part 1: risks for independent E&Ps
written by: Mark Dickson, VP energy transition
The world will still need oil and gas in 2050, even in the IEA 2°C Scenario (2DS) – where oil provides 29% of the energy supply and gas 22%. However, the era of Energy Transition based on the consensus view of Climate Change is here and beginning to influence traditional oil and gas business strategy.
The Major E&Ps through their participation in the OGCI have spent or stimulated around $6.3 Bn USD in Clean Energy investment – largely focused on renewables and investing in new technologies. We have seen that Total and Shell intend to spend $2bn per year and Total has made public commitment to have 20% of its portfolio in renewable assets by 2030.
Energy markets are prioritising renewables in Power-Purchasing Agreements (PPA) and provide benefits for low carbon energy sources. In addition, in electricity markets by 2030, new build renewables will outcompete existing fossil fuel generation on energy cost. This milestone will in fact be reached in most countries within the next 5 years.
Some Independent E&Ps are embracing the first step of Energy Transition, Greenhouse Gas (GHG) emission intensity and reduction thereof. However, we have not seen the Independent E&Ps make the same moves as the majors in investment in clean energy, renewables or new technology, this poses a major risk.
This article considers – What risks and opportunities do the Independent E&Ps face in the future pathway to 2050?
And our follow up article considers – Steps an Independent E&P should consider in the Energy Transition?
Energy Transition Risks
Availability of Capital – In recent times we have seen various institutions demonstrate commitments not to invest in oil and gas production. In her article on Sept 23,2019, Christina Figueres refers to the various institutions no longer willing to finance oil and gas capital projects including Norwegian Sovereign Wealth Fund, European Investment Bank and Danish Pension Fund.
io has also noted the “climate hedging” Investment Banks have under taken by investing in both renewables and hydrocarbons, while calling for effective government leadership and policies that recognise the costs of price carbon. For instance, consider the following banks, amongst the top lenders to oil and gas.
These banks however are committed to investing in Clean Energy projects 
- / JP Morgan – $200 bn in clean financing through 2025 – to facilitate new energy, transportation, waste management, water treatment and technology innovations
- / Citi – $100 bn Environmental Finance Goal
- / Bank of America – Commits $300 bn by 2030 to Low-Carbon, Sustainable Business
- / ScotiaBank – $8.5 bn in 2018 in financing to the global renewable energy sector
Is this therefore a two-pronged strategy for “climate hedging” or the beginning of a major change in energy investment? Either way this represents a risk to Independent E&Ps in competing for future capital.
Emission Reporting and Disclosures. The oil and gas industry is already making great strides towards in following the Task Force on Climate-Related Financial Disclosures (TCFD) which gives references to Shell, Equinor, ENI and Total as examples of effective disclosure practice following TCFD recommendations. However, the acceptance of TCFD by the Independent E&Ps is not yet universal, with some websites and financial reports surveyed by io, not using the TCFD recommendations.
Emissions Intensity of Future Projects, Closer scrutiny by Institutional Investors – Active investors are successfully influencing E&P company strategy. Note the following recent developments:
- / DONG Energy – completely divested from oil and gas in 2017 and rebranded to Ørsted to underline its step away from oil and gas.
- / Shell – aiming to cut emissions in half by 2050, while also linking executive compensation in meeting those targets. This has the potential to drive Shell’s investment into clean energy. This decision came after pressure from Climate 100+ and investor led coalition, that represents $33 Tn USD in managed assets, to take the right actions.
- / Exxon – Legal and General Investment Management (LGIM) has excluded investment in Exxon due to failure to meet LGIMs key minimum requirements on emissions reporting and targets.
- / BP, in recent weeks, has divested its Prudhoe Bay, Alaska oil & gas assets after previous statement by Bob Dudley on being prepared to divest oil projects to meet climate goals.
While BP and Shell are arguably under greater scrutiny due to the scale of dividend and their historical attractiveness to pension funds, a change in the pensions industry will start to effect Independent E&Ps.
In the UK, the view now is that climate change poses a material risk to pension funds. By 1 October 2019, almost all UK occupational pension schemes were required to document their approach to Environmental, Social and Governance (ESG) factors and how they manage the Statement of Investment Principles (SIP), with reference to climate change.
Independent E&Ps may be reluctant to shift some of the portfolio out of oil and gas into clean energy as returns on projects in renewables do not compare to oil and gas. A study by Macquarie found that US unleveraged return on onshore oil was 33% and Pre-FID Conventional Hydrocarbons 21%. Comparing this to Photovoltaic (PV) and Wind which produce returns of between 5% and 8.7 %, it is not hard to understand why E&Ps will want to stay in oil and gas projects, however a recent paper by the Oxford Institute for Energy Studies  highlights the conclusions of Energy Transition on the oil and gas industry rather well, it concludes that Energy Transition risk is already here and is beginning to influence the investor expectations who are demanding higher hurdle rates for longer cycle oil projects. Considering this demand for higher hurdle rates (IRR) this will put additional pressures on Independent E&Ps whose financial statements cannot tolerate as much risk as the Majors. This will of course eventually affect valuations of E&P companies with consequences for cashflow and share price.
io concludes that the Energy Transition is here and now is the time for the Independent E&P companies to address the new pressures that they are under.
In our follow up article, we describe a framework for Independent E&Ps in developing a roadmap for Energy Transition.
VP Energy Transition
The 2°C Scenario (2DS) lays out an energy system pathway and a CO2 emissions trajectory consistent with at least a 50% chance of limiting the average global temperature increase to 2°C by 2100.
 Global Energy Perspective 2019 – McKinsey Energy Insights Jan 2019