WHITE PAPER
DOES OIL LEAD OR FOLLOW REPORT PREPARED BY HAMISH WILSON
March 2019 Report
Introduction The oil industry has been receiving significant bad press of late,
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In this paper I will address three topics: 1) We have to acknowledge that such ‘anti’ public sentiment exists and it is in the industry’s interests to address this sentiment.
epitomised by the headline in the Economist of Feb 9th 2019 entitled
2) Investors are being encouraged to turn
Crude Awakening.
away from the oil industry
The article was a case study on Exxon and
3) The energy transition is coming and is
challenged Exxon’s plans to increase production
both a threat and an opportunity to the
by 25% in the coming years, despite evidence
industry.
that this increase production would contribute to
climate change.
The ‘red thread’ running through the paper is
The article goes on to accuse the industry of standing in the way of efforts to build a global consensus to reduce carbon emissions.
the understanding that the world needs oil and gas, and therefore the core function of all oil and gas companies is to continue to find and produce low cost oil and gas.
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Public sentiment and the reality of climate change The public accepts the reality of climate change and is responding to campaigns that challenge the oil companies and their ability to operate.
BP ends Tate sponsorship after 26 years (2017) Shell ends 12-year sponsorship of the National Gallery (2018 Public antipathy to the oil industry is preventing our ability to find and produce hydrocarbons onshore and close to the public. Credits: British Museum Festival of Protest. Photograph: Anna Branthwaite. Liberate Tate group protest at Tate Britain in April 2011 Photograph: Amy Scaife/Corbison. Protesters demanding end to Shell sponsorship of National Gallery and reinstatement of sacked PCS Union rep Candy Udwin. Photograph Kristian Buus.
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A sad reflection on poor industry communication The picture above (from the Isle of Wight County Press) shows protestors on Compton Beach, Isle of Wight challenging an exploration project. Note the misunderstanding reflected in the protestors' signage - the exploration opportunity is for tight gas, not oil, it will be produced through conventional extraction methods (not fracked) and thus will not result in an oil spill. It is noteworthy that the protests are not against the industry and climate change.It is also interesting to note that the second well in this programme is close to a landfill site, which is far more polluting to the aquifer and its surroundings than any oil and gas production. What is needed is a sustained marketing campaign supported by the industry and involving all the industry associations (for example AAPG, PESGB, The Energy Institute, Oil and Gas UK, and companies themselves)
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to inform the public about oil and gas and the impact of their (our) behaviour on energy demand and thus carbon emissions.
The UK public perception is also reflected in the US.
The chart covers the last 10 years covering the Obama administration, who were supportive of action on climate change, to the present administration who are not. Despite the change in rhetoric from the Whitehouse, there is growing public sentiment that global warming is real and action is needed.
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Amongst all the negative press, it is vitally
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World Energy Outlook IEA 2018
important to recognise that most likely growth energy demand as predicted by the IEA (as shown below), requires the industry to find additional conventional hydrocarbons. The IEA predict that part of the shortfall in matching energy demand will be taken up by US shale oil. This is reflected in a number of US based oil companies pulling out of international exploration and production in favour of investing in US onshore..
Work done by the IEA says that even if energy demand were to be reduced to match the carbon emissions to achieve a 2 deg C rise in temperature,
The Global Economy Needs Hydrocarbons The industry must continue to focus on finding and developing low cost oil.
the industry still needs to find more conventional oil and gas. Despite the need to continue to find oil, there have been a number of articles in leading papers and journals that the oil industry should do something about climate change. The articles also exhort investors to divest from oil company stocks and encourage the oil industry itself to invest in alternative energy.
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Investment in Alternative Energy The industry invests an average of 1% of its CAPEX in renewable energy according to the Carbon Disclosure Project. Is the public perception correct in its view that this investment level is ‘window dressing’ and ‘green wash’?
Stock market performance
The position is more nuanced; the chart below shows the investment by company and shows the European majors taking a lead in renewable energy investments. Total, Shell, BP and Equinor have announced ambitious campaigns to embrace the energy transition. Equinor have announced a target to invest 20% of their capex in renewable energy over the next 5 years. This is a material change in oil company investment profiles
According to Wood Mac analysis, the returns from exploration are 10 – 15 %; those for onshore US shale oil are over 20%. Conventional oil and gas projects deliver a higher return than a typical renewable project.
The returns from a typical community solar project are around 5% money is made in the UK because cost of borrowing is 2.5% Returns from wind are 8- 10%.
Despite the high project returns oil stocks have under-performed their industrial peers on the global stock market. Oil stocks have not recovered from the oil price drop of 2014.
Disclosed low-carbon investment as a proportion of total CAPEX 2010 - Q3 2018
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Clean Stocks 200 Despite the increase in renewables investment and the higher returns from oil and gas project, investor sentiment is against the industry. Is there something deeper and more substantive going on? Do investors believe that the oil industry is threatened by the energy transition? Â Investors seem to favour renewable energy stocks over oil and gas, as reflected in the press where there have been a number of articles in Forbes, Bloomberg and the FT challenging the oil industry to respond to the energy transition.In effect the energy transition is portrayed as a significant threat to the industry.
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How should the oil industry respond to the energy transition?
Three strategies: There are 3 possibly integrated strategies that an oil company could adopt to respond to investor pressure. These strategies support the core business of an oil company is finding and producing low cost oil and gas. Any capital that might be invested in the energy transition must first be earned from conventional oil and gas activities:
1) Continue as is 2) Invest in measures that mitigate the climate change impact of the industry’s products 3) Lead the Energy Transition
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1) Continue as is This is a perfectly reasonable and acceptable strategy and suggests that an oil company should focus on what it is good at with its activities aligned with its culture and skill set. This strategy also accepts that investors will invest in a company and industry if the returns are good enough. It also understands that investors are generally agnostic to ethics and will invest where the returns are highest. A stance evidenced by the superior performance of both defence and tobacco stocks against their industrial peers.
2) Invest in measures that mitigate the climate change impact of the industry’s products This strategy is largely being promoted by the US based majors. The industry accepts that climate change is caused by carbon emissions. If the globe is to continue to burn hydrocarbons, then the industry take the lead in reducing the carbon emissions of its products. Activities under this strategy include: Investing in Carbon Capture Use and Storage Converting methane into hydrogen, sequestering/using the CO2 and using the hydrogen for transport and ‘spiking’ the gas grid to reduce the emissions of gas heating. This has the advantage of continuing to use the gas infrastructure that is already in place. Capturing CO2 direct from the atmosphere for either use or storage. This industry might get involved with the plastics debate and either look to recycle plastics or make them more bio-degradable - initiatives promoted within the framework of the ‘Circular Economy’.
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Unsubsidised Levelized Cost of Energy Comparison
This is the current position. But wind, solar and battery technology have seen major reductions in cost over the last view years and the LCOE for the alternative energy sources will move to the left over the coming years.
3) Leading the energy transition The Energy Transition is both a threat and an opportunity to the industry. If alternative energy turns out to be more convenient and cheaper than oil and gas, then the demand for the industry’s product will decline and the industry reduced in size.
There are cheaper cleaner alternatives to oil and gas. The viability of various energy sources is defined by their price and the LCOE ( Levelised Cost of Energy - opex plus amortized capex discounted at a standard rate – 7%- over the life of the asset).
The end game will be that oil production will come from those areas with the lowest cost of production (the Middle East). The energy transition represents a large opportunity for the industry. The ability to earn and deploy capital provides the industry with a significant competitive advantage in this space.
The table above prepared by Lazards show the LCOE of conventional and unconventional energy alternatives.
As was noted by this famous quote of over 20 years ago by Sheik Ahmed Zaki Yamani "The Stone Age didn't end for lack of stone and the oil age will end long before the world runs out of oil"
The other, mainly solar based energy sources, are more expensive.
The industry is facing a fundamental challenge:
This shows that the cheapest fossil fuel is gas. The cheapest renewable alternative is wind energy (although it is intermittent and therefore possibly not comparing like with like).
This is the current position. Wind, Solar, and Batteries have seen major reductions in capital cost over the last few years.
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The energy transition There is no reason to doubt that the cost reduction in alternative energy will continue as illustrated left. Â These dramatic and continued reductions in the cost of renewable energy is driving a change in in the energy ecosystem
Note that battery energy for cars as approaching parity with the internal combustion engine.
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The changing energy landscape and the energy transition A typical business eco system (i.e. a
The oil industry, in an ecosystem defined
network of companies based around a
by taking a resource (hydrocarbons) and
particular product line or service) is
selling to the end consumer, the locus of
controlled by a small set of companies or
power has changed
service providers (e.g Microsoft/Intel of old, Apple, Coal mining etc etc).
In the 1970’s, in times of resource scarcity and high oil prices, the power of the
Control is defined by the companies that
ecosystem was rests by the resource
earn the highest margins from that
holder i.e. OPEC. OPEC sets the oil price
ecosystem and those that set (or
and the rest of the industry benefitted
influence) the price charged to the end
from the prices set.
consumer.
Today the situation is changing, low cost alternatives and the possibility of energy abundance shifts the locus of power to the consumer.
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The democratization of energy Any strategy capitalising on the energy
For example, in the UK there was a gale
transition must include consideration of
warning for Sunday 10th March. The auction
winning the consumer. Current thinking of
price of electricity dropped to £42 MW on the
energy firms in investing large scale wind and
Saturday after averaging around £46 to £50
solar installations is flawed. This thinking
the previous week.
reflects the current paradigm of ‘big’
centralised power plants and replacing fossil
As renewable energy generation and
fuel power stations with wind, solar and bio
management technologies drop in price, so
mass equivalents.
the consumer has choices as to where to buy
energy. Currently the consumer is locked
Further, the oil industry is used to an
into a regulated energy supplier through
environment in which the price is set and,
electricity and gas. As capital costs fall, so
fortunately for the industry, set high enough
the consumer can choose alternatives. With
to make margin. But in the emerging energy
market de-regulation, different business
world, electricity prices will be driven by the
models will offer the consumer more choice.
balance of supply and demand and money
will be made in managing and exploiting the
This is classically illustrated in the energy
supply/demand in-balances. In addition,
generation map of Denmark (from Energinet)
when renewable assets generate power, the price of electricity falls, and the more
showing the transition from ‘power stations’
generation capacity, the more price will come
years or so.
down.
to distributed energy generation over 25
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March 2019 Report The graph left shows the wholesale electricity price for Monday 11th March over 24 hours, showing a range of prices from a low of £30/MWh to around £80/MWh at peak. This price profile is demand driven – it peaks in the evening when residential consumers demand energy. However as more energy generation comes to the grid, this profile will be increasingly driven by both supply and demand.
The potential impact of Electric Vehicles needs to be included in the mix. A typical electric vehicle has a battery bank of about 100 kWh; drivers will expect to charge this bank in a short time – say 30 minutes. Consider that today, the average house uses about 100kWh of energy per day in winter. Thus the grid will have point loads over minutes that currently would be delivered over 24 hours.
Technologies and costs The pace of change is driven by the costs of
The technologies that are available today
renewable energy technology and the rate
include:
at which they are deployed on the market.
A PV array on the roof
Consider the following two technology
Ground source or Air source heat pump
suites, net energy positive homes and
(i.e. technology that converts electricity
electric vehicles:
into heat)
Net Energy Positive Building This is a building that, over the course of a year, generates more energy (from PV), than it uses. The diagram (from Microsoft Powerpoint Clip Art) shows a house with a range of renewable technologies
Batteries Thermal storage (i.e. hot water tanks) With this suite of technologies, the energy generation costs are about 0.05 p/kWh. This is based on the following assumptions: A grid electricity purchase price of 8p/kWh (based on buying electricity at cheap times of the day PV generating a net positive amount of energy over the year. There is not enough energy from the sun to power a standard house throughout the year. A Heat Pump with a heat conversion factor over the year of 4 (one unit of electricity for four units of heat). Battery and thermal storage of about 4 hours energy use.
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These technologies are available today. The challenge is the capital cost of the technology and as prices fall so the technology will become even more economically attractive. Compare this 0.05 p/kWh generation costs with current grid prices of 15 p/kWh for electricity and 7 p/kWh for gas (inclusive of connection charge). There is a business opportunity in this price differential, and an opportunity to ‘win’ the consumer.
Electric Vehicles A study by Stanford University (RethinkX.com) on the impact electric vehicles (and in particular Autonomous Vehicles) on the transport ecosystem predicts that the cost per mile of electric vehicles will drop to over half that over a current internal combustion engine, (see right, by 2021. It is this cost reduction that will drive the change. Including EVs’ into the house described above will further reduce a households energy costs. The EV’s could charge from the PV through the day when the house is not using energy. . The impact of both residential energy and electric vehicles at scale is considerable. The opportunity is in networking distributed energy generation units (i.e. houses) into Virtual Power stations. At scale, energy balancing services can be provided to the grid through distributed energy storage, alongside providing with low cost energy to the consumer. These opportunities need to be deployed at scale which requires capital. Controlling both energy generation and demand is where the value lies in the emerging energy landscape. .
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A threat and an opportunity For the oil industry, this transformation is both a threat and an opportunity. The Stanford University study comments that the move to Electric Vehicles and removing transport from oil demand will reduce the oil price to 25 $/bbl.
Conclusion The public has turned against the oil industry and which is hindering onshore UK operations and influencing investors to take their money out of the sector. The oil industry has lost the public relations ‘battle’. It's questionable if it will ever win it back again. The global economy needs more oil even if demand drops to match the 2 deg C emissions target. The oil industry has to continue to find and produce low cost oil and gas. It is important to respond to the challenge from the public to educate the role oil and gas plays in our economy and its importance in the transition to a low carbon economy.
There is a valid case to be made both to the public and investors that continued oil exploitation is both profitable and necessary. Investors are turning away from the oil industry; stocks in green energy outperform the oil industry . This reflects the fundamental challenge to the industry in that there are cheaper, cleaner alternatives. Investors can see this and are including this threat in their corporate valuations. Therefore the oil industry has two choices: 1) Participate in the energy transition: the oil industry has vast expertise in deploying capital at scale to address complex challenges. It is this skill that is needed in the energy transition. The transition requires capital, and the more capital is deployed the more the risk reduces. 2) The alternative is to focus on finding and producing oil and gas, knowing that the energy transition will result in continued downward pressure on oil price and thus margins.
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CONTACT: Hamish Wilson BluEnergy Consulting hamish@bebluenergy.com Mobile +44 7768 355 000