The Energy Transition - how fast will it happen, what form will it take, and how should companies best position themselves?

In the wake of the COP21 climate change talks in Paris last December, many people are discussing what form the transition to a more decarbonised energy system will take, but opinion remains sharply divided. This was well reflected by the speakers at the FT Energy Transformation Strategies event in early June, who disagreed over the real costs and subsidies of various energy forms, as well as the outlook for the oil price and the importance of renewables. There was also disagreement over what role oil and gas companies should or would play, or whether their best strategy might be slow liquidation.

The transition will create opportunities for a variety of new business models, according to Nick Butler, Chair of King's Policy Institute, but that isn't a “single mould”. He said: “Companies will pursue different strategies – gas, or expensive oil (based on expectations of a return of higher prices), and others are looking more closely at renewables… The fourth choice is to harvest the business - to pay out, after deciding that this is a business with a finite life.” He said shareholders are already making it plain they want a clearer explanation of which option was being pursued and why, along with an assessment of risks. “They must not destroy value by trying to do too much,” he added.

Philip Lambert, CEO of Lambert Energy Advisory, said there was more behind the concerns of ‘big oil’ than just the oil price fall, with an “underlying drumbeat of the end of an industry,” linked to rising costs, climate change concerns and failure to replace reserves. “There has never been so little confidence, with investment and support draining away… The oil price fall is just another punch in a battered body. The critical threat is that the fossil fuel industry becomes so battered it doesn’t invest enough to keep the system going – we are not yet ready for renewables to take over… It is an unbelievable risk… destroying a system without something sustainable to replace it is the greatest threat to the global economy,” he said.

Laszlo Varro, Chief Economist at the International Energy Agency (IEA) agreed that the drop in investment in the oil sector was unprecedented, but said it was driven by the oil price much more than climate change policy progress. “However, the oil price fall is not totally unrelated to energy transition - while electric cars are not hitting demand yet, improved fuel efficiency is cutting as much demand as new shale oil production is adding to supply.”

He said it is important to distinguish oil in the transport sector, from gas and coal in the electricity sector, where there really is a transformation underway. Renewables are dominating new capacity, and power demand in developed countries is falling even when economic growth is strong – so fossil fuels are getting an ever smaller share of a shrinking pie. “Consumers won’t buy more power if the electricity price falls, but they might buy an SUV if the gasoline price goes down,” he added.

Scott Foster, a director at the UN Sustainability Division, said that rather than the climate change agenda driving change in the oil and gas sector, it is the fundamentals. He noted wind and solar are outcompeting fossil fuel based alternatives in auctions across the world, without subsidies. “Consuming countries are opting for wind and solar instead of expensive LNG, much of which has overrun cost by 50% or more.”

Walking the talk

Among those oil and gas companies that are considering the third option of moving more into renewables, are Total – which has plans to invest $500 million a year in renewable energy, including biofuels and solar - and Statoil.

Speaking at the FT event, Bjorn Sverdrup, Statoil’s SVP of Sustainability, said the challenges are offering opportunities. “We are positioned to be a winner – stay competitive, costs down, transform the way we work with suppliers, universities, and become relevant for a low carbon world. Building optionality exploring aspects and now walking the talk.”

In response to COP21, he said Statoil was making revisions to “people, performance and portfolio”, including training staff in the business risk of climate change, so they are aware of and able to capture opportunities. He said CO2 intensity will be included in the performance measures against which CEO and others’ pay is assessed. Portfolio changes will involve assessing which assets are compatible with a low carbon future, and the company will also develop key technologies – CCS, fuel cells and hydrogen.

“Then we will be shifting from oil and gas into renewables… We have doubled offshore wind investments in the last few months, and also CCS. It is a big strategic challenge to respond to business risk; look at carbon risk.” He didn’t however, say how shareholders would react to the lower returns currently prevailing in the renewables sector, when compared to those traditionally made in the oil and gas sector.

Stress testing

He said Statoil was looking at risks if government policy toughened to enforce tighter emissions targets, something that had been resisted by Chevron and Exxon. In fact, Anthony Hobley, CEO of Carbon Tracker, pointed out that 38% of Exxon shareholders and 42% of Chevron shareholders have actually recently voted for management to carry out stress tests on their investment plans based on 2C warming, making it likely that even these companies will come round to the idea soon. “Yes, we need to look at what happens to the business if carbon price goes sky high, and we need to do analysis on this – it would lead to a reduction in the value of the company,” said Mr Sverdrup.

Mr Hobley said: “Shareholders care about shareholder value and ability to pay dividends, so now they care about climate risk. Carbon Tracker’s recent analysis suggests putting oil companies on the 2C path is the best way to retain value and service dividends. Climate risk equals financial risk.”

Scott Sheffield, CEO of US independent Pioneer Oil, said companies may become more discriminating in the type of oil they would invest in – gas and light shale oil (LTO), rather than heavy tar sands due to its higher emissions levels. “My biggest concern is that we are setting up for massive price spike in 2018-21 – with US LTO and oil sands down, who will supply growth over next 10 years?”

However, others including Hobley are less concerned about a tight oil market, suggesting that renewables had the potential to fill the gap. “I don’t think they [oil prices] will go back up, they will just be volatile – in an age of plenty producers may need to form new alliances with consumers to ensure they are able to keep investing to produce the energy we need in a low-priced world.” He said there has been repeated under-forecasting of renewables’ growth and cost reductions, and that new business models similar to Uber, and now political will in the wake of COP21, could speed the transition up dramatically.

“But it’s not about switching off oil and gas completely, although coal is another question. Some oil and gas projects just don’t make financial sense, and the real danger is that companies and shareholders misread the timing and extend of the transition. This has happened elsewhere in the past – Kodak, Olivetti, Blockbuster. It is important to move to smarter energy demand models and 2C stress testing. But we want real evidence of change from companies like Statoil and Total, not just talk…”

Mr Sheffield said majors are trying to change their business models, but they have too much debt. “Debt went from $200bn in 2014 to $600bn now, so don’t expect US industry to respond quickly when prices recover – there’ll be a 2 year delay in production recovery for 90% of companies… There’s been $77bn in bankruptcies with 52 companies in the US so far, but very few asset sales – there’s too much of a spread between buyers and sellers.”

A number of delegates said it was a mistake for oil companies to borrow to continue to pay high dividends, rather than investing for future growth (whether it be oil, gas or renewables), based on a continued belief that oil prices would go back up. This might have looked a little like liquidation, but the markets clearly see it differently, with investors now pushing oil company share prices back up as they seek to position themselves to benefit from what they expect will be a rebound in the oil price over the next few years. Whether that happens or not and to what extent will determine the success of the various approaches adopted by new and old energy companies, but overall a more diversified and carbon aware approach is slowly gaining ground.

Image: Wind turbines generate electricity behind a pumpjack in Muenster, Texas. Source: Ben. CC-BY licence.