Can oil and gas investment go hand in hand with energy transition?

Can investments in oil and gas (O&G) go hand in hand with a commitment to the energy transition? Reading the news, it seems not. Frequently, stories highlight institutional investors and banks announcing that they are divesting fossil fuel exposure, citing the need to align their portfolios with the Paris Climate Accords. Similarly, attention is given when O&G companies respond and change their strategies to increase investments in renewables and setting net-zero emission targets for their operations (scope 1 and 2 emissions) or even the use of their products (scope 3).

The urgent need to act cannot be overstated. Existing infrastructure (power, industry and other) alone locks in a temperature rise of 1.65˚C, and current planned fossil fuel production (which includes coal) by 2030 is twice the maximum production consistent with the 1.5˚C limit. So, is divesting of O&G assets the only alternative and are all O&G assets destined to become stranded? Will these divestments have a positive impact on global emissions? Or can investments in O&G be supportive of the energy transition?

Three key factors are at play: O&G supply, O&G demand and the energy transition itself.

O&G supply

The majority of the world’s O&G production and reserves comes from National Oil Companies (NOCs) controlled by governments – often in emerging countries – instead of institutional investors. These governments depend on their NOCs to generate revenues that contribute to government budgets, fund essential government services and provide a substantial source of foreign currency reserves. Until countries diversify their economies (in some cases made possible by the energy transition) or feel pressure to follow others in declaring net-zero targets, it is unlikely that they will make decisions against monetizing their valuable O&G reserves.

O&G demand

Even though some forecast that oil demand has peaked, it is likely that a significant portion will remain for the foreseeable future. In 2019, the International Energy Agency (IEA) estimated that even in a scenario compliant with the Paris Climate Accords, crude oil demand will still be around 67 mb/d in 2040 (compared to 91 mb/d in a COVID-19-impacted 2020), and gas demand will be more or less similar to 2019 levels. However, current investments in O&G are not keeping up with these demand projections. The IEA’s analysis indicates that without new investments, oil supply will diminish to 16 mb/d by 2040. Adding projected investments in existing fields will lead to an expected production of 39 mb/d by 2040.

With this scenario in mind, it seems unlikely that assets divested today by European oil majors will immediately become stranded. If demand remains, during the next ~20-30 years, it will justify continued operation of these assets and other companies will likely assume ownership – in absence of further regulation or limitations on the operation of these assets. Hence, the resulting impact on global emissions could very well be marginal.

Energy transition

At a fundamental level, a “just energy transition” is one that delivers across the equally important, but sometimes competing objectives of economic development and growth, energy security and access and environmental sustainability.

Renewable energy, especially wind and solar power, are one of the main solutions to provide affordable and clean access to energy, and can provide significant opportunities for economic progress. However, challenges remain around intermittency and decarbonization of “hard to abate” sectors, such as aviation, shipping and heavy industries. Furthermore, given the O&G industry’s current impact and strategic importance to economic growth, job creation and socioeconomic prosperity in many countries, investments in the sector are evaluated with this “just” definition of energy transition in mind.

How to move forward

The task ahead is significant. The O&G industry needs to transition itself to align with the global climate targets, while also requiring significant new investments, particularly in the coming decades. Hence, a key question is: what investments can produce the lowest cost and lowest emitting barrels of oil and units of gas?

In other words, how to make investments that enable the industry to meet existing, albeit lowered, oil and gas demand, while at the same time supporting a “just energy transition” and keeping all stakeholders, including shareholders and governments, satisfied?

1. It should be acknowledged that there are different roadmaps for the various O&G players, dependent on their current asset mix, role in the value chain and country of operation. Besides electrification, technologies such as carbon capture, utilisation and storage (CCUS) and bioenergy will need to be recognized as important solutions. Undoubtably, the energy transition is shaping the future of the O&G industry, but the transition pathways and how investors react to them differ greatly among players.

2. In fighting climate change, the overall target is to reduce emissions consistently and rapidly, regardless of where they are originated. Hence, one area of focus should be on the most cost-effective, lowest hanging-fruit measures. Potential measures include a focus on energy efficiency and electrification of operations, CCUS, elimination of flaring and methane leak detection and repair. The good news is that many O&G companies, including the large NOCs, have included these measures in their strategies, and included others such as the use of 4IR technology such as remote sensing and big data to capture process efficiencies.

3. Low carbon technology adoption and fast-paced innovation in value chain decarbonization are game changers and sources of competitive advantages for O&G companies. The industry’s ingenuity and extensive project management skills are invaluable qualities required to manage the energy transition. Recent examples of these innovation capabilities are “hydrogen-ready” pipelines or turbines.

4. Investment decisions in energy projects, including O&G, require a holistic approach. Feasible investments (particularly in emerging markets) need to hit the mark in more than one place, including sustainability, inclusive economic growth and energy access. The System Value framework, developed by the World Economic Forum and Accenture, aims to shift political and commercial focus beyond cost to include value. This framework could very well form the basis for investment decision criteria needed to holistically evaluate investments in O&G projects.

5. Finally, since you can’t change what you can’t measure, O&G companies across the board need to be transparent about their climate strategies, emission targets and their progress. Preferably in an industry-wide agreed framework, so that investors can rely on the disclosures and make apple-to-apple comparisons in order to make proper and well-informed investment decisions in the efforts to pursue a climate-aligned portfolio.

Given the industry’s importance in terms of market capitalization, economic contribution, employment and carbon footprint, the O&G sector has a role to play in the “just energy transition” journey. A collaborative and inclusive approach to financing this transition demands continuous engagement between the O&G and financial sectors to make it a success.