With the recent US commitment to a 50-52% fall in carbon emissions by 2030, and other key economies like China and Japan drastically ramping up their ambitions, policy trends among the major economies are becoming increasingly clear. In the build up to the COP26 Summit in November, pressure is likely to grow on developing countries to strengthen their own commitments to emissions reduction. However, given that a number of such countries’ economies are highly dependent on revenues from hydrocarbon production, the transition to a low carbon future presents a very real threat, not just to their economic integrity and development plans, but also to political stability and social cohesion. This could undermine the basis on which most oil and gas companies have managed their relationships with host governments and stakeholders for many decades – and failure to mitigate against the associated risks could have consequences for their license to operate.
The term ‘stranded assets’ – i.e. those assets no longer able to earn an economic return in a lower-carbon future – has become common parlance in the oil and gas industry, especially as the pace of the energy transition has rendered high-cost and carbon-intensive assets potentially unviable. The large scale impact this phenomenon could have on hydrocarbon-dependent countries leaves them at risk of becoming ‘stranded’ themselves, due to associated revenues drying up and a signification proportion of the country’s main source of wealth being permanently lost. According to research by Carbon Tracker, an independent think tank, hydrocarbon producing countries could see a drop of 51% in government oil and gas revenues as the rest of the world transitions to a low carbon future over the next two decades. The countries most at risk of becoming ‘stranded’ can broadly be placed into two categories.
- Countries that are so heavily dependent on hydrocarbons that, unless their economies diversify rapidly in the coming decade, they will likely see their tax revenues reduce year-on-year. Examples in this category would include Iraq, Nigeria, Equatorial Guinea, Venezuela and Libya, among others.
- Countries that have bet heavily on oil and gas in recent years but are likely to have arrived too late to reap the full economic and developmental rewards of resource utilisation. Countries that have long pinned their hopes on ‘making it big’ with oil and gas, such as Mozambique, Guyana, Uganda, Senegal and Mauritania, could face a situation where they are not getting anything near the returns they expected, with significant impacts on their industrialisation and development efforts.
The more dependent a country is on hydrocarbon revenues, the more painful the transition will be. Companies operating in countries that fail to adequately respond to the demands of the energy transition, could face a deteriorating operating environment. Some of the factors that could contribute to an increasingly challenging operating context include:
- Political instability or regime collapse
Dwindling returns from resource revenues may no longer be enough for some administrations to meet their obligations, with potentially significant implications at the ballot box. They could potentially also face more direct threats from within the government or military. The loss of such revenues would constrain patronage opportunities and limit the avenues for corruption with the potential to undermine their long established grip on power.
- Greater expectations on companies
Potential job losses, not just in the oil and gas sector directly but also in associated industries, could have significant implications. The threat of rising unemployment is compounded by dramatic population growth, particularly in Africa and the Middle East. Lack of opportunity and limitations on government spending power could result in greater expectations being placed on companies to provide services and benefits – or demands for a greater fiscal take by governments.
- Increasing indebtedness
The loss of oil and gas revenues means many countries could face the prospect of increasing dependency on external loans and foreign aid while at the same time having fewer resources to service them. Even if oil prices rise in the short term, the recent past shows a clear direction of travel; between 2015 and 2020, the average oil price was around $60 but government debt in hydrocarbon dependent countries nonetheless doubled in this period.
- Shift in the geopolitical focus away from oil producing countries
The trajectory of the transition (and the rise of domestic production in the US, among other places) means that regions like the Middle East are unlikely to command the same geostrategic importance in 2040 as they do today. Other key players like Russia may also see their geostrategic options hampered, if oil and gas revenues dwindle. A shift in geopolitics could have repercussions for IOCs, who have traditionally been able to call upon the diplomatic muscle of their home nation to protect and further their interests, particularly when they have broader geostrategic implications.
What can companies do?
Many oil and gas producing countries are already starting to invest in diversifying their economies, but will continue relying on hydrocarbons to fill gaps in their own energy mix and for securing much-needed capital. Not all hydrocarbon-producing countries have the necessary resources or capacity to rapidly or effectively wean themselves off hydrocarbon revenues. Companies operating in hydrocarbon-dependent countries can therefore demonstrate partnership with national governments and relevant stakeholders to define and support realistic and practical transition pathways. Furthermore, in the face of the energy transition, traditional forms of CSR like encouraging local content and job creation specifically in the hydrocarbons value chain may become less valuable, therefore requiring new approaches. Fundamentally, the more companies can do to help governments solve their overall energy challenges, or better use hydrocarbon resources for value-adding industries (as opposed to just exporting crude or natural gas), the better positioned they will be to strengthen relations and secure their license to operate.
Particularly in countries where companies have made commitments spanning decades into the future, there will be a need for longer term strategic cooperation as well as immediate short-term action. Based on our discussions with companies and local stakeholders, we have outlined some of the approaches companies might consider:
- Where a resource-dependent country has yet to set out a clear stance, companies can help inform key national positions on the international climate debate, e.g. around climate justice and the share of developing countries in the global carbon budget.
- Similarly, companies can support the development of the country’s overall energy transition strategy, for example through sharing best practice around the establishment of robust policy frameworks to foster economic growth and employment, and helping drive the diversification of the economy. Companies can also align their own in-country investments with the host government’s energy transition priorities, in order to progress key initiatives and demonstrate partnership.
- Companies should redouble their efforts to monitor the evolving climate policy landscape, both internationally and at a local level, in order to avoid being caught out by policy shifts and to identify areas of opportunity. Careful monitoring will also enable companies to better understand and asses the ‘softer’ side of transition risks and adapt their in-country approach accordingly.
- In countries that face severe physical impacts from climate change, companies could focus their local efforts on climate change adaptation and mitigation. Given that the impacts of climate change will often also affect the company’s own operations, it is doubly important to address the issue.
- To maximise the socio-economic benefits from the energy transition, countries need to develop a workforce well-prepared for a diversified energy context through building local capacity in ‘green jobs’, as well as in other value-adding industries (which could be hydrocarbon-based, e.g. petrochemicals or heavy industry). Companies can play a role by up-skilling parts of the workforce for the countries’ future energy needs or making direct investments in areas that align with their own business models and shareholder interests.
- Companies can help countries advance emissions reduction initiatives by engaging with suppliers (and domestic industry more broadly) on issues such as flaring and operational emissions reductions, and working to address longer-term scope 3 emissions. Effective knowledge sharing and capacity building around low-carbon solutions in local supply chains could also be impactful.
 A concept first defined by James Cust, et al, in the policy paper ‘Stranded Nations? The Climate Policy Implications for Fossil Fuel-Rich Developing Countries’