Squaring up to the net zero circle. Is it right to vilify the Oil and Gas majors?

Now don’t get me wrong – I am far from being a climate change denier and I am passionate about renewable low carbon energy. Yes, there is a BUT, though not one that should make you delete me from your LinkedIn contact list, so please read on. 

The oil majors are currently under attack for their slow pace in transitioning to a new net zero carbon economy. It’s easy to make the attack but so much harder to come up with a sensible answer to the question “How?” 

From an economic perspective the oil majors face three conflicting objectives;

1.They have a business which is founded on the production and distribution of hydrocarbons.

These huge organisations employ millions of people directly and via their supply chain. That’s not a resource that can be turned off easily or without any impact on wider society. 

They have a huge asset base but the biggest element of that, their reserves, is potentially stranded. Analysts have concluded that if we are to meet the 1.5°C target 84% of those reserves need to stay in the ground or at least not be burned. Imagine the impact on any business following the news that they have to write off 84% of their long-term revenue sources. 

Despite all of that, these businesses still face the need to invest in their existing operations to maintain supplies. This means opening new fields, not merely running off those currently in production. That takes money and resource. It is also counter intuitive in a world travelling to net zero. So it attracts criticism and results in a tightening of their funding lines, as their cost of capital is pushed up by reducing PE ratios and consequently growing yield expectations. 

2.They have a need to invest in the creation of a new energy business based on low carbon renewables. 

Creating our new energy pipeline will involve huge investment for all of us. The EU recently estimated that the investment requirement by member states power suppliers to get to net zero was €1trn (5% of the EU 2019 GDP). The immediate reaction from the financial world was that this was an underestimate – I agree. But, look at the challenge for the Oil and Gas majors – the annual turnover of the top 7 is around €1.25trn and we expect them to completely change their core business at a rate of knots. Ask yourself, how quickly could you change the fundamental nature of your business’ product offering to something you don’t currently do. Then have a think about where the investment would come from. They need to do it, but HOW? 

These organisations have much of the intellectual and infrastructural capacity to deliver our low carbon renewable future, so society shouldn’t exclude them from their role in our new low carbon world. But, how do they access the cash with an ever-rising cost of capital and a world that increasingly sees them as “unclean” in a social as well as an environmental sense? 

3. They have a commitment to dividend streams for their current vast shareholder base which demands significant steady cashflow. 

When faced with this sort of conundrum, it’s always nice to think that it’s someone else’s challenge and that if they fail it’s not our problem. BUT WE can’t ignore these challenges in our move to net zero. The fate of these organisations has a direct impact on our personal finances, and their resources and capability could be an asset to our conversion to a new sustainable future. 

Dive deep into the source of cash for your pension manager and I suspect, that you will find that a big chunk of the cashflow to pay pensions that are now being drawn, relies on dividends from old economy companies such as BP. What will happen to your income or future security if these cashflows disappear overnight? If you are playing the equity market, you may have made big gains from the meteoric rise in the share price for companies such as Tessler and Oersted. The valuations of these “New Energy” companies aren’t based on dividend yield, they come from an expectation of future growth. Their value is based on expectation and hope, neither of which will deliver the cash to pay pensions at the end of each month in 2020 or, arguably 2030. Whilst all of these new energy businesses are in investment mode, we need the dividend yield from old economy businesses whilst we create cashflow from our new ones. 

That’s not all. There is another challenge which people seem to have missed. Stop anyone in the street, show them a picture of a barrel of oil and ask them what they see. In their own way, they will probably all tell you that they see a barrel of propulsion. That’s because we constantly talk about the Oil industry in those terms. Not surprising I guess, given that this is the main use of the product, that we naturally assume alternative forms of propulsion mean we won’t need oil anymore.

Cast your mind forward to the new net zero carbon world of the future; You are driving home in your electric car. What will that be made from? I doubt that it will predominantly be steel forged in a furnace powered by green electricity. Steel is too heavy.

A big part of the move to greater efficiency is weight reduction. The most environmentally friendly energy is that which we don’t use. 

We currently deliver much of our weight reduction in our transport sector, through advanced composites with much of that material being derived from the O&G sector.

It’s not just about cars – just look at how much of the Boeing 777 is made from advanced composites.

What will your electric car be driving on? Asphalt (another O&G industry product) or will we have found an alternative for that? Cast your eyes around your house as you arrive home and ask yourself, how many of the products within the fabric or furnishings of the house rely on a hydrocarbon material to make them work the way we want them. What raw materials supply chain does your TV, laptop or games console rely on? Where does the adhesive that holds your furniture together come from?

Don’t forget to look in the wardrobe – nylon is largely made from hydrocarbons. It’s true to say that many of these products can be made or replaced by non-hydrocarbon alternatives, but where is the supply chain for those alternative products? If we were to make all nylon from castor oil, what other crops are we planning to displace in order to create sufficient feed stock? 

If we can solve the commercial conundrum of transitioning the O&G industry to a new renewable energy supply chain, how are we going to address our need for oil and gas production, to provide the feedstock for all the other products that rely on it? 

The assumption that a barrel of oil = a barrel of propulsion isn’t far from the truth. That’s where most of it goes and that also means it’s where most of the financial return comes from. Currently only about 15% of the oil “crack” goes to non propulsive uses.

Companies such as BP have made huge commercial advances over the last ten years, to a point where they get pretty much the same financial return from a $60 barrel of oil as they once had from one selling at $100. BUT take propulsion out of that equation and suddenly our challenge becomes either; 

–      How can the oil producers make money out of a $10 or $20 barrel, or

–      Can all of the industries currently reliant on feedstock at “by product” return levels cope with sustaining the production cost currently funded by 85% of a $60 barrel. 

So….. what’s the simple answer?

That bit is easy – the simple answer is “there isn’t one”. This isn’t a facetious comment, it is something that we all need to recognise.

I am an enthusiastic supporter of David Attenborough and Greta Thunberg. Both do an essential job in making us all wake up to the fundamental need to make changes quickly. BUT, pious as we may all feel in deriding the champions of the carbon economy, we need to avoid behaving like King Canute. We won’t deliver real change through strong words and self-confidence. We all need to recognise the complexity of the challenges we face and put our intellectual and emotional energy together with our collective imagination into solving those problems. Let’s stop looking for the silver bullet that will solve everything and realise that we have complex challenges to overcome. That needs collaboration between old and new world. 

There is no point for example in deriding efforts to reduce the carbon footprint of the O&G industry as “green washing” – on any measure, we need this industry to be around for decades to come. BP has just made a commitment to being carbon neutral by 2050. That’s a huge promise and we should celebrate the boldness of their ambition. Particularly as they have linked it to the objective of maintaining dividend streams.

We all complain about the quality of our politicians, but much of our problem with the current batch comes from making it a toxic place for good and capable people to go. Do we want to do the same to our hydrocarbon industry just at the time it needs to face its biggest challenges?

Squaring up to the net zero circle. Is it right to vilify the Oil and Gas majors?Strange as it may seem the hydrocarbon industry needs lots of clever, enthusiastic climate change activists to help it transition to the new world that we all want so much..