How the oil and gas industry can grow old gracefully

The oil and gas sector should seize the initiative from its critics by planning more proactively for its twilight years

A summary version of this article was published by the Financial Times on 7th July 2021: see here

By Daniel Litvin, Founder and Managing Partner of Critical Resource. Please note Daniel writes here in a personal capacity.

Some people grow old gracefully, planning decades ahead for their retirement, sometimes gaining a new lease of life by taking on new challenges. Others struggle to plan ahead, age disgracefully, and leave a chaotic legacy. This is the choice of paths now facing the oil and gas industry.

After a century or so at the heart of the global energy economy, oil and gas is not about to die a sudden death. Of course, there are many climate activists who would like it to do so, given that oil and gas production and use accounts for some 40% of global greenhouse gas emissions. But with these fuels continuing to meet over half of global primary energy demand, and with much of the world’s infrastructure constructed around them, an abrupt shut down looks economically implausible.

Is twilight for the industry ahead?

The giant challenge for the industry, however, is that if the world is to have a hope of meeting the globally-agreed goal of limiting global warming to “well below 2, preferably to 1.5 degrees Celsius”, a steep downhill trajectory in oil and gas demand over the next few decades is needed – even assuming large-scale efforts by the industry to ‘offset’ and sequester some of its emissions. Under the International Energy Agency’s recently-unveiled ‘Net Zero by 2050’ scenario, for example, no new oil and gas fields are approved for development beyond projects already committed as of 2021.

With long-term retirement looming, a key question for the industry then becomes whether outside forces, largely driven by its opponents, should be left to determine the path ahead, or whether the industry seeks to shape this proactively itself. So far the opponents seem to be making all the running.

The crude battle lines

This is not to downplay the many innovative climate initiatives in parts of the industry, from multiple investments by oil and gas firms into low-carbon technologies to collaborations with clients to improve energy efficiency[1]. On the critical question of the industry’s plans to tackle its overall emissions trajectory, however, the picture is decidedly patchy.

It is true that a handful of oil and gas firms (particularly the very big European-based firms) have recently set targets to reduce to ‘net zero’ by 2050 not just the greenhouse-gas emissions from their operations, but also the emissions from the end use of their products (so called ‘scope 3’ emissions) in part by moving away from oil and gas production over time and ramping up investment in renewables. They are thereby seeking transformation in old age: to reinvent themselves as ‘energy’ rather than oil and gas firms. However, even for these climate leaders within the sector, definitions of what is covered by their targets vary, while the pathways to achieving them are somewhat vague (and also often include ill-defined future schemes to ‘offset’ much of their emissions, for example through industrial-scale tree planting).

Which way to net-zero?

Meanwhile, across much of the rest of the industry, companies are either setting ‘net zero’ targets solely for their operational emissions (which typically are a tiny fraction of their scope 3 emissions) or are not yet focusing on setting such targets at all. Many reject the notion of setting scope 3 targets, arguing that end-use emissions are the responsibility of customers. And again methodologies used to measure emissions, set targets, and define pathways to net zero, vary wildly, often chosen so as to fit companies’ current business plans, rather than triggering major strategic shifts.

Amid this confusion of voluntary actions by companies, a disparate army of climate activists and increasingly powerful green-minded investors is now driving much of the debate. Most notably, in May ‘Big Oil’ suffered a string of extraordinary defeats at their hands: ExxonMobil was forced at its annual shareholder meeting to appoint three climate-conscious new board directors following campaigning by an activist hedge fund; Chevron’s shareholders voted for a resolution obliging it to set explicit targets for its scope 3 emissions; and Royal Dutch Shell was told by a Dutch court in a case brought by seven green groups to cut its emissions much more steeply by 2030 than it had planned.

Less noisily, but also influential, a growing number of investor- and activist-driven initiatives, such as Climate Action 100+ and the Transition Pathway Initiative, are seeking to benchmark companies’ climate commitments within and across different sectors. Such initiatives are also creating frameworks to evaluate whether companies’ targets are consistent with globally-agreed climate goals. Meanwhile a group of activists, academics and luminaries have recently come together to call for a global “Fossil Fuel non-Proliferation Treaty”, a global inter-governmental agreement to phase out oil, gas and coal production – in April this year, 101 Nobel Laureates, including the Dalai Lama, signed an open letter to world leaders in support of this particular initiative.

Saving the world, maybe

All this external activity has certainly grabbed headlines (rarely good ones for the industry). However, taken as a whole, it hardly seems to amount to sensible retirement planning for fossil fuels either.

For a start the pressure applied has so far been highly uneven across the oil & gas sector, limiting its effectiveness. The pushes by activists and investors to change company behaviour have generally been targeted at large, well-known, western-listed firms. This is for understandable campaigning reasons: companies like Exxon, Chevron and Shell are prominent brands useful for attracting media attention; their investor base is relatively easy to target; and they are at least somewhat sensitive to public opinion. But the bulk of the world’s oil and gas is produced by state-owned national oil companies, privately-owned firms, and smaller, less-prominent listed companies. More difficult to influence through activism, many such firms have as yet shown little inclination even to begin to plan for a radically different kind of future.

A more sophisticated plan may be needed

Moreover, any reduction in emissions achieved by persuading high-profile western firms to set tougher targets on their scope 3 emissions and thereby reduce production, seems likely to be cancelled out as some of the less-climate enlightened firms in turn ramp up their production to meet demand (unless of course demand has also fallen by an equivalent amount). As in the game of ‘Whack-A-Mole’, thumping one set of firms is likely to be insufficient as others will pop up.

The impending decline of fossil fuels also raises profoundly difficult questions about how the burden should be shared within the industry, yet activist and other external initiatives have only begun to grapple with these issues. For example, as demand begins to fall off, which parts of the sector should be expected or allowed to produce the last barrels of oil and shipments of gas? Should it be those countries and companies producing at the lowest cost (as market forces would  dictate), or is there a moral case for somehow privileging exports from poorer countries which need the jobs and revenues the most, or perhaps from regions where the social and economic disruption from a steep wind-down of production would be most painful?

The Fossil Fuel non-Proliferation Treaty initiative has admirably begun to think through some of these questions. But a number of the externally-developed methodologies which seek to evaluate the robustness of individual companies’ emissions targets seem to be relatively silent about them. For example, some of the methodologies assume companies should reduce emissions simply in line with the average required for their sector, while others take as given that companies’ cost of production should be the main determinant of how much they can still produce and thereby emit. Key contextual factors such as development needs of the oil and gas producing regions would appear to be missing.

Such complexities are sometimes highlighted by executives to make the case against swift corporate action. They are not intended so here. The point rather is that the outsiders and activists seem to be struggling so far to plot the right climate path for the industry – and that an ambitious and progressive industry attempt to seize the initiative could have a more powerful effect. Three core elements of industry leadership are needed in this respect.

Three steps to occupy the high ground

First, the industry should develop a robust, sector-wide standard for disclosure by individual oil and gas firms of their current and predicted future emissions. This should cover not just companies’ direct emissions but also those from the end use of their products (i.e. scope 3). In this respect, oil and gas firms need to recognise that, in the court of world opinion, they cannot entirely disavow responsibility for the consumption of their products (just as decades ago, the tobacco industry tried, and famously failed, to make the case that consumers chose to smoke and therefore were responsible for the consequences).

A common disclosure methodology would not only make comparing oil and gas firms’ climate performance easier (the current profusion of approaches makes it hard to discern corporate spin from substance): importantly, it also would begin to create a common understanding across all parts of the industry of the task at hand.

Secondly, albeit more challenging to pull off, the industry should develop a common standard or methodology for individual firms to set their own emissions targets, and pathway to achieving those targets, which are genuinely aligned with the international goal of limiting warming to “well below 2, preferably to 1.5 degrees Celsius”.

As above, to ensure credibility, the standard would need to oblige firms to target their scope 3 emissions over the long term. However, the corporate strategy they choose as they wind down hydrocarbon production in the coming years or decades would be up to them – whether diversification into clean energy (i.e. transformation in old age), or returning cash to shareholders (i.e. comfortable retirement). The standard also would allow companies to deploy offsets and carbon capture projects as a limited or demarcated element of their emissions pathways, but such projects would need to be robust and verifiable, not vague statements of future intent or other forms of magical thinking.

Which way to turn?

To win acceptance across the industry, this standard would need to be adaptable enough to apply to all sorts of oil and gas firms (including state- and privately-owned, upstream and downstream, etc.), and therefore incorporate a set of assumptions on how to solve some of those fraught questions of burden sharing between different producers and regions. But therein lies its potential: by bringing along the sector as a whole through a calibrated approach to these issues, its climate impact could be greater than any number of campaigns focused on single brand-name firms.

Thirdly and more challenging still, the industry should look to support the long-term winding down of oil and gas production that ultimately will be needed across the sector through some sort of supply-limiting enforcement mechanism, backed by governments. Perversely, this could be an important way to protect industry profits in a shrinking market. As demand for oil and gas declines in the years ahead, the current relative lack of coordination across the industry suggests that many firms will simply race to maximise production in the hope of making some money before the good times finally end. But that will likely trigger a future collapse in prices that is potentially deeply damaging to all in the industry.

Just as OPEC seeks to limit production among its members partly to put a floor under the oil price, an arrangement covering an even broader cross-section of the industry could look to ensure companies stick to progressive restrictions on production aligned with their long-term emissions reductions goals. There are clear parallels here with the proposed Fossil Fuel non-Proliferation Treaty. While this is conceived more as a global agreement between governments, governments certainly would need to provide backing and legal support to what is being suggested here, lest companies are accused of cartel-like price-fixing. Whatever the institutional form of the arrangement, the key point here is that in the future the industry may find it has a strong commercial incentive to come together to police individual companies’ emissions reductions activities: a potentially powerful win for climate action.

Braving the pain

Again, none of this is to underestimate the complexity of the challenge were the industry to seek to seize global leadership of its climate performance in this way. Implementing all three recommendations would require input and oversight from credible non-industry groups, to provide independent expertise, adjudication between different interests, and reassurance to the many stakeholders skeptical of any industry action. Investors, as well as governments, would need to be intensively consulted.

On the way to industry transformation

Industry collaboration on climate has certainly begun to strengthen – for example, through the good work of the Oil and Gas Climate Initiative – but it so far appears far from the level of ambition set out here. Oil and gas remains a competitive and fractious sector, with historic divisions between OPEC producers and the rest. Building agreement around burden sharing would likely be an intensely fraught political process.

On the other hand, planning a graceful, potentially even heroic, retirement of oil and gas (a sector worth a few trillion dollars) alongside alongside the transformation of at least some in the industry into new energy giants was never going to be easy. And the pain and ignominy for the industry will surely be worse if its opponents continue to lead the charge.

Daniel Litvin is the Founder and Managing Partner of Critical Resource, which advises energy and resource companies on climate, ESG and geopolitical risk, and author of ‘Empires of Profit: Commerce, Conquest, and Corporate Responsibility.’ He writes here in a personal capacity.

[1] Various cross-sectoral initiatives are also now important in catalysing new ways of thinking. See for example, the World Business Council for Sustainable Development’s recent ‘Time to Transform’ report.