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Waiting for Big Oil to clean up its act

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Screen Shot 2016-06-11 at 22.29.07By Jillian Ambrose

11 JUNE 2016 • 7:22PM

“The world is going to have to continue using fossil fuels, whether they like it or not.” There’s little disguising the defiance in the words of Exxonmobil chief Rex Tillerson.

In a Dallas concert hall, less than six months after the historic global climate deal in Paris, the long-standing leader of the world’s largest listed oil company locked horns with shareholders in an increasingly familiar battle for Big Oil.

For years, placard-wielding green activists have raised warnings that echo the financial collapse: a “carbon bubble” could leave markets reeling as trillions of dollars’ worth of existing fossil fuel assets become worthless in a low-carbon world.

The hyperbole is easy to dismiss when it’s delivered through a mega-phone, but concerns over the future of high-carbon companies have made the leap from the picket line to the boardroom, where the world’s largest investors are asking tough questions on what a lower carbon environment would mean for the balance sheets of the largest fossil-fuel producers.

At Exxon’s latest AGM, over 38pc of the company’s investors rebelled against the board by backing calls for it to publish an annual study of how profits may be affected by climate risk. The concerns are sector-wide and the stakes are high: Blackrock, the world’s largest investment fund, together with insurance giant Axa and Norway’s $900bn sovereign wealth fund, are all raising concerns over climate risk and beginning to divest from carbon-exposed investments.

It’s a trend that has not gone unnoticed by the international Financial Stability Board (FSB), led by Mark Carney. In 2015, G20 finance ministers and central bank governors asked the FSB how the financial markets could take into account climate-related issues.

Last week, prominent climate economists Dimitri Zenghelis and Nicholas Stern told the FSB’s task force on climate-related financial disclosures, chaired by Michael Bloomberg, that there is a growing gap between the stock market valuations of carbon-intensive companies and what their value would be if the commitments made in the Paris Agreement on climate change were taken seriously.

“This gap should alarm policy-makers and central bankers: it suggests either asymmetric information or a lack of credibility in policies,” the report warns. The revelation is worrying news for investors, but potentially calamitous for world markets, which would struggle to cope if there was a sudden revaluation of companies exposed to the risks of climate change.

“The speed at which such re-pricing occurs is uncertain and could be decisive for financial stability. If the transition is orderly, then financial markets will likely cope,” claim the authors.

The submission adds that “it is becoming increasingly risky for companies to pin all business strategies on the assumption that extensive decarbonisation will not happen” and that “business models reliant on the assumption that governments were not serious in Paris are looking increasingly vulnerable”.

Oil companies argue that the bigger obstacle to limiting greenhouse gases that threaten dangerous levels of global warming is the world’s continued reliance on fossil fuels rather than their plans to deliver them. In BP’s annual survey of energy trends, the company found that oil remains the number one energy source, making up a third of primary energy use. For all the noise of the renewables lobby, energy from wind, solar and biofuels makes up just 2.8pc of global consumption, up from 0.8pc a decade ago.

The words of Exxon’s Mr Tillerson may have seemed strident in the face of a shareholder rebellion, but the data backs up his defence: “Just saying ‘turn the taps off’ is not acceptable to humanity.” BP economist Spencer Dale is just as clear about the long and uphill road towards a cleaner energy system.

The company can see, clearer than most, just how great the scale of change needs to be to line up political goals with market reality. Last year, Mr Dale says, the carbon intensity of global GDP fell by 2.8pc, its largest fall since 1992 apart from the financial crisis.

“That’s the good news. But how much progress is it? To give you a ballpark estimate, if you look at the [International Energy Agency] scenario which says what we’d need to do to hit the Paris agreements, you’d need an average decline in the carbon intensity of GDP of 5.5pc sustained each year for the next 20 years,” Mr Dale explains.

“Last year’s decline was a one-off, and we’d need to have double that, and we’d need to have that every year for the next 15 years. That offers some perspective on the size of the challenge associated with Paris,” he adds.

BP accepted shareholder calls last year to report on its plans to address climate concerns in its official financial reporting, and boss Bob Dudley wrote to investors to assure them of the  steps being taken.

“We are increasing the proportion of natural gas in our portfolio – gas being a cleaner alternative to coal – everywhere, from the US and Europe to China and India. We are pursuing energy efficiency in our operations as well as providing advanced fuels and lubricants for customers.

“We are running renewable energy businesses in biofuels and wind and we fund research into climate change solutions at leading universities,” Mr Dudley’s letter reads.

Ten years ago, BP’s portfolio consisted of 60pc oil production compared with 40pc gas. Today, the hydrocarbon stakes are split 50:50 and in five to 10 years’ time, the share will be 60:40 in favour of gas. It is a far cry from BP’s greener “beyond petroleum” brand overhaul at the turn of the century, when its newly launched alternative-energy division hinted at a new direction for the major.

In 2005, BP committed to spending $8bn on solar, carbon capture, wind, and gas-powered power generation, before quietly letting the slogan fall by the wayside. BP still has arguably the largest renewable energy portfolio of any of the major oil companies, but from 2013, in the wake of the Deepwater Horizon disaster, the focus has returned to where it can cut carbon from its core interests. The answer, for many oil companies, is gas.

“We see natural gas as playing an absolutely key role as a bridge fuel in transitioning to a lower-carbon economy,” Mr Dale explains. To critics of the industry, an incremental shift from one fossil fuel to another over two decades seems both glacial in pace and unambitious in scale.

To oil companies, it represents a rational strategy in line with the outlook for the world’s future energy needs. By 2035, the global population is expected to reach nearly 8.8 billion, meaning an additional 1.5 billion people will need energy, according to BP’s annual world energy forecasts, and based on current forecasts it won’t be sourced from renewables.

BP says fossil fuels will remain the dominant form of energy until then, meeting 60pc of the projected increase in demand and accounting for almost 80pc of the world’s total energy supplies in that year. The global dash for gas is a multi-billion-dollar bet that Royal Dutch Shell was happy to take. Earlier this year, the Anglo-Dutch supermajor defied tumbling oil market prices to snap up BG Group for £40bn.

The former British Gas subsidiary is now a global leader in producing and transporting gas that is compressed into liquid form to be carried on tankers and sold on the international market. After the oil market downturn, Shell says the tie-up will be a springboard to profitability in the near term and will help to “future-proof” the company.

“We have to bear in mind that the world is going to need oil and gas for a long time to come,” says Shell boss Ben Van Beurden. “But the more we can invest in the lowest carbon alternatives of that part of the system, the better.

“Bear in mind our portfolio is not long-life. We are not a company that is sitting on 200 years’ worth of oil or gas for that matter. We are a company that has a reserves life of about 10 to 15 years, so therefore we do have the opportunity – and the need – to adapt as we go along,” he adds.

How far and how fast oil companies adapt to a changing world will depend on governments’ ability to set a price for carbon, both companies agree. The EU’s carbon emissions market has failed to offer a meaningful price signal to investors, but an effective market design, adopted globally, could provide the financial incentive for companies to make rational financial decisions.

“What BP says very loudly, very clearly, is that we need governments to lead on this. We need them to set the right incentives and we need a meaningful carbon price,” Mr Dale says.  “If we do not put a price on carbon, you can forget about it,” Mr Van Beurden adds.

“That is not because companies like ourselves would not be making the right choices. We have to make choices that are economically viable, but also our customers and consumers are going to be rational to a very large degree. They are going to act on economic drivers and no matter how green, no matter how progressive, many consumers are – ultimately they act rationally as well.”

If oil companies are happy to rely on government to solve the trillion-dollar dilemma of a new energy order, they’ll need to hope that when the time comes for regulatory action, policymakers are willing to act rationally, too.  

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