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The energy transition reality gap

Industry predictions for the demand for oil and the speed of the energy transition vary wildly. If it cannot coalesce around a compromise plan, politicians and investors may seize the initiative

Jarand Rystad is a brave man. The CEO of Rystad Energy strolled onto the Oil & Gas Council’s World Energy Capital Assembly (Weca) stage in December and declared one of the most bullish predictions yet on the energy transition. Peak oil demand would occur within a decade and then experience “a steady decline after that”, with peak gas demand following maybe a decade later.

This could be music to the ears of world leaders filing into the COP25 United Nations Climate Change Conference in Madrid. Most national governments were prepared to sign up to the COP21 Paris Agreement but far more reluctant to implement the potentially painful measures necessary to achieve it.

But it has rapidly become an unignorable political issue across a growing number of countries. In the US, it is another of the stark differences between the Democrats— whose presidential candidates have various takes on a so-called Green New Deal—and Republican president Donald Trump. It has also been a far more prominent issue in the UK’s general election campaign than in previous contests, running perhaps third, to Brexit and the country’s health service, in voter issues.

Growing environmental concerns within mainstream political debate could result in governments passing misguided kneejerk legislation, Lord Browne, executive chairman of Russian oil investment vehicle L1 Energy and a former CEO of BP told a meeting on the fringes of Adipec in early November.

The industry must do more to engage with governments and environmentalists to understand their concerns and propose effective solutions based on science, he says. “We have a clear obligation to listen very carefully to the build-up of concern and emotion from our customers of today and our customers of tomorrow,” he says, while forewarning of a more material threat to the industry.

“We will never get back to the investment levels of 2014. I think that was peak investment in the oil and gas sector ever” Rystad, Rystad Energy

“For non-state companies to ignore what people are talking about will be to bring on, in the end, probably some very difficult times, times which are made more difficult by the response of governments in regulation and taxation, which could be extreme and possibly not well thought through. It is always very important to listen and get to the point where you can sit around a table with those criticising you.”

Investor retreat

Investors are also voting with their wallets on the direction they see the world moving. A report published by environmental lobby group 350.org found that 1,100 investors globally have committed to not investing in oil and gas, equating to $11.5tn being taken out or not reinvested in the sector. Oil and gas sector market capitalisation in the US S&P500 is only c.4pc, whereas it had been in the 10-15pc range for many years.

Share prices became disconnected from oil prices around two years ago, according to Rystad. “Clearly, investors are either seeing that there will be a limit to growth, and we have to discount that into values, or for the pure reason that they want to be compliant with the climate movement.”

While he predicts investment increasing in the next few years, “we will never get back to the investment levels of 2014”. “I think that was peak investment in the oil and gas sector ever,” he says. “Investment in the whole sector collapsed completely since 2014, 40pc down on average.”

The attitudes and policies of investors are “far more biting in terms of their impact on the industry [than government policies] being imposed on the industry by the financial community”, says Peter Tertzakian, chief energy economist and managing director of private equity firm Arc Financial. Investors, pension plans, large endowments and other suppliers of capital to the world’s energy business, “especially the fossil fuel industries”, are increasingly shunning the industry, he notes.

Meeting demand

Others, focusing on growing demand and less confident about the development and implementation of alternative technologies, believe the unfashionability of the sector will pass. “There’s a lot of gloom around industry, about whether it is a dying industry, but I do not think that’s the case,” says Keith Hill, president and CEO of independent producer Africa Oil. “There is no doubt in my mind that we are going to have continued demand. That does not depend on the oil price or world economy—it is just that there is a growing middle-class population that needs energy.”

Investor money is still available for good quality projects and companies, according to Hill. “People talk about the funds that will not invest in the fossil fuel industry—but only about 23pc of funds are not going to invest, so that means 77pc will invest. There is still an awful lot of money out there for the right projects and teams.”

$11.5tn Investor capital committed to not investing in oil and gas

By 2040, according to ExxonMobil, conventional oil demand will increase by 20mn bl/d. “That is two Saudi Arabias,” says Hill. “I can tell you, having been an explorer for 34 years, that there are not many Saudi Arabias out there that we have not found yet. We are in for a supply-driven shock, probably in the next three to five years.” Global supply will depend in part on what happens politically in Iran, Venezuela and other volatile producing countries. But “here is no way supply will keep up because of the lack of investment in exploration and conventional development, and oil is going to be a big part of our mix”, in Hill’s view.

Reality gap

Ultimately, many investors’ attitudes will depend on long-term profitability. While few people dispute the direction of travel and ultimate destination, profitability will depend on the speed of the transition. Opec’s World Oil Outlook, released in early November, predicts that energy demand will increase by 25pc by 2040 and “oil is expected to remain the fuel with the largest share in the energy mix throughout the forecast period”, reaching 110.6mn bl/d.

Conversely, Rystad predicts that technology will eat away at both supply, particularly via solar power generation, and demand, as EVs replace internal combustion engines. “Those two technologies are so competitive that they will be able to outcompete [incumbent technologies],” he says.

Opec’s prediction in part relies on EVs only making up just 13pc of vehicles by 2040, which seems low given the pace of EV launches not just from pioneer Tesla and mainstream brands such as VW but enthusiast marques such as Porsche and Jaguar. Ford is even launching an EV version of its Mustang muscle car.

“[My assumptions] are actually more conservative assumptions than current car manufacturers’ plans in terms of the deployment of EVs and factories to build them,” says Rystad. That said, manufacturers are certainly making plans ahead of actual demand.

“There is a reality gap,” says Martin McAspurn-Lohmann, head of oil and gas and energy at Spanish bank Santander, noting that, in 2018, 45pc of all vehicles sold were fuel-hungry SUVs. “That is not really in line with the story that we read about Tesla and EVs almost every day,” he adds.

Compromise solutions

While decreasing demand for its core products is certainly not good news for the industry in its current form, its innovative nature and deep balance sheets means it is perfectly positioned to lead the transition.

“The realisation has to set in that the oil and gas industry has to be part of the solution,” says Arc’s Tertzakian. Even the more bullish Hill acknowledges the potential; for a change in the industry’s role. “We are in transition and, as an industry, we need to be part of that transition and lead it. Honestly, I do not think anybody else can.” And the industry has options to stay ahead of both political and investor pressure.

“Of course, we see the transition is a threat to the current oil and gas sector— but it also represents a lot of new opportunities,” says Rystad noting the sector “has a huge job to do to reduce the emissions [that are] part of the production process”.

Emissions at the Johan Sverdrup field operated by Norway’s Equinor are below 1kg CO₂e/bl, the average global level is 18kg CO₂e/bl and oil sands emit more than 100 kg CO₂e/bl. “There is big potential and the improvements here can actually be faster at influencing emissions than the penetration of EVs,” says Rystad.

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