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Can Big Oil survive in a low-carbon world?

Oil prices slumped to their lowest levels since May on October 29th, with Brent Crude oil prices falling below $37 per barrel. Renewed lockdowns in Europe and resultant falls in demand serve as a reminder for an industry, scarred by the freefall of oil prices in March and April, of the difficult short-term outlook it faces. Saad Rahim, chief economist at Trafigura, summed up the bleak near future for oil stating “The trajectory of restrictions is clear — it’s likely to get worse before it gets better.” However, the pandemic is not the only concern for the industry and huge adaptation is required for Big Oil to survive by addressing long-term trends.

Short-term outlook

The demand outlook for oil in 2021, in light of new nationwide lockdowns, has been adjusted downwards as expectations of further restrictions across Europe and North America, following recent restrictions in nations like the UK, have risen. Energy consultancy firm Energy Aspects cut global demand estimates by 1.7m b/d for the first quarter of 2021, whilst OPEC revised down estimates of demand for their barrels by 600,000 b/d for 2021 as a whole. The IEA has acknowledged that a successful vaccine would be unlikely to have a significant impact on oil demand “until well into next year”. Brent Crude contracts for December 2023, for example, can be bought for only $48 per barrel, suggesting only a price rise of around $3 per barrel over the next three years even though oil was trading at $70 as recently as January 2020. As worrying as these short-term trends are for oil firms, the greater cause for concern for the industry are the challenges that it faces for a long-term recovery or, more aptly put, survival.

Issues for long-term recovery

Firstly, there are huge amounts of spare capacity in the industry: Russia and OPEC are keeping 8 million barrels per day offline. New estimates for peak global demand of oil by Rystad Energy are as early as 2028 at only 102m b/d. With new discoveries in areas like Guyana, supply levels will likely well exceed peak oil demand in the near future, forcing oil companies to find new sources of revenue. 

Climate change is at the forefront of public consciousness. Oil companies are under huge pressure to adapt to a low-carbon world, and banks and governments are more willing to finance ‘green’ action going forwards. Goldman Sachs has predicted that spending on renewable power will exceed spending on oil and gas for the first time in 2021. Energy now only accounts for 3% of the S&P500 compared to 15% a decade ago. Assets in sustainable mutual funds reached an all-time high of $1tn during the second quarter of 2020 and Big Oil must adapt if it is to meet this rapidly growing ESG investor sentiment. 

Joe Biden’s victory in the US is another factor of concern for oil giants, particularly his plans to re-join the Paris Climate Agreement and spend $2tn on clean energy, adding further momentum towards climate-friendly investment. If Biden re-joins the international nuclear pact with Tehran that Donald Trump left in 2018, he could end US sanctions on Iran’s oil exports, serving to add even more supply to an already oversupplied industry.

It is, therefore, essential that Big Oil adapts to address these trends, innovating to reinvent itself in a post-pandemic low-carbon world.

How can Big Oil adapt?

Big Oil must show to global communities that it can meet environmental trends, to secure the levels of investment that it needs from banks and governments, but also to match consumer trends. There are a number of potential routes to this reinvention of the industry. For example, firms may choose to become decarbonisation specialists, offsetting carbon emissions with renewable energy investments and carbon capture storage; national oil companies can invest heavily in the wider energy system, transitioning from Big Oil to Big Energy whilst maintaining some of their current roles in oil; oil companies could exit the industry all together, becoming the leaders of growing low-carbon solutions such as biofuels and hydrogen.

Many firms have made pledges to reduce fossil fuel output, confronting the implications of climate change for the oil business and showing they are open to change. BP has pledged to reduce its own fossil fuel output by 40% and increase low carbon investment by 10-fold by 2030. Royal Dutch Shell and Total have targeted net zero emissions by 2050 and Equinor by 2030. However, this is not uniform across the industry. ExxonMobil has contrastingly pledged to increase oil and gas production by more than 1m b/d from its current 4m b/d production by 2025. Time will tell whether ExxonMobil’s gamble on oil will pay off, but as investors and consumers increasingly focus on the climate impact of companies, it is not obvious that Exxon’s strategy will work. Paul Sankey, an oil analyst at Sankey Research, has recognised the sheer risk Exxon is taking, “If it is wrong, it has an existential crisis.”

Commitments by oil firms, like BP and Royal Dutch Shell, suggest that the industry may be able to adapt and survive, but greater commitments are needed. If firms in the industry can make this shift to lower-carbon strategies, showing a capability to generate sustainable returns, they may be able to match investor and consumer ESG sentiment. However, with firms like ExxonMobil and Chevron continuing to commit to hydrocarbons, the extent to which change and adaptation may occur throughout the industry is unclear, for now at least.

Sources

https://www.ft.com/content/2596d26c-76a6-46e6-9493-b2490b28fb24

https://www.ft.com/content/83b4ba6b-bef9-45d3-a6fb-087ef3143a43

https://www.ft.com/content/30ffa51b-2079-400e-84f1-2e45991194c8

https://www.ft.com/content/c343b958-63f4-44a4-9485-130d7740a843

https://www.ft.com/content/e1b7bab4-b962-4fab-ae7f-10da597b1cf6

https://www.ft.com/content/eedf958c-c425-4a1b-bc90-6e213f7b8ba4

https://www.ft.com/content/75ff69c2-e83f-4c18-9451-598b6f17edd8

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https://www.ft.com/content/99bf5a08-5521-43e8-a860-6623b09ea646

https://www.theguardian.com/business/2020/nov/01/end-of-oil-and-beginnings-of-a-low-carbon-planet

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