What’s truly going on in the minds of oil-industry executives these days? Jeremy Oppenheim, head of McKinsey’s sustainability and resource productivity practice, shared one unique perspective at a closed-door event in Toronto last spring. Oppenheim, whose clients are among the world’s largest oil companies, said there’s a reason most of them quietly or publicly support putting a $40 to $50 price on carbon – and indeed, already assume such costs when deciding long-term capital allocation.
“It’s to knock out coal,” he said.
A sure sign of disruption in a sector is when its key players begin to turn on each other, like the survivors of a remote mountain plane crash trying to figure out who gets eaten first. Coal, as the most carbon-intensive fossil fuel, is that flabby dude who ends up roasting in the campfire.
If, as the International Energy Agency says, no more than a third of proven fossil fuel reserves can be consumed before 2050 – presumably keeping the average global temperature from rising more than 2 degrees C – then the oil industry wants to lock up as much of that “carbon budget” as possible. For the oil companies, more coal kept in the ground means the more oil that can be taken out.
But turning the knife on coal is Plan B for the oil industry. Plan A appears to be business as usual, with some efficiency improvements thrown in to incrementally lower the carbon-intensity of their product.
“The senior management and current major shareholders do best if they assume humanity will still dither when it comes to stopping rising emissions,” said Mark Jaccard, professor of resource and environment management at Simon Fraser University in Vancouver.
Yet there have been signs over the past year that humanity’s dithering may be drawing to a close. Those signs, combined with a number of technology and market trends, are beginning to make the oil industry less untouchable than some executives still think. Consider the following:
- At a UN climate conference in September, institutional investors representing over $24 trillion in assets called for a price on carbon. More want to know how exposed their oil company investments are to climate risks;
- A climate deal between the United States and China in November gave a major boost to international climate negotiations. With the two biggest emitters on the planet readying for a carbon crack down, holdout nations have fewer excuses not to follow;
- The Bank of England became the first major central bank to warn about the potential for “stranded” fossil fuel assets, with bank governor Mark Carney pointing out that to avoid the worst of climate change “the vast majority of reserves are unburnable.” Britain’s energy secretary now wants to force oil companies to disclose their “risky” assets;
- A number of investment banking reports released over the past year described renewable energy as in increasingly competitive with fossil fuels, the impact of which is causing ripples through the electric utility sector.
Just a few years ago, such developments would have been considered heresy. “For too long the orthodoxy in the energy sector has been that the world’s economic health is synonymous with its production of carbon emissions,” wrote Michael Liebreich, founder of Bloomberg New Energy Finance, in an end-of-year review. “2014 was the year when evidence of uncoupling became inescapable.”
Zeroing in on the United States, the evidence behind Liebreich’s claim is clear. For the past seven years oil use in the U.S. has been falling while GDP has been steadily rising – and the gap is getting bigger. Before 2007 the two always moved in tandem. The result is that oil use per dollar of GDP is the lowest it has been in more than 40 years, according to an analysis from Bloomberg.
There are many causes of this decoupling, including improved vehicle efficiency, greater adoption of alternative energy sources, more young people moving to cities and riding public transit, and retiring boomers who are driving less. Supply is exceeding demand, and the plunge in oil prices over the past few months is proof that endless growth in consumption may be an illusion, even before a price on carbon is tossed into the mix.
High-cost, high-carbon oil projects expected to deliver value for decades, such as those in the oil sands, are no longer looking like slam dunks, hence the concern over stranded assets.
But are oil company executives paying attention? They should be, according to a Chatham House report released in 2012 describing such a perfect storm. It called climate regulation the “largest and most unmanageable risk” for investors, and compared the situation to the emergence of the Internet, which had direct and indirect effects that were both unpredictable and severe.
“In a world where technology and environmental threats are changing industries and society so rapidly, the slowly turning supertanker is not an image that excuses inertia,” the report stated. “The combination of changes that the industry now faces requires epic, rather than incremental responses, for the industry to evolve and prosper.”
It’s difficult to say who is doing a better job at adapting. Andrew Leach, a professor of energy policy at the University of Alberta, said it’s too soon to tell – it’s not as if anyone can pin down what a low-carbon transition looks like for an oil company.
“One thing that I often wonder about is whether we have any good examples of primary resource companies navigating that transition,” Leach said. “We have a few coal players with oil and gas positions, but not many, and a few oil names who are bit players in renewables, but again, they’re not at the leading edge.”
Take the example of two oil pipeline companies that were frequently in the news in 2014: TransCanada, with its proposed Keystone XL and Energy East projects, and Enbridge, with its Northern Gateway project.
Well-organized protests against these projects have made it increasingly difficult to get them approved, to the dismay of oil executives charged with finding new markets for their product. All evidence suggests the resistance movement that has formed around pipeline projects will only grow larger and more intense, while low oil prices have at least temporarily destroyed the economic case for investors.
“This is not going to get easier,” Enbridge chief executive Al Monaco told investors at a conference in September.
Investors are beginning to notice. A report last fall from the Institute for Energy Economics and Financial Analysis found that, with the exception of one company, the top 10 producers in the oil sands have underperformed the Dow Jones Industrial Index since 2010. It’s troubling, the report said. “Any indication that these companies are not leading economic growth is cause for concern.”
TransCanada and Enbridge are both known as oil pipeline companies, but their mix of assets tell different stories. Between 2005 and 2009, the vast majority of TransCanada’s capital investments were in natural gas pipelines and power generation, particularly natural gas-fuelled and nuclear facilities.
“If you think about that portfolio, 85 per cent of it is either zero emission or very low emission,” said Alex Pourbaix, president of development at TransCanada.
But over the past five years, TransCanada has exposed more of itself to climate policy risk by shifting the lion’s share of investment to building oil pipelines, which represent more than half of its $46-billion portfolio of current projects. Investment in generation has stalled, other than some toe-dipping in solar.
Asked about the difficulty building oil pipelines that rely on continued growth in the oil sands, Pourbaix described it as a “temporary thing.” If it was to continue, he added, “it would really make our lifestyles untenable, and I think over time that realization is going to hit home with people.”
Enbridge, meanwhile, relies more heavily today on oil pipelines than TransCanada. Such assets represented 39 per cent of its adjusted earnings in 2000, but rose to 68 per cent by 2013 and are projected to hit 76 per cent by 2018.
But at its investment conference in November, the company recognized the need to rebalance its asset mix. It’s doing this by investing in alternative energy technologies such as wind, solar, geothermal, run-of-river, and waste-heat recovery, as well as expanding its recent entry into the power transmission market.
Clean power generation is expected to double to 3,000 megawatts of capacity in 2018. “The renewables and transmission business is significant for us, and will be in the future,” said Don Thompson, vice-president of asset performance and development at Enbridge.
Even so, it’s a drop in Enbridge’s asset bucket, and as fast as it’s growing Thompson acknowledged it isn’t keeping up with growth in the total business.
“The general industry trend toward making sure we have a diversified strategy for energy is not lost on us,” said Thompson, though he wouldn’t comment on the growing risks posed to Enbridge’s oil pipeline assets.
Fact is, we will still rely heavily on oil for the foreseeable future, and, as the oil industry reasonably expects, coal will be the first casualty of meaningful international climate action when the dithering stops. But continued growth of the oil market isn’t assured, and closer to home consumption appears poised to fall.
If oil executives are worried about the slippery slope ahead, they’re not showing it.