Financial markets have already started to factor in the prospect of peak oil demand into their calculations, contributing to a dramatic underperformance by oil companies across the board relative to other sectors.
Not all companies will fare the same. But a new analysis looks at some of the financial risk facing the world’s top oil companies as the energy transition proceeds.
$10 energy transition risk
One way to think about how the epochal shift from fossil fuels to renewable energy and electrification is through a least-cost framework. As clean energy takes hold, the market for fossil fuels will shrink, but not disappear. As the market shrinks, uncompetitive companies will be forced out of the market, leaving only stronger producers, and stronger producers tend to have the lowest production costs. It’s a pretty straightforward concept, but nonetheless a useful way to frame the risk to the oil and gas industry.
This analysis is the most obvious when thinking about different types of production. For example, in an October 2020 report, Carbon Tracker detailed a list of major oil and gas projects that would become economically unviable if the world got on track with 1.65-1.8-Celsius warming scenario as laid out by the International Energy Agency.
A low-carbon world would imply some combination of carbon taxes, regulation and other policy changes that shrinks oil demand. Carbon Tracker identified $60 billion of capex allocated to 15 large projects given the greenlight in 2019 that would be at risk, such as ExxonMobil’s Greater Liza project in Guyana and Royal Dutch Shell’s Prelude floating liquefied natural gas project in Australia. The NGO also put out another analysis that looks at country risk due to the transition, concluding that trillions of dollars of revenues could vanish as transition accelerates.
A new analysis from Rystad Energy puts another spin on this approach. Rystad finds that the energy transition creates a $10-per-barrel downside risk to the market. Put another way, if the energy transition accelerates, oil prices could end up $10 lower in the long run than they would otherwise be.
This is a bit different than the notion that some volume of oil and gas production gets left behind as stranded assets. The risk of lower volume, Rystad says, is comparatively low, often cutting company value by only 1 percent or so. Instead, the threat of lower prices (a symptom of falling demand) is the mechanism that destroys value.
That $10 downside risk may not seem like much, but it could wreck the valuations of some of the largest oil and gas companies in the world. In Rystad’s survey of the top 25 non-government oil and gas companies, the $10 downside risk reduces the value of their portfolios by an average of 30 percent.
The biggest risks, unsurprisingly, are concentrated in companies with high-cost production and carbon-intensive operations – Rystad says Canadian oil sands companies and North American shale face the most transition risk. These projects have high breakeven costs and are sensitive to price changes. Some Canadian oil sands companies lose 50 percent of their value with a $10 hit to prices.
Canada’s oil sands are also extremely carbon-intensive. If a carbon tax of around $100 per tonne were implemented, Canadian oil sands companies would lose roughly 30 percent of their value, Rystad estimated.
It’s worth noting that ExxonMobil just erased nearly all of its Canadian oil sands reserves from its books in its latest securities filing, cutting its total reserves by roughly a third to 15.2 billion barrels, down from 22.44 billion barrels previously. The oil sands were taken off the books because, at least for the moment, they not expected to be viable.
The risk for oil majors
Among the oil majors, there is divergence in Rystad Energy’s new analysis. The European oil majors – Eni, Royal Dutch Shell, Equinor and Total – score similarly. ExxonMobil, on the other hand, faces higher risks due to capital-intensive projects in the Permian basin and offshore Guyana.
“The energy transition risks vary depending on each individual E&P company. Equinor, for example, whose risk is relatively smaller compared to other peers, could see the value of its upstream portfolio reduced by $21.8 billion, almost 30%, with an oil price decrease of $10 per barrel and a CO2 tax,“ Espen Erlingsen, head of upstream research at Rystad Energy, said in a statement.
Industry proponents often note that unwinding oil demand will be a protracted process, citing the ubiquity of fossil fuels as evidence that the business case remains sounds. But as Carbon Tracker and other market analysts have argued in recent years, financial markets do not necessarily care about market size, or the fact that it will be difficult to displace 100 million barrels per day of oil demand. Instead, financial markets are highly sensitive to growth. As soon as an industry stops growing, it can result in significant financial turmoil, even if the subsequent demand contraction proceeds slowly. This is especially true if the business case for the sector has always been based on inexorable growth.
In other words, even if the clean energy transition unfolds over the next few decades, the fact that we are nearing a peak in oil demand (some say it has already passed) is momentous. Brent crude is now trading in the mid-$60s, in roughly the same range as where it traded three years ago. Over that same timeframe, ExxonMobil’s market cap has fallen by around $100 billion. The biggest difference between then and now is not the spot price for crude, but the long-term outlook for oil prices – and for the fortunes of the oil industry.
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