Oil companies and the energy transition

How oil and gas firms can navigate energy transition | EY - US

Climate change has become one of the greatest threats of this century to the environment, as well as to global security including health, wealth and political stability. Over the past decade, energy-related carbon dioxide (CO2 )emissions have increased 1% annually on average. If this average growth rate continues, it is expected to result in global warming by the end of the century of more than 3 degrees Celsius (°C) compared to pre-industrial levels. The Paris Agreement aims to limit the increase in global temperature to “well-below” 2°C, and ideally to 1.5°C (compared to pre-industrial levels) this century. Governments’ current and planned policies would result in a flattening of emissions by 2050, to levels similar to those today, but this would still cause a temperature rise of around 2.5°C. As such, to realise the Paris climate target, a profound transformation of the global energy landscape is essential.

OIL COMPANIES AND HISTORICAL ENGAGEMENT IN RENEWABLE ENERGY

Climate change challenges and the rise of renewable energy sources are increasing the social and environmental pressure on oil companies to re-position themselves in the societies in which they operate. They have been doing this in a variety of different ways. Firstly, some oil companies have continued with business as usual and are strengthening their current strategies of oil extraction to maximise profits. Secondly, other oil companies have switched to low carbon sources, such as natural gas, blue hydrogen and biofuels. Switching from oil to gas would result in fewer greenhouse gas emissions and greater efficiency, while biofuels are already being used to a large extent (blended into petrol and diesel) but raise concerns regarding biodiversity effects and competing land use. Some oil companies are already using carbon capture and storage (CCS) for enhanced oil recovery,nd are converting natural gas into hydrogen and capturing the CO2 released to produce a valuable fuel that could be used in home heating, industry and eventually ships and planes (Mills, 2019). Finally, other oil companies are, with different degrees of intensity and commitment, transitioning to renewable energy and related technologies, such as solar, wind, EVs and green hydrogen.

Overview of oil companies’ engagement with low-carbon technologies

In addition to the above activities, all seven companies (as well as some national oil companies) are members of the Oil and Gas Climate Initiative (OGCI), a CEO-led initiative founded in 2014 aiming at leading the oil and gas industry response to climate change and scale up low carbon energy solutions – focusing on areas where OGCI can add value, beyond what individual members can do, or the market already offers. OGCI prioritises its activities around three objectives: i) reducing CH₄ emissions, ii) Reducing CO₂ emissions and iii) removing CO₂ (CCUS).

WHAT ARE THE COMPANIES’ ANNOUNCED FUTURE COMMITMENTS?

All seven major oil companies have publicly agreed through their annual reports and statements that climate change is one of the major threats of our times and that they should contribute to the energy transition. However, a major difference exists between European companies (i.e., BP, Eni, Equinor, Royal Dutch Shell and Total) and US-based companies (i.e., Chevron and ExxonMobil) in the urgency and pace with which these companies are planning to transform their activities.

Overview of oil companies’ climate and emissions commitments (as of January 2021)

Total revenues and profits per segment and allocation of investments

All of the seven companies examined are integrated oil companies, which means that they have both large upstream and downstream operations. The total revenues and revenues per segment of activity between 2018 and 2019 have been declining for all analysed companies , with weak upstream returns reported, despite the large investments. Yet, despite the low returns on capital employed, they all continue to rely on their upstream businesses to fund
their investments and drive shareholder returns (Fitz et al., 2020). The increase in investments in the upstream and other segments can be seen for both US as well as European companies, which despite the commitments to cut emissions, are still not cutting back their oil and
gas developments. This indicates that companies are still investing to keep future production at the same level and keeping the focus on fossil fuel production for the years ahead.

Evolution of crude oil prices (2017-2020)

Low oil prices pose a key strategic problem for the oil industry, which has traditionally made high profits from upstream activities. The argument of a “profitability” gap between investments in upstream oil projects and investments in renewables no longer holds. With
oil prices plummeting and renewables becoming more cost competitive in the power sector, returns in upstream oil projects will inevitably decline, as the oil industry is forced to compete with an energy source that produces energy with a short-run marginal cost of zero and at a much lower cost over the lifetime of a project (Lewis, 2019).

THE WAY COMPANIES SEE THE FUTURE – THE ROLE OF SCENARIO ANALYSIS

There are numerous tools and models to assess low-carbon and energy transition pathways. In general, the usefulness of developing scenarios lies in the ability to provide strategic insights to enable decision makers to think about the possible wider and longer-reaching implications of specific trends. In the context of oil companies, scenarios help to clarify a company’s view of the future that is more sensitive to the external environment, as well as to explain their current priorities by providing prospects and visions of how they foresee the future to unfold.

Comparison of scenarios – key indicators

company expects an electrification rate of 45%, as the progressive decarbonisations of the energy system leads to increasing amounts of final energy use being electrified (BP, 2020). The impact of COVID-19 has caused carbon emissions from energy to fall sharply in the near term. However, even if emissions pick up as the global economy recovers, the level of carbon emissions in the Rapid Scenario does not return to pre-pandemic levels, but rather falls by around 70% by 2050 to a little over 9 Gt of CO₂ (BP, 2020). The share of renewable energy in primary energy increases to 44%, and in the power sector to 74%.

Global energy-related CO2 emissions vs. electrification rate in various energy scenarios
(Current levels, 2040 and 2050)

From the scenario presentation and analysis, a few considerations can be drawn regarding how oil companies see the energy future shaping in the coming decades. Among the European companies, a clear reference to oil demand peak is made by Shell and Total, which foresee it occurring around 2030, and BP, for which it has already peaked this year. Despite this, the share of oil and gas in the total primary energy supply is still significant.

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