In this exclusive Q&A with Critical Resource, Andrew Grant from the Carbon Tracker Initiative and Critical Resource’s Senior Advisor discusses the mounting pressures and challenges around climate change for oil and gas companies and argues that their resilience will depend on where they sit on the cost curve.
Andrew Grant is a Senior Analyst at the Carbon Tracker Initiative, an independent think tank, where he leads research on oil & gas and mining and has authored several of the organisation’s most influential reports for financial stakeholders. Prior to joining Carbon Tracker in 2014, Andrew was a private equity professional at Barclays Natural Resources Investments. Andrew is part of Critical Resource’s Senior Advisory Network.
How do you rate the progress on global climate targets since the Paris Agreement?
“It is taking time for policymakers to determine exactly how to implement the Paris Agreement, which significantly advanced global ambition. The publicity that surrounded it and the fact that all nations signed up and submitted their plans was an extremely important development.
However, 2018 was not a banner year for the climate. Carbon dioxide emissions rose after being flat for a few years. The rate of investment in renewables relative to fossil-fuels also fell. Increased gas use in the US power sector had previously been a source of relative emissions reductions as it had displaced coal but is now driving increased emissions in its own right.
Despite these issues, the factors driving the energy transition are still in place. Auto manufacturers continued to announce plans for electric vehicles and the cost of renewables and storage continues to fall, making them an increasingly viable alternative to fossil-fuels. The most significant change in the past year was arguably an enhanced public consciousness of climate change, which manifested itself in increasingly detailed announcements from fossil-fuel producers and utilities around their role in the energy transition.”
Carbon Tracker’s recent report predicts a peak in fossil-fuel demand around the mid-2020s – what are the implications of this for climate action?
“This is based on a simple exercise that demonstrates the maths of compound growth. If renewables grow at a rate of around 15-20% and global energy demand at the expected 1-1.5% a year, then renewables will displace the entirety of growth in aggregate fossil-fuel demand in the 2020s.
It is well-accepted that there are more than enough fossil-fuel reserves available to satisfy demand in low-carbon scenarios. The projects that will successfully supply limited demand will be those that are most competitive on a supply-cost basis. Energy companies that hold projects further up the cost curve will be disproportionately affected. They may need to reconsider expansion plans or run the risk of investing in assets that ultimately become stranded. The majors have a range of options available to them, so there may be concentrations of risk in players that specialise in high-cost and early-stage projects that will be developing in a more uncertain future demand environment.
Oil companies will react to these challenges in different ways. Depending on their experience, management and shareholders, some companies may be able to diversify their portfolios into low-carbon energy. Another alternative is the “harvest mode”, focusing only on the lowest-cost assets or putting a greater priority on nearer term projects, aiming to deliver the highest return to shareholders and distributing cash rather than reinvesting it where such opportunities are not available.”
What are investor expectations towards oil and gas companies on climate change?
“Investors are not a homogeneous group. They have different motivations, time horizons, perspectives and levels of engagement on climate change. Some investors may be more interested in the risk-management angle and concerned about the financial implications without actively trying to contribute to a low carbon outcome. Large investors are exposed to sectors across the economy; and given the wide range of impacts from climate change, they may decide that this cannot be diversified away, and the only economically rational solution is to act to prevent it in the first place. Companies will therefore increasingly need to show that they have a plan which is aligned with international climate goals, rather than pulling in the other direction.
Whatever the motives, there is a trend towards greater climate awareness. The most visible example is probably the Climate Action 100+, an investor initiative with over $32 trillion under management that seeks to engage with investee companies to lower their emissions and improve their climate-related disclosure and governance. Rather than climate being lumped in with other ESG factors, the magnitude of the issue is now being appreciated and incorporated into more traditional risk analysis. This is not because of altruism, but because clients are requesting it.
Among investors, the supply-cost framework is generally well-understood for determining whether a project is viewed as “compliant” or not. Companies will need to credibly prove to investors that they are in the lowest cost bracket.”
How have companies responded to climate-related pressure?
“Companies have been increasing their climate-related disclosures, which is symptomatic of increased visibility and pressure from all sides, especially large institutional investors. There has been a range of responses, from unsatisfactory box-ticking exercises to more instructive disclosures at the asset level. The challenge for companies is to incorporate this analysis meaningfully into their business plans and link it to project-sanction processes. Companies have produced a lot of glossy literature which ignores the fact that they might still be planning to increase fossil-fuel production.
A small number of companies have set targets to reduce scope 1, 2 and 3 emissions intensity. The inclusion of the combustion of production is very important as it amounts to approximately 85% of life-cycle emissions. While such targets recognise climate pressures and are a positive step, this has been framed in relative terms – focused on the amount of CO2 emissions per unit of energy – which allows companies to continue to grow their fossil-fuel production as long as it is offset somewhere else. The amount of carbon emissions that can be released for a given warming outcome is finite, so at some point there will need to be recognition that producers are going to have to get smaller.
While some companies might be able to grow even against a backdrop of falling demand if they are among the lowest-cost producers, this implies that everyone else is going to have to cut production even more to make up the surplus. Currently, every company seems to think that they will be the one who will win this game of musical chairs. There is clearly therefore an information asymmetry between investors and the corporates they invest in. This has always been a challenge – and is an evolving area. While there may be legitimate reasons why companies do not want to provide detailed data, it makes it harder to understand which companies are better or worse positioned.”
What will be the role of new technologies or carbon capture and storage (CCS)?
“One of the most effective ways to reduce emissions is to improve energy efficiency. However, we are in a position where we cannot afford to close any other avenues. It is generally unwise to underestimate future technological advances and R&D in fields such as direct air capture as a part of emissions mitigation. If delivered economically and at scale, they would be revolutionary. However, given what is at stake, it is probably better to take a conservative view point.
For its part, CCS technology works but has not yet been deployed economically or at scale. Renewables are increasingly cost-competitive with unabated fossil-fuel generation in different countries around the world, and CCS would be an additional cost for generators to bear. We are also on a very short time frame as our carbon budget is ticking down. Current carbon emissions are around 41.2 gigatons per year. The recent IPCC report emphasised the harm that will be inflicted on the planet even in the lowest warming outcome. For a 50% chance of limiting warming to 1.5 degrees, the carbon budget of allowable emissions is around 580 gigatons in total. By the time major CCS projects have been commercialised and rolled out at scale, we will probably be out of time.
We need to start drastically reducing emissions as soon as possible, and to do so we will need to pull on all the levers available. Some sectors may be difficult to decarbonise, in which case some CCS may well be needed. However, we cannot rely only on CCS or some other undiscovered technology to solve our problems. It is better to plan to mitigate emissions using today’s technologies and end up with a better outcome, rather than cross our fingers, hope for the best and lose that gamble.”