El Camino de Santiago, also known as The Way, is a popular modern-day pilgrimage route, beginning in the French Pyrenees and concluding in Santiago de Compostela, Spain. At somewhere around 500 miles, hiking El Camino can be a serious commitment of time and energy. Many are intrigued by the spiritual elements of the process, embracing the concept that the journey, not the destination, makes traveling El Camino so special. Several times I have contemplated this journey. Each time, a busy schedule or other priorities interfered, along with a nagging feeling that maybe it would be too hard or tiring and perhaps I was not up to the task. For now, for me, El Camino goes untraveled.
Opting out is not on the menu for the conventional oil and gas industry as it faces its own El Camino de Santiago—the energy transition. What will be the fate of the oil and gas industry in a lower carbon world? The analysis is complicated. The pre-COVID world consumed 100 million bbl of crude oil each day and a similar amount of natural gas. Hydrocarbons literally power and propel our economies, bringing a better life to virtually all the world’s population. However, governments, corporations, social influencers, and millions of people across hundreds of countries are increasingly focused on CO2 emissions and the risks of global warming. Already, we are seeing trillions of dollars committed to decarbonization, raising the question of peak demand for oil. Furthermore, hydrocarbon producers are also receiving a loud message from capital markets—stop growing oil volumes and return cash to shareholders.
Various global energy organizations like the International Energy Agency, Organization of the Petroleum Exporting Countries, and the Energy Information Administration forecast peak demand in the 2030 to 2050 timeframe. BP contends peak demand has already occurred, in 2019. We believe the 2035 to 2050 timeframe feels accurate, but there is no doubt the time has now come for oil and gas companies to ponder the long-term future of the industry, as well as their own path forward. What is The Way?
It is an incredibly complex task to manage the dual challenges of operating a core business during a long-running downturn while creating a strategic plan to deal with a changing and unforecastable future. When will peak demand occur? How quickly will demand fall after it peaks? What energy transition technologies will be winners? How should capital and human resources be allocated? Are current assets—whether they be a bbl of reserves, a drilling rig, a refinery, or a pipeline—at risk of being obsolete? Should a company ignore the energy transition and simply focus on being a low-cost producer? Should a company pivot quickly and find its place in the evolving world of energy transition? These are the questions that will be increasingly dominant in the board room of energy companies. Environmental, social, and governance pressures from individuals, institutional investors, and corporate peers are intense and cannot be ignored.
Major integrated oil companies have been tackling the issue for the past several years. Statoil renamed itself Equinor to remove the word “oil” from its name. British Petroleum became BP. Carbon neutrality pledges have proliferated among the large European state oil companies. Chevron’s new motto is “Higher Returns, Lower Carbon.” Big Oil’s investments remain primarily focused on oil and gas, but capital spending is ramping dramatically on renewables, carbon capture, and hydrogen. Investments are also being made in integrated power solutions, including electric charging and grid storage. The most meaningful shift has come from BP. Consistent with its new viewpoint of 2019 peak demand, BP has indicated capex will shift to 50% green energy by 2030, allowing current production to fall from approximately 2.6 million BOEPD to approximately 1.3 million BOEPD. Even Saudi Aramco, the world’s largest oil producer, has ambitious carbon and clean energy goals.
Fortunately, even with oil prices in the $40s and $50s, the majors have meaningful cash flow from diversified sources (oil, gas, liquefied natural gas, petrochemicals, refining, etc.), allowing them to invest gradually (but meaningfully in dollar terms) in the energy transition. Near-term practicalities and long-term consequences collide when it comes to smaller energy producers. With focused assets, specialized knowledge, and squeezed profitability, the question isn’t so much how they should be investing in the energy transition, but whether they should consider it at all. Does a Colorado gas producer have an edge in the wind business? Should a West Texas exploration and production company be building solar farms?
There will be energy transition-driven changes for all facets of the current energy system. It is likely that oilfield service companies will incrementally add capabilities in the energy transition area, providing services to renewable energy companies much like they do to oil and gas customers. Midstream companies will gradually expand their asset base to include hydrogen transport and storage. Electricity providers will look toward grid storage solutions, as well as vehicle charging infrastructure.
Regardless of industry subsector, capital allocation to the traditional oil and gas business will be under intense scrutiny over the next 3 to 5 years as the industry evaluates the speed and magnitude of the disruption coming from a lower carbon future. Energy transition is the shiny new toy. However, the global transportation, petrochemical, and electricity systems are massive and complex. They will not be disrupted at the pace of iPhone adoption or e-commerce. Oil and gas demand will be high for decades. My view is that even with rapid electrification of transportation and an intense focus on conservation, efficiency, and lower carbon, the world will consume 75 million bbl/day or more in 2050 and 50 million bbl/day or more in 2075. It’s a very long runway for today’s hydrocarbon players—long, but not infinite.
A look back at the shale disruption of the past decade provides a reasonable roadmap for the energy transition. Private companies, first movers, venture capital, and incumbents will accelerate capital deployment into energy transition plays (happening). Public markets will bid up public companies with even ancillary energy transition exposure (happened/happening). Technologies and experience will lower costs (ongoing). New pools of capital will be raised to attack the opportunity (early but happening). Governments will provide tax incentives and subsidies (happening/accelerating). Asset values will rise notably (happening, particularly with wind/solar now at project-level internal rate of return of 3% to 6%). With the spotlight of opportunity shining, envy and fear-of-missing-out will drive incumbent players to acquire existing assets and companies (happening, with BP’s pivot the most visible example). With a herd of players clamoring to deploy capital, lower-quality opportunities will be purchased or receive funding (2021 and beyond). Billionaires will be minted. Some projects will be better than expected, but many will underperform overly optimistic expectations. Billions will be made, but even more billions, maybe even trillions, will be misallocated and generate low or negative risk-adjusted returns. Periods of overcapacity and low prices will occur. Just like the shale-induced crude oil oversupply generated cheap gasoline and products, the unequivocal winner from the energy transition will be energy consumers.
Even though there will be cyclical peaks and troughs associated with the current energy transition enthusiasm, there is also a secular inevitability to a lower carbon future. Incumbent players must find The Way…or at least, their Way. We suspect many companies will scrutinize their strategic options around the energy transition and opt for status quo. Others will look to be fast followers or eventual followers via acquisitions. Over the next several decades, few companies will look exactly like they do today. The energy industry will be much more than oil and gas. The Way is out there….and for the energy industry, it is about the journey and the destination. Onward!
[The article was sourced from the author by TWA editor Stephen Forrester.]
