities such as tar sands.
Stimulation of investment and innovation in clean and efficient fuels has led to increasing supply and demand for renewable energy.
In future, other actions may be taken such as “cap and trade” schemes that limit CO2 emissions and high taxes on production or sale of carbon based fuels. Obligations could be imposed on companies taking carbon out of the ground to arrange for a rising share of what they extract to be buried again, e.g. in CCS plants.
(2) Consumer Behaviour. A combination of tax and subsidy changes, and increased awareness of climate change, is leading consumers to change their behaviour to reduce emissions, especially in the transport and domestic heating sectors.
Consumer products are being developed (e.g. light bulbs, electronic goods] that significantly reduce energy demand.
Campaigns to reduce personal usage of energy by switching off appliances when not in use, reducing distances travelled, and buying items produced or grown locally are starting to proliferate.
(3) Technology Innovation for Efficiency. Technological innovation is already being applied to improving energy efficiency, for example by upgrading building insulation, and developing more fuel efficient cars and electrical appliances.
(4) Increased Electriﬁcation Using Low-Carbon Sources. Changing energy sources from fossil fuels to electricity can lead to significant overall reduction of CO2 emissions if the electricity is generated using low-carbon sources like renewables, nuclear or hydrogen. Additionally, domestic heat pumps and electric cars, buses and trains tend to use energy more efficiently than gas or oil-fired heating systems and petroleum-driven vehicles.
Electrification in rural and remote areas in developing countries like India and China is progressing fast, and most power stations being built in these countries are coal or gas fired, providing a significant demand for fossil fuels. Should India and/or China follow a low-carbon path to electrification in future, this will have a significant effect on fossil fuel demand.
(5) Battery Storage. Batteries are used to store energy when production exceeds consumption, and is especially useful for intermittent energy sources like renewables, or for managing peak loads. Homeowners can store solar electricity generated during the day and use it later or sell it back to the grid leading to ‘distributed generation’. Electric vehicles also rely on batteries to run, and ranges are limited by battery storage.
There are various types of batteries being developed, and technology is advancing towards producing batteries capable of storing megawatt-sized loads — enough to power entire towns — economically. This technology could be significantly disruptive for the oil industry, opening up considerable competition from renewables.
2.1.2 Risk of Poor Investor Appetite
Investors are critical to finance the capital-intensive fossil fuel industries. Climate change has not featured as a key investment theme or as a major strategic driver until recently, when the risk that fossil fuel assets could become ‘stranded’ with ‘un-emittable carbon’ in a world of carbon-controlled emissions was highlighted (Carbon Tracker Initiative, 2013). Poor investor appetite is influenced by (1) climate change risk awareness; and (2) the global divestment movement.
(1) Climate Change Risk Awareness. Investors are starting to integrate climate risk into their investment decisions, and will expect oil companies to become much more open about their exposure to climate change risks, (such as lower demand, persistently low prices, regulation and taxation of CO2 emissions), and their strategies to deal with them. Investors will be less willing to put capital into high-cost, high-risk projects with long-term high CO2 emissions.
(2) Global Divestment Movement. A bottom-up movement to divest out of fossil fuel investments is currently sweeping across the world. Investors like the Norwegian Government Pension, Rockefellers Brothers Fund and various Universities in the UK and US, have decided to divest from companies producing or burning fossil fuels, and to invest the money instead in efficiency or renewables projects (Howard, 2015).
2.2 Maximise the Opportunities
2.2.1 Fuel Switching Opportunity
Switching from using fossil fuels to cleaner forms of energy is an important way of reducing CO2 emissions. Whilst initially posing a risk to the fossil fuel industry because of reducing demand and de-stabilising oil prices, opportunities are also available for diversification and growth due to (1) replacement of coal and oil with gas; (2) increasing use of renewables; (3) developing a hydrogen- based economy; and (4) increasing the use of biofuels.
(1) Replace Coal and Oil with Gas. Replacing the burning of coal with less carbon-intensive gas offers the largest emission reductions for the least financial loss, and many coal-fired power stations are being replaced by gas-fired ones. Gas is also being considered as a substitute for oil in the chemicals industry as well as in transport. Gas may be considered to be a ‘bridge’ from a fossil fuel economy to a low-carbon one. However building new gas-fired power stations locks in significant CO2 emissions for the life of the plant unless there is the potential for a retrofit CCS plant.
(2) Increase Use of Renewables. Switching energy generation from fossil fuels to ‘clean’ renewable fuels is well underway, and is reducing demand for hydrocarbons. In August 2015, renewable electricity generation outpaced natural gas to become the second largest source of electricity worldwide [after coal], according to the International Energy Agency [IEA]. Technological breakthroughs are reducing the costs of renewable sources of energy. The intermittent nature of renewable energy sources is a problem that could be addressed by optimizing renewable systems between countries, and investment in various types of storage (batteries and pumped hydro systems).
In the 1990’s and 2000’s, several of the major oil companies invested in developing expertise in renewables (Shell, BP, ExxonMobil), but they exited the sector because of poor returns. Total remains the only major to continue to invest in solar and tidal, whilst Chevron is still involved in geothermal energy sources. Significant reductions in costs and increasing demand for ‘clean’ energy may encourage oil players to try again, and pressure from the climate change lobbyists may also result in increased interest in this sector. Competition in the sector is now significant however, and there is a high cost of entry due to investment required and lack of expertise.
(3) Develop a Hydrogen-Based Economy. Hydrogen is currently mainly used for the production of ammonia in fertilisers, in some chemical processes (like hydrocracking which converts heavy petroleum products into lighter fractions), and to power space rockets, but it has long been recognised that it could be used much more widely as a ‘clean’ energy source. It can be burnt in air to produce heat, generating very few pollutants (and no CO2), and it can be converted in a fuel cell into electricity and heat with relatively high efficiency. Its applications include electricity generation, and in the heat and transport sectors.
Hydrogen however is not freely available and needs to be extracted from other compounds, usually either water or hydrocarbons, and this separation uses energy. Currently hydrogen is produced in large quantities by ‘steam reforming’ gas. In future, this could be done cheaply and efficiently using coal, oil or gas, with CCS of the CO2 as an integral part of the conversion process. Developing a hydrogen-based economy could increase demand for fossil fuels in low- carbon ways, provided CCS is part of the process.
Significant barriers exist to developing the hydrogen economy however. As a gas, hydrogen is difficult to store and transport, and it requires major changes to the current energy infrastructure, especially in the transport sector. There could however be a significant increase in demand for fossil fuels as the hydrogen economy matures. Total is the only oil company currently investing in this sector, as Shell and BP have withdrawn.
(4) Increase Use of Biofuels. Biomass, grown and converted to biofuels, is a renewable, but limited resource, which even in optimistic scenarios can only be expected to cover a small fraction of the world’s energy needs. Each year crops store carbon as part of their natural growth cycle, and any CO2 released in their consumption is then stored again in the following year’s crops. Crops can also be grown locally thereby reducing transport effects. Concerns about competition with food production and pressure on land resources are issues in increasing biofuel production.
Several oil companies are involved in developing and marketing biofuels, including BP, ConocoPhillips, ExxonMobil, Shell and Total. Their activities build on their core expertise of fuel production and distribution operations.
2.2.2 Technology Innovation Opportunity
Technology innovation that will impact the oil and gas industry by lowering CO2 emissions is happening all the time. Two highlighted in this paper are (1) CCS and (2) Enhanced Oil Recovery (EOR) techniques.
(1) CCS can reduce CO2 emissions from large stationary sources, such as power stations, and industries like steel and cement. Chemical processes remove the CO2 during the burning processes at the plant. The CO2 is then captured and transported, and finally stored underground, safely and permanently.
CCS can be used with oil, gas and biomass to make low carbon electricity, and fossil fuels can be used, with CCS, as a source for hydrogen as a major means of storing and carrying low carbon energy. Currently, there are 14 large-scale CCS plants in operation globally (Global CCS Institute, 2015), with another 8 under construction. Feasibility studies for the first UK CCS plants are underway.
CCS technology builds on oil companies’ core strengths of subsurface and large-scale project management. Risks to manage include the assessment and management of storage integrity, along with effective allocation of risk between key parties.
In future, there may be pressure from public and regulators that will force fossil fuel companies to invest in CCS to capture and store CO2 from their operations. Feasibility for CCS projects should be assessed before any decommissioning project that removes vital infrastructure is agreed.
(2) EOR techniques increase the amount of oil that can be extracted from a reservoir. Various methods are already in use, such as thermal recovery, gas and chemical injection, with resulting recovery factors increasing from some 20-40% to almost 60%. This increase in recovery efficiency potentially reduces the requirement for new CO2-intensive oil developments.
EOR methods that inject CO2 into the reservoir to increase recovery have the potential to result in further reduction of total CO2 emissions.
3. A Blueprint for Adapting to a Low-Carbon Economy
Based on the risk and opportunity assessment, the following is a blueprint for the oil and gas industry to adapt to a low-carbon economy in the short to medium-term:
(1) Integrate Climate Change into Business Planning, Governance and Strategies. The main challenge is to anticipate changes in demand due to climate change factors as well as the usual economic ones, and to ensure that the companies’ business planning, governance and strategies are robust from the perspective of transitioning to a low-carbon economy. This means developing a detailed understanding of the issues arising from climate change, and creating different far-sighted scenarios against which to make investment decisions. Risk assessments need to include long-term lower demand and volatile oil prices, and ensure a degree of flexibility for capital investment in the near to medium term.
Compliance with any regulations is essential, and steps need to be taken to ensure future proofing against potential new regulatory developments.
(2) Improve Capital Management. In an uncertain future, companies need to guarantee financial ﬂexibility so that they can respond to fast changes in the market. This requires disciplined capital management supported by excellence in project management.
With an outlook of significantly lower ‘allowable’ CO2 emissions in future, companies should avoid large high-cost, high-risk long-term projects with a high carbon footprint, for example in the Arctic, ultra deep-water and tar sands.
Careful selection of limited new exploration projects is essential to minimise future potential ‘stranded’ assets.
Projects that increase recovery efficiency in brownfields, for example using EOR techniques (and in particular re-injection of CO2), should also be a focus.
(3) Increase Transparency. Oil companies need to demonstrate to potential investors that they are able to deal with the risks facing shareholder value due to climate change. They need to be transparent about their portfolio, activities and plans to reduce their CO2 emissions. Strategies for managing the transition to a low-carbon economy need to be made explicit.
(4) Improve Engagement with Investors and Policy Makers. The oil and gas industry needs to increase its dialogue with both investors and policy makers to ensure optimal regulation that succeeds in both dealing with reduction in CO2 emissions and in preserving and creating shareholder value. The current combative approach and preference for self-regulation needs to change to be more collaborative to give assurance of a commitment to tackling climate change.
(5) Exit Potentially ‘Stranded’ Assets. Early exit of any assets that risk being ‘stranded’ is paramount.
(6) Minimise Carbon Footprint. With the fossil fuel industry operations contributing some 5% of global CO2 emissions, there will undoubtedly be pressure to reduce this. It makes sense both financially and reputationally to minimise the operational carbon footprint, for example by developing and/or investing in modern efficient equipment, using cleaner fuels to power plants, and stopping any venting or flaring.
(7) Increase Balance of Gas Assets in the Portfolio. Increasing the proportion of gas assets in an oil company’s portfolio will lower its carbon footprint and allow it to compete better in a carbon-constrained world.
(8) In the longer term, seriously consider options to:
a. Diversify into renewables.
b. Develop expertise in the hydrogen fuel economy.
c. Invest in biofuels.
d. Invest in CCS for stationary CO2 sources.
To read the full “Blueprint for Transition to a Low-Carbon Economy” please contact Pale Blue Dot Energy by clicking here.