While many investors consider integrated oil and gas stocks to be attractive investments, there can be no doubt that the world's low carbon focus poses major headwinds for the industry. Renewable energy consumption is up more than 1,200% since 1990, compared to 78% for gas and 37% for oil.
Fossil fuels may continue to meet the bulk of the world’s energy demand over the short run, but changing patterns of energy consumption, driven in part by carbon regulation, are likely to significantly affect the profitability of oil and gas firms.
The Paris Agreement, adopted in December 2015, creates a country-driven, global framework to achieve emission reductions. While most countries are struggling to meet their reduction targets, the agreement is ultimately expected to spur broader and deeper adoption of carbon regulation. Achieving the Paris Agreement’s 2 degrees Celsius goal will effectively require a complete phase out of fossil fuels.
However, we concur with the International Energy Agency, which opined in its latest World Energy Outlook that “it is far too early to write the obituary of oil.” Nevertheless, we expect carbon regulation to ultimately take its toll on the industry, in the form of dampened profits, and an increased cost of capital. Electric vehicles, whose rapid ascent is being driven in part by government policy, may also lead to significant demand destruction for gasoline, which accounts for 45% of crude oil supply.
Oil and gas companies at greatest risk are those with higher average production costs, those involved in carbon-intensive projects, including oil sands mining in Canada, high Arctic drilling and certain LNG projects, and those that are not diversifying their product line-up.
We evaluated the performance of the world’s 10 largest publicly traded oil majors based on their risk management capabilities. Company performance varies widely: leaders include Royal Dutch Shell, Total, Eni and Chevron, while laggards include Rosneft and Sinopec.
The importance of conducting this analysis is likely to increase as the low carbon transition intensifies, and investor expectations for such disclosure is certainly on the rise, due in part to the success of the TCFD.
Royal Dutch Shell: Decarbonising Assets
Shell (RDSB) has a strong position on climate change and energy transition: “A key role for society – and for Shell – is to find ways to provide much more energy with less carbon dioxide.” In order to achieve this goal, the company has developed a strategy that is based on six pillars: natural gas, carbon capture storage, renewable energy, carbon pricing mechanisms, low-carbon transport and power generation.
Recent developments indicate that Shell has been actively implementing this strategy. Most important was the acquisition of BG Group in February 2016, which reflects the company’s increased focus on natural gas. Moreover, in May 2017, Shell sold all its in-situ and undeveloped oil sands interests in Canada and reduced its share in the Athabasca Oil Sands Project from 60% to 10%. These developments significantly improved the carbon footprint of the company’s asset portfolio.
Shell has been active in the biofuels business since 2010, through its join-venture Raizen, a sugar-based ethanol producer, which is now third largest energy company in Brazil. Together with its efforts to develop hydrogen fuels, Shell is discovering ways to reduce GHG emissions from road transport. Additionally, with the acquisition of NewMotion, the owner of one of Europe’s largest EV charging networks, Shell has signalled its intent to become a major player in the fast-growing electric mobility market.
While Shell has made significant steps to improve its portfolio, the company’s core business remains the sale of oil products and petrochemicals. Shell has been disclosing comprehensive scenario analysis since the 1970s, but the company does not disclose a clear vision on how its business model may evolve under different scenarios in a carbon-constrained world. We expect to see Shell provide its investors with such informed analysis in the years to come.
