Executive Summary
The next thirty years are forecasted to witness an increased reliance on renewable energy technologies and a decreased dependence on fossil fuels. While the speed of this transition and the size of its impact on future demand for fossil fuels are still uncertain, oil and gas companies are facing strategic challenges with regards to the sustainability of their business models. To respond to these challenges and reposition themselves for the future, International Oil Companies are trying to rebalance their portfolios by investing in new technological innovations at both; their core upstream oil and gas business as well as in the broader energy sector. While all major oil and gas companies are aligned on the importance of this transformation, each company is taking a different approach. Generally, four main drivers affect the design of their portfolio strategy:
- The climate change policies of the headquarter country where the company is established,
- The broadness of its business activities beyond the upstream sector and its ability to switch to low-carbon options,
- Their existing experience in energy-transition technologies, and
- Their own beliefs about the speed of the energy transition
Grenoble Partners describes the directions that oil and gas majors are following in response to the energy transition and provides rationales for making their strategic choices.
Introduction
The Paris agreement, approved in 2015, constitutes a major milestone in the global efforts to combat climate change. This international binding treaty adopted by 196 parties aims at limiting global warming to well below 2°c, preferably to l.5°C, compared to pre-industrial levels. Since then, governments, cities and private sector participants are declaring commitments to reduce their carbon footprints through increased investments in renewable energy technologies and carbon sinks as well as plans for decreased reliance on fossil fuels. While there is international agreement on the increased importance of renewable energy technologies and reduced reliance on conventional fuels, the speed of the energy transition is still uncertain and depends on a multitude of geopolitical, technological, economic, and social factors. Given the uncertainties that this energy transition is introducing, oil and gas companies (OGCs) are facing a strategic trilemma :
- Should they continue growing their lucrative core business of oil and gas exploration and production despite a projected shrinking market size for fossil fuels?
- Should they invest in the energy transition to join the competition in the larger energy business market, hoping that these investments will pay off in the longer-term?
- Or should they maximize dividends to their shareholders and limit some aspects of business growth, to reduce the migration of investors to other sectors of the economy such as the technology firms for example?
In this document, we discuss how OGCs are responding to the challenges that the energy transition is posing on their long-term business continuity. We focus on the seven major International Oil Companies (IOCs) for two reasons: first, they are market leaders in the industry and their actions will drive other participants; and second, because these companies are privately owned and therefore are purely driven by commercial considerations; compared to National Oil Companies that could act within the umbrella and mandates of their national governments agendas. We show that the strategic directions of these oil companies are not always aligned and discuss drivers for the different paths that they are following.
IOC’s Responses to the Energy Transition
One common aspect across IOC majors is their awareness and continuous monitoring of the changes in the energy sector.
They all classify energy transition and the emergence of competing energy sources as a key risk to their businesses, whether it being through the ”unforeseen” reduction of the share of hydrocarbons in the energy mix, or through unprecedented and uncontrolled drops in hydrocarbon prices. Some of these companies are also actively marketing their evolving positioning towards climate change policies and the future of the energy sector.
Slogans such as “Performing while transforming from IOC (Integrated Oil Company) to IEC (Integrated Energy Company)” or ”Higher returns, lower carbon” indicate how transformational the challenge that the sector is facing. Lately, one of these majors -Total- rebranded itself and changed its name to become Total Energies reflecting the structura I evolution that the company is witnessing.
To achieve their new positioning in response to the energy transition, IOCs are considering strategic choices across two key themes:
- i. Choices within their core upstream oil and gas sector
- ii. Choices in the broader energy sector
i. Choices within their core upstream oil and gas sector
Upstream oil and gas has always been the core business of the oil and gas majors. It is not surprising that the first actions that these companies are undertaking to respond to the energy transition are the direct adjacencies. We present below five key choices:
- a. Commitment to zero routine flaring and reduced methane leakage
- b. Decremental targets for liquids production
- c. Targets for net-zero emissions in operations
- d. Including carbon price in project valuation
- e. Brownfield and low-cycle investments
a) Commitment to zero routine flaring and reduced methane leakage:
When an oil discovery is encountered, volumes of associated natural gas are generally present in the reservoir. Sometimes, due to the lack of nearby gas infrastructure and the absence of economic incentives to build it, oil is produced while the associated gas is flared to the environment.
Natural gas or methane is a very powerful greenhouse gas with a global warming potential 80 times higher than carbon dioxide over the first 20 years after reaching the environment.
To reduce their unit emissions and to commercialize the wasted natural gas, many companies and governments are endorsing the World Bank Zero Routine Flaring by 2030 Initiative and setting intermediate targets to achieve that. Six of the seven majors have already endorsed this initiative.
Another parallel development is the efforts that many companies are putting to employ advanced technological tools to detect, measure and minimize the amount of methane that ends up leaking to the environment from the installed gas infrastructure.
BOX 1: What technology is bringing forward
The monetary revenues foregone due to methane leakages from natural gas infrastructure can amount to $30 Billion per year. Therefore, in addition to the associated environmental concerns, OGCs are incentivized economically to detect methane leakages and eliminate them. Several technologies are under various levels of development, testing or deployment. Gas sensors placed in gas fields and configured to act as Ad Hoc Networks connected to the cloud, drones equipped with laser technology and light sensors and satellites that measure methane concentration are some of the solutions considered. Automated systems and machine learning capabilities are two key technologies that are also being put into practice to achieve these goals in a cost-effective manner for the industry.
b) Decremental targets for liquids production
Historically, OGCs preferred exploring and producing oil rather than gas because of their higher economic returns and reduced infrastructure and transport costs. Yet, burning oil or its derivatives is more polluting than natural gas. Considering the ongoing decarbonization of the energy systems and the diverse role that natural gas can play across a multitude of industries and use cases (ranging from electricity generation to industrial feedstock, heating, and mobility among others), forecasts place the natural gas market as the most resilient among other fossil fuel markets. The oil market on the other hand, is challenged by strongly competitive renewable alternatives and the foreseen electrification of large fractions of the mobility sector. Many companies are rebalancing their portfolio mix by setting targets for decreased production of liquid hydrocarbons. Total Energies, Shell and BP are aiming to gradually reduce the share of liquids in their company portfolio. Eni is explicit about its intention to increase the share of natural gas in its hydrocarbon portfolio from 48% in 2020 to 90% in 2050.
c) Targets for net-zero emissions in operations
According to the ”2018 Intergovernmental Panel on Climate Change (IPCC) Special Report on Global Warming of l.5oC”, to achieve the targets set in the Paris Agreement, global carbon neutrality must be reached between 2050 and 2070. Many governments including the EU,the UK,Korea, and Japan have committed to reaching carbon neutrality by 2050. China declared its intention to achieve this goal by 2060. The Paris Agreement, and the commitments of many governments to net-zero emissions pressured some OGCs to set targets to achieve carbon neutrality on their own operations by 2050 (Scopes l & 2). The European IOCs are also aiming to achieve carbon neutrality on the hydrocarbons they produce and sell (Scope 3) “as a joint effort with the society”. A multitude of technologies and approaches are under development to achieve these goals, including reducing the carbon footprint of the upstream sector, captu ring emitted carbon when it makes sense, and offsetting emissions through the installation of renewable energy, the adoption of energy efficiency or the use of carbon sinks etc.
Figure l: Announced scopes 1 & 2 emission reduction targets. (ExxonMobil targets only include upstream operations and uses 2016 as base year, Total Energies, Shell and Eni use 2016 as base year, BP uses 2019, and ConocoPhillips uses 2015. Chevron announced emission reduction targets but does not provide aggregate numbers.)
d) Including carbon price in project valuation
Across many jurisdictions, and in line with national commitments of the 2015 Paris Agreement, carbon emissions are being priced to induce reductions in emissions and to use the collected amounts to combat climate change. Since the upstream activities and the produced hydrocarbons are generators of emissions, many companies are already internalizing carbon prices and computing the project economics considering emission costs. Some companies, such as BP, clearly publish the prices of carbon that they use in the valuation of their upstream projects, even in jurisdictions where no current costs on emissions are set. Others such as Chevron use carbon prices but consider the actual values used as a business secret and do not publish them. ConocoPhillips on the other hand, among others, do not use carbon prices in estimating project economics beyond jurisdictions where this is currently applicable.
e) Brownfield and low-cycle investments
A natural response of OGCs to the risks of stranded assets and new projects failing to break-even due to the energy transition is to be more selective in their upstream investments. Projects requiring high investment costs and long payback periods are deprioritized, given the uncertain future of the sector. Exploration activities in new areas are drastically reduced. BP and Total Energies announced that they will not pursue upstream activities in new countries anymore. Capital expenditures are mostly spent on brown-field developments connecting new discoveries in areas where enough infrastructure is already in-place. Short-cycle assets became of increased importance as they offer the timely flexibility needed to quickly respond to price signals. Chevron, for example, believes that the fact that its upstream investments are focused on short-cycle unconventional assets is one important mitigation strategy for the risks of low prices or stranded assets.
ii. Choices in the broader energy sector
Many IOCs are expanding their presence not only along the oil and gas value chain, but also to the wider energy sector. In the latter, different challenges and opportunities exist. Some expansion potentials share commonalities with upstream oil and gas projects in terms of the requirement for deep pockets, excellent logistical experience and centralized technologically complex investments; such as carbon capture or biorefinery projects. Others have totally different economic profiles, such as distributed renewable energy projects (PV, onshore wind, etc.). The go/no go decision criteria of such options along the wider energy sector are more complex and differ from one player to the other. We comment on these choices, starting from the ”closest” to the upstream oil and gas core business to the furthest of them:
- a. Invest and expand carbon capture and storage capacity
- b. Increase biofuel production
- c. Invest in hydrogen
- d. Develop offshore wind
- e. Invest in a portfolio of RE technologies
a) Invest and expand carbon capture and storage capacity
Carbon Capture and Storage (CCS) technology aims at installing the necessary filters at the chimneys of fossil fuel powerplants and industrial plants that heavily emit CO2then storing the captured CO2in underground reservoirs. CCS is a natural extension for upstream activities: the projects are generally large, centralized and require a high degree of sophistication and upfront investments. They also rely on storing CO2underground, mostly reusing exhausted oil and gas reservoirs by repurposing the existing production wells.
ExxonMobil is a global leader in this industry with equity share amounting to 20% of the world’s capacity in CCS and currently advancing plans for more than 20 new opportunities around the world. Some OGCs, such as BP, are planning to take early positions in CCS, while others consider this technology one key milestone in their future expansions: Shell wants to expand its existing capacity six times in the next 15 years while Eni aims to be a major player in th is industry by 2050.
Figure 2: Installed CCS capacity and announced future targets
b) Increase biofuel production
Biofuels are liquid or gaseous fuels produced from plant, algae, and animal waste. They provide renewable alternatives for fossil fuels and arguably have limited and sometimes negative carbon footprint. Instead of using crude oil as the primary input, biorefineries are fed with biomass that is processed and converted into beneficial byproducts in the form of biofuels and biochemicals. OGCs with existing businesses in refining, fuel delivery and chemicals are investing in research and development related to efficient biorefining. ExxonMobil as one of largest manufacturers and marketers of fuels and lubricants and Shell as one of the largest blenders and distributors of biofuels are just two examples of companies with competitive starting positions. Eni, Total Energies, and BP declared future targets for biofuel production highlighting the importance of this business segment in their energy transition strategies. On a similar track, Chevron is committing $500 million over the next few years to make biofuels more scalable and competitive.
c) Invest in hydrogen
Hydrogen is a clean fuel that when burned generates pure water. Forecasts by leading agencies and institutes monitoring the energy sector indicate that hydrogen has a growing role in the global energy mix once its economics are made more competitive. Hydrogen can be relatively cheaply stored and transported when compared to electricity and can provide a competitive alternative for hard to electrify sectors. Most of the hydrogen produced today comes from fossil fuel sources mainly natural gas. If combined with modern CCS solutions, net-zero hydrogen can be produced through reforming. Another developing net-zero technology methane splitting, transforms methane into hydrogen and solid carbon. The latter can either be used to produce various products such as tyres or rubber or can be buried in its solid form.
OGCs are uniquely positioned to thrive in the hydrogen economy for three main reasons:
- They hold large reserves of fossil fuels especially natural gas
- They are market leaders in CCS technology
- They have extended experience in the natural gas supply chain and infrastructure that can be repurposed to be used for hydrogen. Existing natural gas pipelines, for example, can accommodate small volumes of hydrogen mixed with methane with no additional costs and can be repurposed to fully accommodate hydrogen at 10% to 30% the costs of building new dedicated hydrogen pipeline infrastructure . Similarly, Liquified Natural Gas (LNG) plants used to transform natural gas into a denser liquid form, to economically sea-ship it, can be modified to liquify hydrogen instead. Six out of the seven majors have either started investing in the hydrogen value chain or are publicly indicating future plans to do so.
BOX 2: The different “colors” of hydrogen
While hydrogen is a colorless gas, codenames in the form of colors are used to identify the way it is produced:
d) Develop offshore wind
While the wind turbine technology is not related to the oil and gas business, OGCs are benefiting from their proven experience in carrying offshore upstream exploration and production activities. Underta king investments in offshore infrastructure is costly, technically complex and requires strong marine logistical capabilities which many majors enjoy. European majors such as BP and Total Energies have already beefed up their technical capabilities in offshore wind through partnerships and acquisitions. Several large projects are under development in the UK and the US. The Norwegian-based Equinor is one main OGC that clearly specifies its intension to be a global offshore wind energy leader. It targets the installation of 12 to 16 GW of offshore wind capacity by 2035.
BOX 3: Floating offshore wind (and offshore solar?)
Hywind Scotland is the first floating offshore windfarm developed in 2017 by Equinor with a capacity of 30 MW and remains the only operational windfarm in its category. The average capacity factor reached record high numbers of 57.1% compared to any other wind farms in the UK.
Floating offshore wind technology opens deep water seas for wind energy where wind speeds are generally faster and where acreage is vastly available. While this technology has been technically proven, reducing its costs is the next challenge.
On a parallel track, Equinor is also leveraging its maritime capabilities by developing and testing the first open seas floating solar photovoltaic technology near the coasts of Trondheim in Norway. Given the rough sea environment off the Norwegian coasts. Equinor believes that technical success in Norway means that the technology can be applied anywhere in the world, opening up wide opportunities across the globe.
e) Invest in a portfolio of RE technologies
In addition to sectors that share some similarities with their core business areas, the European majors are diversifying their investments to a wide range of renewable energy technologies spanning solar, wind, geothermal, electricity storage and e-mobility solutions. Total Energies objective is to become one of the top five renewable energy companies by 2030. Shell aims at installing 2.5 million e-vehicle charging stations by 2030. BP endeavors to invest $5 Billion per year in all the spectrum of RE technologies starting 2030. Eni targets multiplying its renewable energy capacity by more than 60 times over the next 30 years. The European majors, through these diversified investments, are making large steps outside their core business and comfort zone and are placing considerable bets on the energy transition.
Figure 3: Sanctioned RE capacity and announced future targets for European majors
Drivers for Different Strategic Directions
While all majors are deeply involved in understanding the energy transition and mitigating its associated risks, their responses are not always aligned.
We categorize their energy transition strategies in three different strategic themes:
We believe that four drivers affect the strategic directions that these companies are taking in response to the energy transition.
a) Climate change policies of headquarter country
The difference between the response of European majors and their American counterparts is hard to go unnoticed. This geographic ”rift” is affected by the consistent climate policy that the EU has been adopting in the last few years championing the Paris agreement and pushing for its implementation compared to the lack of consistency in the US. The former Trump administration exited the Paris agreement and promoted oil and gas activities. The Biden administration has recently rejoined the Paris agreement. One could therefore forecast that this cautious response from US majors is still expected to evolve and become more active in the near future once the national direction is believed to be final.
b) Broadness of activities of the company
Many low-carbon initiatives share several commonalities with the broader oil and gas sector beyond the upstream business. It is therefore normal for independent oil and gas companies (working in upstream oil and gas only) such as ConocoPhillips to have limited exposure and investment potential in the wider spectrum of energy transition initiative in sectors that are related to midstream and downstream oil and gas activities. This structuraI impediment reduces the leeway for these companies to diversify their response to the energy transition challenge and limits their mitigation efforts to only reducing emissions on their upstream activities. In contrast, integrated oiI and gas companies have the knowledge and scale in various markets and can expand their knowhow and develop low-carbon alternative solutions: Refineries can be transformed into biorefineries, networks of fueling stations can become e-charging stations etc.
c) Existing energy transition-related experience
Many European majors started pilot projects and small investments in renewable energy technologies more than a decade ago. They have also entered the electricity market and provided CCGT-based power for tens of thousands of customers. ExxonMobil has been a pioneer in CCS technology for decades now. This market leader position or early investments in future technologies provide a strong starting point for companies to craft their response to the energy transition leveraging their existing know-how, experience, and competitive edge. It is therefore unsurprising if ExxonMobil bases its strategy on its strong CCS, hydrogen, and biofuel basis while European majors delve further into the electricity market with a portfolio of solutions that rely on natural gas, aka the most resilient fossil fuel, and on renewable energy and battery storage technologies.
d) ”Beliefs” about the speed of energy transition
The speed of the energy transition is a multi-trillion-dollar question. OGCs do not probably share the same beliefs about how the future energy market will unfold. Chevron wants to provide its shareholders the largest possible short-term value mainly through its well-crafted upstream oil and gas investments while taking limited and cautious early positions in low-carbon investments. Chevron therefore believes that its upstream profile is resilient enough to accommodate its own range of energy transition scenarios at least in the short-term and bets to over-perform its peers based on that. In contrast, European majors are increasing the diversification of their investment profiles betting on a relatively faster energy transition and replacing reduced short-term shareholder value with hopefully not very far and more robust medium-term value. ConocoPhillips wants to maintain or maybe increase its investments in the shrinking upstream oil and gas sector. It aims to do so by optimizing its upstream portfolio and making it as resilient as possible to energy transition betting on a relatively slow transition.
Conclusion
Most of the commitments to energy transition that major OGCs have declared took place last year during an unprecedented economic slow-down caused by the Covid-19 pandemic, and after witnessing the progress in low-carbon technologies and the increased international commitment to combat climate change. While the declared targets differ in their ambition levels, they are always prone to be revised in line with the evolution of the energy systems and the geopolitical, economic, and social responses that they initiate.
Within the upstream oil and gas space, OGC majors have five key strategic choices today:
- Commitment to zero routine flaring and reduced methane leakage,
- Decremental targets for liquids production,
- Targets for net-zero emissions in operations,
- Including carbon price in project valuation, and
- Brownfield and low-cycle investments.
Within the broader energy market, OGC majors also have another set of five strategic choices:
- Invest and expand carbon capture and storage capacity,
- Increase biofuel production,
- Invest in hydrogen,
- Develop offshore wind, and
- Invest in a portfolio of RE technologies.
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