How oil & gas companies are addressing climate risk

BNEF’s latest report discusses how oil & gas companies are addressing climate risk in terms of regulatory, technology, physical & reputational risks.

How oil & gas companies are addressing climate risk

Introduction

Climate change risks & opportunities

A decade ago, the BDO Natural Resources practice conducted a survey to assess the top 20 risks affecting the oil and gas industry.

Environmental guidelines were certainly toward the top of oil & gas executives’ concerns a decade ago. They worried about tighter safety and environmental regulation leading to higher compliance costs. However, this did not specifically mean climate change – it mostly related to ecological impact.

The one risk that was, and still is, universally recognized is material vulnerability to extreme weather conditions. Even in 2012, some 75% of oil & gas CDP survey respondents acknowledged physical climate risks posed the potential for substantial negative impact on their business.

It was widely understood that climate change and extreme weather could result in construction delays, production downgrades, blow outs or increased decommissioning costs, if poorly managed.

The table on the right shows the % agreement on climate risks identified by oil & gas executives in 2011. Percentages show the proportion of companies that cited a risk factor, and those highlighted in blue those that allude to climate change risks. However, only one risk explicitly mentions climate change. The next page features a summary of climate-related risks and their related opportunities.

Regulatory
- Regulatory changes and increased cost of compliance - 100%
- Environmental restrictions and regulations - 94%
- Inadequate or unavailable insurance coverage - 87%
- Impact of climate change and greenhouse gas legislation - 69%

Demand
- General macro-economic concerns - 91%
- General industry competition - 87%
- Decrease in demand for oil or natural gas - 76%
- Competition from alternative energy sources - 72%

Market

- Volatile oil and gas prices - 100%
- Inaccurate reserve estimates - 96%
- Inadequate liquidity or access to capital, indebtedness - 95%
- Credit or financial risk of partners, customers, vendors or suppliers - 75%
- Increased operating costs - 67%

Operational
- Inability to expand reserves or find replacement reserves - 98%
- Natural disasters and extreme weather conditions - 96%
- Operational hazards including blowouts, spills and injury - 97%
- Reliance on third-party transportation and processing - 83%
- Ability to attract or retain key personnel - 78%
- Failure to properly execute corporate strategy - 73%
- Shortage of rigs, equipment and personnel - 72%

Summary of oil & gas climate-related risks and their related opportunities

Regulatory risks

Policy makers continue to signal support for action to limit climate change. The introduction of increasingly stringent climate change laws and regulations in numerous countries could compel oil & gas companies to curtail, modify or cease certain operations or implement temporary shutdowns of sites. These actions could significantly reduce profitability over time. Many oil & gas companies have operations in over 50 countries, all with differing degrees of political, legal and fiscal stability. This exposes operations to a continuous review of changing laws and their license to operate. Any of these, individually or in aggregate, could have a material adverse effect on a company’s financial condition, including operating income, cash flow, and reputation.

Operational

- Changes to trade compliance regulations e.g. In Norway, carbon sequestration has been made a condition of extraction.
- Unforeseen or newly introduced regulation, leading to higher operational costs, such as energy and/or transportation costs.

Metric: Reporting on local regulation

Environmental taxes

- Introduction of carbon price schemes, with over 50 already in place around the world.
- Fines related to any unsuccessful litigation cases.
- Changes to regulatory enforcement leading to additional build costs e.g. stricter flaring requirements.
- Forced divestment of assets.

Metric: Exposure to countries with carbon tax

Project cancellations

- Regulations designed to gradually limit fossil fuel use may negatively impact the development of new projects, due to a projected decrease in demand for their output.
- This could lead to project cancelations, as well as a write-down in the value of existing assets.

Metric: None

License to operate

- Additional compliance obligations & changes to disclosure requirements add to administrative burden.
- Local product content requirements in favor of a lower-carbon energy mix, lower the share of fossil fuels e.g. addition of biofuel.
- A cancelation or forced renegotiation of contract rights.

Metric: Number of legal disputes in progress

Opportunities: Staying ahead of regulation can lead to using lower-carbon (more efficient) transportation, production and distribution processes, lower environmental taxes, lower legal costs and improve access to capital. It will also secure a future license to operate.

Technology & physical risks

Technology risks: The March 2020 collapse in fossil fuel prices due to an oil price war between Russia and Saudi Arabia was exacerbated by the demand declines caused by the Covid-19 pandemic. However, there are structural factors that threaten a long-term resurgence in demand. There's the risk of a demand tipping point approaching in the industry, with associated declining returns on investment. Fossil fuels are increasingly competing with renewable energy sources. These benefit from steep technology learning curves, which mean that renewables get cheaper every year. Combined with a growing ambition from business and retail customers to reduce the carbon intensity of energy they consume, this spells out longer-term uncertainty over demand for fossil fuels.

Renewable energy transition

- An increase in solar and wind installations by a factor of 13 and 60, respectively, between 2015 and 2050. These already account for more than half of new power generation capacity additions each year.
- Competition from renewable energy technology costs, e.g. the cost of PV modules is down by 90% since 2008.

Metric: Renewable spending targets

Uptake in electric vehicles

- Erosion of demand for petrol and diesel from electric vehicle (EV) uptake.
- EVs reach price parity with internal combustion cars. EV sales are expected to exceed 100 million by 2035.

Metric: EV charging spending

Changing energy use patterns

- Industrial production falls, and total energy consumption declines further due to the uptake of more energy-efficient equipment and processes.
- Fall in fuel demand is accelerated by the electrification of heating, industry and transport.
- Fall in demand for kerosene from electrification of cooking in non-OECD countries

Metric: New refineries & petchem assets capex

Shift to different fuels

- Accelerated uptake of low-emission fuels for marine and aviation sectors, including a blend of biofuels, or a move away from fossil fuels altogether.
- Decarbonization of heating and cooling, as countries try to reach their Paris goals. This will lead to an increased uptake in hydrogen and electric heat pumps.

Metric: Hydrogen & alternative fuel production

Opportunities: Becoming a power utility selling clean power is an opportunity to seek new customers. There is also a chance to sell low emission products, such as petrochemicals and alternative, low-emission fuels or biofuels.

Physical risks: The oil & gas sector is capital-intensive, with many long-life fixed assets, long supply chains and significant water requirements. The sector also often operates in remote high-temperature or sub-zero temperature locations, many of which are exposed to risk of cyclones and flooding. Therefore oil & gas companies are already exposed to many extreme weather and water supply related risks that have historically resulted in sudden production downgrades, project delays or costly liabilities. More intense weather due to climate change may damage oil and gas infrastructure, pipelines, equipment, and staff accommodation. This, in turn, can disrupt operations and performance, and also add to decommissioning costs.

Cyclones

- Damage to assets e.g. increased risk of major spills/leaks, resulting in clean-up costs and potential litigation.
- Loss or disruption of construction and/or production.
- Potential injury to personnel or delays to decommissioning.
- Considerable increase in weather-related insurance and re-insurance costs.

Metric: Weather-related insurance liabilities

Sea level rise/storm surges

- Disruption to production and/or construction, increasing costs.
- Potential injury to personnel or delays to construction, operations or decommissioning.
- Higher costs of building soft (e.g. mangroves) or hard (e.g. sea walls) coastal defense structures.

Metric: Value of assets located in coastal zones

Temperature rise

- Potential threat of bushfires to energy distribution and transmission infrastructure.
- Damage from local bushfire exacerbated by gas leaks, which can ignite embers as methane is highly flammable.
- Extreme temperatures will impact the ability of equipment to operate efficiently e.g. the chillers at LNG plants.

Metric: Weather-related insurance liabilities

Flooding/drought

- Damage to facilities, refineries, loss of production and increasing risks of dispersal of salt and chemicals from coal-seam gas mines onto farming land from flooding.
- Limited drilling activity during those events.
- Drought causing delays or inefficiencies for water-intensive operations.

Metric: Water volume consumed in operations

Opportunities: Adapting to weather risks can lead to fewer delays to construction, operation and decommissioning, as well as less disruption to supply chain management. This all saves costs over the long run.

Market & reputational risks

Market risks: Approximately half of the value of oil and gas companies in the industry lies in the assets they have yet to exploit – their reserves. However, a range of studies suggest that only 20-35% of remaining known oil & gas reserves can be used if the world is to stay within 2 degrees of global warming. Therefore, as lower oil prices and the prospect of ‘peak oil’ increase the risk of stranded unproductive assets, investors are demanding stricter capital discipline. There is also increasing investor and reputational pressure to reduce upstream and downstream CO2 emissions. By exploring some of the options that the sector has for reducing GHG emissions, oil & natural gas companies can not only stay ahead of regulatory and economic developments but also potentially profit from them

Stranded assets

- Loss of revenue in upstream operations, where much company value is derived from the future potential to exploit reserve assets. - - Without commercially viable carbon capture and storage, the asset value of reserves is likely overstated.

Metric: Embedded carbon in reserves

Lower demand for oil

- The disruption caused by Covid-19 and the gradual recovery will bring forward the peak oil demand from the road transport sector.
- U.S., Europe, Japan and South Korea demand has already peaked, as alternative drivetrains and fuel-economy mandates have impacted these markets first.

Metric: New exploration and production capex

Carbon liabilities

- Under-reported fugitive methane emissions leave investors vulnerable to uncertain liabilities under a carbon price.
- Increased coverage of carbon taxes. According to the World Bank, carbon taxes or trading systems cover 20% of global emissions, compared with 15% in 2017.

Metric: Total scope 1 and 2 emissions

Investor pressure

- Investor demand for greater transparency and better carbon risk management from their portfolio companies.
- An increasing number of climate risk shareholder resolutions being passed e.g. requests for scenario analysis consistent with achieving 2 degrees warming.

Metric: Number of shareholder resolutions

Opportunities: Staying on top of market risks can improve energy efficiency with new technologies e.g. source energy from lower-emission or renewable sources. There are also new low carbon goods and services to sell.

Reputational risks: The investment community is increasingly considering the environmental track record of companies, alongside other metrics. To make a financing decision, investors will take into account all available evidence of reputational boosts or breaches that demonstrate the company’s true stance on climate change. Similarly, increasingly environmentally-conscious customers are keen to purchase from companies that have made progress on sustainability. Brands that can show leadership in reducing carbon emissions or other environmental impacts are now more likely to win new business. Having a strong environmental message can also help with hiring, especially from the Millennial generation, who will make up three-quarters of the workforce in six years.

Capital flight

- Investors are increasingly hesitant to finance projects and companies that do not demonstrate resilience to risks related to climate or transition.
- Companies that do not attend to their environmental reputation may also find investors divesting.

Metric: Divestment (threats) by investors

Customer loyalty

- Real or perceived failures of governance or regulatory compliance could lead to a reduction in customer retention, or limit the ability to attract new customers.
- A clean reputational record is often a condition of winning new contracts, or renewing existing ones.

Metric: None

Brand value

- Reputational damages arising from real or perceived failures of governance or regulatory compliance can significantly impact brand value.
- A weak environmental track record is a missed opportunity to differentiate company products and services to potential customers.

Metric: Value of intangible assets

Talent retention

- In a 2019 Fast Company survey, nearly 40% of millennials chose their job because of a company’s sustainability credentials. Therefore a bad reputation could limit access to the best talent.
- A poor environmental record could also reduce staff retention.

Metric: Ambition of emissions target

Opportunities: Addressing reputational risks can attract and retain new investors, increase brand value and improve customer loyalty. There is also an emerging opportunity to raise sustainable finance and attract the best talent.

Opportunities & conclusion

There are a number of opportunities available to oil and gas companies as they address climate change. Reimagining ‘big oil’ through a managed transition to ‘big energy’ creates the possibility of selling new products and accessing new markets. Certain activities can also introduce operational cost savings and build in portfolio resilience, reducing the risk of stranded assets. Investors have become more sophisticated about engagement over recent years, whether working alone or collaboratively. Oil & gas companies will increasingly find that finance for climate-change adaptation or mitigation activities is much more readily available.

Selling to new markets

- Seize the new market opportunity presented by commercialization of advanced biofuel technology.
- Similarly, take advantage of an increase in demand for alternative fuels; and of new business options, such as fleet charging services and low-carbon petrochemicals.

Metric: Ethanol and biodiesel production

Access to new capital

- Tap into the sustainable debt available from financial institutions to climate transition initiatives. This follows a broader market trend.
- Oil and gas companies raised just under $13 billion in green bonds, sustainability-linked loans and green loans in 2019, up from $270 million in 2017.

Metric: Sustainable debt issuance

Operational cost savings

- Avoid the potentially extensive heat losses (and energy costs) from steam systems, fired-heaters (furnaces & other flue exhausts), flares, inadequate insulation, and poor heat recovery.
- Save operational costs from efficient facility design and ongoing monitoring through digitalization. Optimize processes and minimize equipment downtime.

Metric: Cost of production improvement

Portfolio resilience

- Join the global trend of investment in renewable power capacity, and sell the power to new and existing customers who are seeking low-carbon alternative energy sources.
- Enter a thriving market: since 2008, global investment in new renewable power capacity has exceeded that for fossil fuel power, year-in-year-out.

Metric: Clean energy spending targets

Risks avoided: Developing stranded assets, an uncompetitive operating model, and a lack of access to new capital.