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Dividing lines appear in transition approaches

Differences have emerged between how IOCs and NOCs are tackling the energy transition—and the size of oil and gas reserves also has a big impact

Oil and gas companies worldwide are facing up to the business model challenges posed by global climate change mitigation and the related energy transition. But companies’ reaction to the challenges varies depending on three factors: whether they are based in an OECD member or not; their shareholder base and public image; and their resource portfolio, which will often dictate the relative advantage specific emissions control actions.

Divisions have emerged between the strategies followed by international oil companies (IOC) and national oil companies (NOC) that are playing out under a cascade of regulations being issued by major energy markets, particularly the advanced industrial economies of the OECD and China. Environmental concerns in OECD countries have historically prompted legislation requiring changes in oil products specifications. The removal of lead in gasoline; the reduction of sulphur content in middle distillates; and most recently the cut in sulphur content in marine fuels under the International Maritime Organisation’s IMO 2020 initiative are examples.

The commercial impacts of such policy change have translated into changes in policies and product specifications in oil producing countries. There seems no reason to believe that the energy transition will not have similar results. Oil producers have signed up to the 2015 Paris Agreement on climate change—although the Trump administration has abandoned it—and markets will reflect the agreement’s impact.

International pressure

Leading IOCs, with shareholders and public relations to maintain, are most under pressure to adapt their business models to the transition. Companies such as Shell, Total and ExxonMobil have faced calls from shareholders, increasingly including large institutional ones, to burnish their climate credentials.

Those with smaller reserves tend to have more aggressive targets, which often involve moving towards electricity

EU-based companies, including Shell, Total, Italy’s Eni and Austria’s OMV are also feeling the pressure of EU directives regarding emissions and recycling. US companies are living through an uncertain regulatory cycle—the Trump presidency has withdrawn from the Paris accord and is loosening federal environmental regulations while state governments tighten theirs—but are nevertheless proceeding with reducing emissions and increasing operational efficiency.

The result has been European companies’ diversification into electricity production and sale at the point of use, often through bolt-on acquisitions of renewable energy activities and power marketing. Shell and Total have led these efforts, acquiring utilities and solar panel producers; among other acquisitions, Shell bought a UK energy supply business through First Utility and Total bought control of SunPower in the US.

Meanwhile, OMV and Finland’s Neste have dedicated resources to biofuels and plastics-to-fuels production and marketing. Eni is rolling out solar photovoltaic (PV) installations to provide emission-free power at its exploration and production (E&P) activities worldwide.

National priorities

NOCs, meanwhile, are “more directly driven by their government owners”, notes Morgan Bazilian, director of the Payne Institute and professor of public policy at the Colorado School of Mines. With the notable exception of Norway’s Equinor—which is listed on major markets—decisions by NOCs are driven by their governments, which are often influenced by increasing export revenue by displacing domestic oil and gas in power generation. This may account for their strategic choices to accommodate changes arising from the transition.

Mid-East Gulf countries appear to be the leaders. The UAE has a goal of 44pc of domestic energy production to be from carbon-free energy by 2050 and the Abu Dhabi National Oil Company (Adnoc) is exploring petrochemicals recycling technology and refining upgrades with Eni, OMV, and chemicals concern Borealis.

Saudi Arabia’s Aramco is boosting its presence in the chemicals sector partly in order to balance expected increased oil demand from that sector with lower expected demand growth from others. Should Aramco’s December IPO result in an activist shareholder base—as the part-privatisations of Eni and Equinor have—then Aramco may follow IOCs down the road of business diversification. In Saudi Arabia and the UAE, renewable electricity is largely being developed separately from their NOCs.

Governments owning large oil and gas reserves may not feel the need to aggressively address renewable energy development

Outside of the Gulf, business model diversification among NOCs is rare, with key actions generally focussed on operational efficiency and largely led by local conditions. For example, Equinor’s expansion into large offshore wind power projects builds on its extensive experience of large-scale offshore engineering. Chinese state-controlled Cnooc is also emphasising efficiency measures. Meanwhile, Thailand’s PTT announced that it will spend 30pc of its development budget through 2021 on non-oil activities, including solar power generation and electricity storage. Denmark’s Orsted, a leading offshore windfarm developer 50pc owned by the Danish state, began life as Danish Oil and Natural Gas (Dong).

Reserves factor

Within IOCs, a secondary split exists between those with large and small reserves. Companies holding larger reserves often have less aggressive energy diversification targets, instead preferring to concentrate on efficiencies and improved fuel qualities. Those with smaller reserves tend to have more aggressive targets, which often involve moving towards electricity.

In a May 2019 paper, Matthias J Pickl of the King Fahd University of Petroleum and Minerals notes an inverse correlation between the activities of IOCs in renewable energy and their levels of proven oil reserves. He concludes that “oil majors with smaller levels of proved oil reserves are moving into the renewable space faster”.

The trend may also extend to NOCs, where governments owning large oil and gas reserves may not feel the need to aggressively address renewable energy development as their reserves will ensure domestic energy supply and export revenues well beyond the point where other producers exit the market. IOCs and NOCs with larger reserves may also feel that energy efficiency and emissions limitation measures from wellhead through to end-user delivery may well address many of their obligations under the Paris accord.

Similarities

While leading IOCs and NOCs can choose their route to addressing the energy transition, their smaller peers confront a different set of challenges. Smaller IOCs have “less levers, less product diversification [and] less investment in R&D” than the major oil companies, notes the Payne Institute’s Bazilian. He adds that how smaller NOCs face climate change mitigation will depends very much on local governance structures, financing and government policies.

Many smaller NOCs and US E&P concerns will likely concentrate on production efficiencies to reduce their emissions. For example, Angola’s Sonangol is pursuing the elimination of approximately 3bn m³ of gas flaring and increasing LNG exports. Reducing economically wasteful and environmentally damaging gas flaring is also becoming an issue in the US, which flared 14.1bn m³ of gas in 2018, up from 9.5bn m³ in 2017, according to the World Bank.

Some mid-sized companies are pursuing technological initiatives to address the energy transition. Occidental Petroleum, which recently bulked up by acquiring Anadarko Petroleum, has invested in Net Power’s technology for using the CO2 created in power generation for enhanced oil recovery (EOR). Among South American NOCs, Colombia’s Ecopetrol has commissioned a 21MW solar PV plant to cover the energy needs of its Castilla oilfield, in a move similar to Eni’s, and is studying use cases in additional projects.

 

Bill Barnes, Director, Pisgah Partners

Keep up-to-date with how the predictions in Outlook 2020 are playing out and get a first look at the themes that will shape Outlook 2021, as well as with relevant events such as the Outlook launch party and publishing schedules, by subscribing to Petroleum Economist’s bi-monthly Outlook newsletter. http://go.pardot.com/l/45692/2020-01-17/89x558

 

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