«Energy transition & climate change Stranded assets, fossilised revenues USD28trn of fossil-fuel revenues at risk in a 450-ppm world A 450-ppm world ...»
24 April 2014
Energy transition & climate change
Stranded assets, fossilised revenues
USD28trn of fossil-fuel revenues at risk in a 450-ppm world
A 450-ppm world would threaten high-cost, high-carbon revenues
Under a global climate deal consistent with a 2°C world, we estimate that the
fossil-fuel industry would stand to lose USD28trn (in constant 2012 US
dollars) of gross revenues over the next two decades, compared with
business as usual. We derive this number by comparing the IEA’s base-case scenario for global energy trends out to 2035 and its scenario consistent with a 2°C world. The oil industry accounts for USD19.3trn of this, gas USD4trn, and coal USD4.9trn. The revenues most at risk would be concentrated in the high-cost, high-carbon sources of production. For the oil industry, this means, above all, deepwater, oil-sands, and shale-oil plays.
But business as usual also has big risks for fossil-fuel companies The oil industry’s increasingly unsustainable dynamics – as manifested, for example, by ongoing capex reductions amid record-high oil prices – mean that stranded-asset risk exists even under business-as-usual conditions: high oil prices will encourage the shift away from oil towards renewables (whose costs are falling) while also incentivising greater energy efficiency.
Engagement now key for stress-testing climate scenarios Ongoing negotiations in preparation for COP-21 next year are only likely to increase the pressure for greater transparency on carbon risk. Against this backdrop, we think investors need more details on the breakdown of oil companies’ assets by project type and on their capital-allocation processes in order to be able to better assess carbon risk and cost/revenue risk. We see an opportunity for the oil industry to engage in a transparent dialogue with investors on the carbon risks it faces and thus provide a transparent stress test of its business model against potential f
Contents Fossilised revenues – an overview................. 3 Overview of NPS and 450S
Current energy emissions unsustainable in a 450-ppm world 10 Closing the gap: the policy framework under the 450S 12 A daunting policy challenge, but what if …? 14
2 keplercheuvreux.com ESG research Fossilised revenues – an overview We see USD28trn of fossil-fuel revenues at risk in a 450-ppm world In a carbon-constrained world consistent with the policy goal of limiting greenhouse-gas (GHG) concentrations in the atmosphere to 450ppm of CO2-equivalent (CO2e) and hence restricting the increase in the average global temperature to no more than 2°C above preindustrial levels, we estimate that the fossil-fuel industry would stand to lose c. USD28trn (in constant 2012 USD) of gross revenues over the next two decades relative to the current trajectory. We derive this number by comparing the IEA’s base-case scenario for global energy trends out to 2035 (known as the New Policies Scenario, or NPS) with its 450Scenario (its scenario consistent with a 2°C world).
Under the IEA’s 450-Scenario (450S), both the demand for and the prices of fossil fuels would fall as policies were put in place to restrict CO2 emissions from energy, which diverge sharply under the two scenarios. By 2035, energy emissions under the 450S are 15Gt lower than under the NPS (22Gt and 37Gt respectively), and this gives rise to a cumulative difference over the next two decades of 156Gt. The measures required to achieve these emission reductions under the IEA’s modelling include both carbon pricing and mandated measures and standards (particularly with regard to energy efficiency), with the 450S positing higher and more widespread carbon pricing across the world than the NPS.
In terms of the volume impact of these policy measures relative to the NPS, we estimate that cumulative demand for fossil fuels over the next two decades under the 450S would be lower by 45,000m tonnes of oil equivalent (mtoe) – which equates to four years of fossilfuel demand at the 2011 rate of consumption – with coal accounting for c. 50% of this difference, oil c. 30%, and gas c. 20%. Cumulative oil demand (crude oil plus natural-gas liquids) over 2012-35 under the 450S is lower by 94bn barrels (bbls) than under the NPS, cumulative gas demand by 10.6trn cubic metres (tcm), and cumulative coal demand by 31bn tonnes of coal equivalent (tce).
In terms of the price impact of these measures, prices would be lower for all fossil-fuels under the 450S than under the NPS. Under the 450S the IEA sees oil prices averaging USD109/bbl (in constant 2012 USD) out to 2035 compared with USD120/bbl under the NPS, and coal USD87/tonne under the 450S versus USD105/tonne under the NPS. For gas, the picture is more complicated, as prices vary greatly across the world, but in all regions prices are on average lower under the 450S than under the NPS (by 9% in North America, 13% in Europe, and 10% in Japan).
The net impact of these volume and price effects under the 450S would be to reduce the revenues of the oil industry by USD19.3trn over the IEA’s projected timeframe of 2013-35, those of the gas industry by USD4trn, and those of the coal industry by USD4.9trn (all in constant 2012 USD).
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Climate politics very tough, but carbon-scenario analysis a useful risk tool The IEA’s 450S is primarily intended to help policymakers make informed choices to put the global energy system on a sustainable pathway consistent with what the climate science says is both necessary and possible if the world is to stand a chance of mitigating the worst impacts of climate change.
In this respect, the third instalment of the Fifth Assessment Report of the Intergovernmental Panel on Climate Change published earlier this month is a timely reminder of why the IEA’s modelling of the 450S is so important.
At the same time, though, the usefulness of the IEA’s modelling extends far beyond the insights it provides for policymakers, and we think that comparing the very different outcomes for the fossil-fuel industry under the NPS and the 450S can also help investors.
Specifically, we think that this kind of comparative scenario analysis can help investors reach a clearer understanding of the magnitude of the risks that fossil-fuel companies face in a world where the threat of a much more carbon-constrained policy framework is one only likely to increase in the future.
This is not to say that we assume the ongoing climate negotiations through the United Nations Framework Convention on Climate Change (UNFCCC) will result in a global policy st deal at the 21 meeting of the Conference of the Parties (COP-21) in Paris in December 2015 consistent with a 450-ppm world. On the contrary, we think the political obstacles to be overcome are extremely formidable, and that a deal of such ambition is very unlikely within such a short timeframe.
Rather, it is simply to argue that the fossil-fuel industry can no longer afford to ignore the issue of carbon risk, and that a transparent stress-testing of its business model against the risk of a 450-ppm world would be the best way of kick-starting a dialogue with investors and other stakeholders over a meaningful risk-mitigation process. This is because a transparent stress test of this kind would reveal where the biggest risks lie in fossil fuel companies’ portfolios, and would therefore begin an engagement process with shareholders and other stakeholders over how these risks should be managed in the future as climate policies continue to evolve at the national, regional, and global level.
ExxonMobil’s recent carbon-risk report was a missed opportunity In response to recent pressure from shareholders and NGOs, ExxonMobil published a report on 31 March explaining how it evaluates the carbon risk in its portfolio (the report is entitled Energy and carbon – managing the risks). We think Exxon’s report was: 1) too dismissive of the risk of a co-ordinated global policy response ever happening; and 2) far too binary in its assessment of the climate-policy risks the oil industry faces.
On the first of these points, we have already acknowledged that a 450-ppm deal by December 2015 does not look at all likely, but the point about global climate policy is as much the direction of travel as the speed, and in effectively dismissing the likelihood of policymakers ever getting genuinely serious in terms of policy ambition, we think ExxonMobil is giving itself a free pass in terms of the need to at least contemplate what a 450-ppm world would mean. Just because it is highly unlikely to happen at COP-21 in Paris next year does not mean that a much more carbon-constrained policy framework will never 4 keplercheuvreux.com ESG research be implemented. Viewed in this way, stress-testing for a much more carbon-constrained world within, say, a ten-year timeframe, would simply be sensible risk assessment.
On the second point, we think ExxonMobil’s report was too binary because carbon risks relate not only to a potential global climate deal, but also to regional and national climate policy. In other words, whether a global policy framework consistent with a 450-Scenario is ultimately put in place or not, there is always also the risk of tighter legislation that could lead to stranded assets in certain markets.
A good example of such a risk at the moment relates to the ongoing debate over the Keystone XL (KXL) pipeline between Canada and the US. If President Obama ultimately decides to veto KXL, this could create stranded assets in the oil-sands plays both for ExxonMobil and other oil companies.
Indirectly, one could argue that the momentum building among institutional investors to screen for carbon risk (as exemplified by the recent pressure applied to ExxonMobil by Arjuna Capital and As You Sow via the shareholder resolution they filed and then withdrew in exchange for Exxon’s agreeing to publish a report on the carbon risks it faces) is itself a form of climate-policy risk for fossil-fuel companies. After all, if investors were to start shunning those fossil-fuel companies perceived to be at greatest risk from a more carbonconstrained world, then over time those companies would likely face much greater difficulty financing their operations.
In short, had ExxonMobil published a report looking at a nuanced range of carbon risk to its project portfolio encompassing both extremes of the spectrum – the 450-ppm end on the one hand, and the business-as-usual (BAU) end on the other with an analysis of the potential options in between – this would already have entailed a higher degree of disclosure regarding future revenues potentially at risk and thus have taken the debate over the carbon risk facing fossil-fuel companies to a new level. Instead, Exxon Mobil chose to focus almost exclusively on the business-as-usual case, and in this way did not advance the debate at all.
Revenue risk for oil industry focused on deepwater, oil sands, and shale oil In our view, the key point about the revenues under threat for the fossil-fuel industry under a 450-ppm framework is that the risks would be concentrated on the marginal producers, i.e. on the companies at the high end of the respective industry cost curves. For the oil industry, the high-cost, high-carbon sources of production – comprising deep and ultradeepwater plays, Canadian oil-sands projects, and the shale plays in the US – are dominated by the international majors and independent private companies. Indeed, the data given by the IEA suggests that over 70% of current output from these sources is in the hands of the international majors or private independents. This amounts to some 6.1mbd (2.23bn barrels a year) of unconventional production out of total current unconventional production of 8.4mbd (3.07bn barrels a year).
Given that 9.2m barrels per day (3.34bn barrels per year) of crude oil burned under the NPS would be unburnable under the 450S, then on the face of it from a straightforward economic point of view, all of this 8.4mbd of unconventional production would be the first to be shut in under a 450-ppm policy framework.
5 keplercheuvreux.com ESG research The key question, though, relates to timing.
In its 2013 World Energy Outlook (WEO), the IEA argues that reserves that are already being produced from existing oil fields “will produce without additional investment and, because the rate of natural decline exceeds any conceivable rate of demand drop due to climate policies, this category [of oil production] is unlikely to be stranded” (2013 WEO: p.436).