A critical assessment of oil and gas companies’ recent commitments for an accelerated decarbonization
When “best in class” is not good enough
A number of publicly listed oil and gas companies has recently committed to “netzero by 2050” decarbonization targets that actually include scope 3 emissions (with the notable exceptions of Chevron, Conoco Philips and Exxon). At first sight, this looks like a positive development, although it goes without saying that it comes decades too late. But while accelerated decarbonization targets may be “good” (some even “best in class”), provided they are reliable, are they good enough? A closer examination reveals that they tend to be based on the continued near-term exploration of proven reserves in combination with plans for increasing volumes of carbon offsetting by virtue of natural climate solutions, carbon capture and storage (CCS), and biofuels (BECCS) in the medium-term. Predictably, the promise of future carbon removal is used as a rationale to soften an incremental decline of fossil fuel production volumes. After all — so goes the argument — fossil fuel profits are needed to pay for transformation costs as well as to satisfy demand and shareholder expectations. On the other hand, the rapid decarbonization of our civilization has become such an urgent priority by now, requiring a “herculean effort” of essentially halving global emissions every decade beginning last year, that the world cannot afford new fossil fuel infrastructure investments that are locking-in future GHG emissions and contribute to a gap between planned and needed production levels (the “production gap”) which is already too wide.
The case of Shell’s decarbonization strategy
Let’s take a closer look at Shell’s strategy day 2021 presentation as an exemplary case, where the company announced an accelerated decarbonization strategy to achieve net zero emissions by 2050. Shell estimates that its absolute emissions peaked at ~1.7 Gigatons CO2e in 2018, of which scope 1 and 2 (~80m tons CO2e p.a.) accounted for about 5%. Shell’s medium-term target is to reduce total emissions by ~20% in 2030 — which would result in absolute emissions of ~1.36 Gigatons CO2e p.a. — and to cut carbon intensity by 45% by 2035. Moreover, Shell plans to purchase a volume of ~120 million tons CO2e (and more going forward) of carbon credits p.a. by 2030. This would cover about 9% of CO2 emissions anticipated by 2030. In addition, if perhaps half of the CCS facilities that Shell forecasts at a capacity of 25 mio tons p.a. by 2035 were already operational by 2030, this could neutralize another ~1%. Shell’s long-term vision is to capture and store “maybe” 50 million tonnes and to remove “maybe” about 300 million tons p.a. by virtue of forests, wetlands and soils. However, this decarbonization strategy is built on continued fossil fuel exploration with USD 8bn being committed p.a. in the near-term. The upstream business is highly profitable with returns ranging between 20–25% and an average break-even price of 30 USD per barrel. Natural gas investments continue to be rather profitable as well, with average IRRs of 14–18% for future projects and a forecast of growing demand until 2040. In contrast, near-term investments of ~2–3 bn USD p.a. are planned for renewables and hydrogen with a targeted unlevered IRR of “more than 10%”. At least no “new frontier exploration entries” are expected after 2025, which is not something we may hear from Shell’s US competitors at this point: Exxon, for instance, is planning to increase its capital and exploration expenditures into “high value assets” to 25 bn USD p.a. by 2025.
There is still too much money to be made in the fossil fuel business
It is obvious that the internal rates of return for fossil fuel projects are terribly misaligned with the Paris Accord. Not surprisingly, Shell’s “best case” SKY scenario foresees a continued role for fossil fuels towards the end of the century (anticipating about 22% of global energy demand provided by coal, oil and gas and 14% by bioenergy by 2070). As long as there is money to be made, oil companies on their way to net zero will argue that if they refrained from production investments, other market players would step in. Indeed, the market reality is such that for every decent corporate citizen there seem to be even more less considerate peers who are eager to capture short-term economic value at any social and environmental cost, as long as they can get away with it (In 2019, for instance, a 12 bn USD bond offering by Saudi Aramco was 8X oversubscribed). But while it is generally a poor excuse to justify one’s own ethical failure by the ethical failures of others, this also shows that the whole industry needs to be transformed at once, by changing its rules and economics, rather than one company after another. Under the current circumstances, something like a 20% emissions reduction by 2030 might be among the most ambitious that we can expect a publicly-listed oil company to announce without chasing its shareholders away. In this sense, Shell’s decarbonization stratey is a shareholder value maximizing effort that makes the most out of the absence of stronger climate policies. It actually would have been surprising had Shell’s management been allowed to sacrifice a substantial share of the economic value that policy makers are leaving generously so on the table for reducing its emissions even more.
The voluntary carbon market
To put those 120 m tons of CO2 emissions that Shell plans to offsett by 2030 into perspective, as of 2019 the total voluntary carbon market was covering ~109 mio. tons in at a valuation of about 300m USD, indicating an average price of just ~3 USD per ton CO2 . In contrast, the (mandatory) EU emissions trading system (ETS) saw average allowance prices rapidly increase from 5.8 EUR/ton in 2017 to 15.5 EUR/ton in 2018 and 24.7 EUR/ton in 2019. The relative price difference to the voluntary carbon market is due to long-term contracts and historically limited demand and willingness to pay, although this is about to change rapidly. According to the “Taskforce on Scaling Voluntary Carbon Markets” coverage will need to grow to 2bn Gigatons p.a. by 2030, in order to enable companies and organisations to align with the Paris Accord. If an average price of e.g. ~15 USD/ton could be realized in the voluntary carbon markets at the scale needed by 2030, it would indicate a potential market size of 30 bn USD p.a., an increase by a factor of about 100X over the next 10 years. Aside from the fact that a 2 Gigaton annual CO2 emission removal is still rather small compared to the goal of halving global GHG emissions (currently at 38 Gigatons p.a.) by 2030, at least the volume itself could be achievable if the conditions are right. At a price of less than 100 USD/ton the theoretical removal potential of nature based solutions has been estimated at ~11 Gigatons CO2e p.a. by 2030, with a potential of ~4.1 Gigatons at prices less than 10 USD/ton. Taking into account mobilization challenges such as project risks and long lag times between the initial investment and the eventual sale of credits, a recent McKinsey estimate anticipates a potential carbon credit supply of 1 to 5 Gigatons per year by 2030. But a major challenge will be the reallocations of capital needed in the absence of sufficient financial derisking facilities (most carbon credits are generated in developing countries) and as long as fossil fuel projects provide lower risk/higher yield investment opportunities.
An intergenerational justice problem
Given the anticipated increase in demand for carbon credits (which should indeed make us “all ”a little nervous” as Jonathan Foley points out) and the scale of emissions to be neutralized, it is no wonder, that oil companies are currently securing long-term purchase rights for carbon offsets at minimum fixed prices. From an intergenerational justice perspective, this is outrageous. Not only would the companies that have made (and continue to make) a major contribution to immense future climate damages and risks for humanity be allowed to use part of their dirty profits to offset part of their emissions at ridiculously low prices (relative to the social cost of carbon estimated at 100 USD/ton by 2030 by Stern & Stieglitz), but they would use these comparetively minor expenses as a rationale to further extent their fossil fuel activities for as long as economics and policy makers allow. This essentially negates the positive impact of natural climate solutions (at least for a substantial part) and reduces their availability for netzero transitions by other industries, where low-cost low-carbon substitutes aren’t readily available yet, thereby substantially slowing down humanity’s race to zero. And regardless of the combined drawdown potential of nature based solutions, CCS/BECCS and direct air capture (DAC), the idea to extract carbon out of the earth only in order to capture that carbon and put it back into the earth at a later point seems insane — especially considering that we have already too much of it in the atmosphere and given the availability of low-carbon substitutes (i.e. renewable electricity plus storage) that provide significantly higher energy returns on energy invested (EROIs).
The problem with national oil companies
While Shell and its European peers have at least begun trying to transform themselves, it is very concerning that we don’t see comparable netzero commitments by the world’s national oil & gas companies (Saudi Aramco, Rosneft, Sinopec, CNPC, KPC, NIOC etc) whose GHG emission volumes are about 2X those of the publicly listed oil companies (according to the Carbon Majors Report 2017, in 2015 about 30% of GHG emissions from fossil fuels came from public investor-owned companies, while state-owned and privately-owned companies accounted for 59% and 11%, respectively). Unfortunately, the fact that these companies are under state (or private) control appears to make them even less accountable to the concerns of the rest of mankind. When faced with the prospect of losing a main source of wealth, reluctance to decarbonize is to be expected from states whose fortunes are dependent on fossil resources. This also includes countries such as the US and Canada, who own vast natural gas and unconventional hydrocarbon supplies. In the end, even they shouldn’t be able to resist a declining oil price and falling demand. But demand for fossil fuels is currently declining too slowly in developed economies. While the demand side plays a critical role, this is not about personal consumption choices. As Michael Mann explains, in an effort to slow down the transition, the supply side (alongside with today’s “climate inactivists”) is attempting to put most of the blame on individual consumer behavior, instead on the absence of stronger climate policies, while spending more than 200 million USD annually for industry lobbyism opposing stronger climate policies. Finally, demand is increasing in developing countries, where it it is critical that the international community actively supports and incentivizes an early and accelerated low carbon transition.
The key to accelerated decarbonization
There is no doubt that stronger climate policies are needed to close the production gap and shift consumer choices e.g. by offering attractive economic incentives and mandating the accelerated deployment of low carbon technologies. Considering that a barrel of crude oil releases about 0.43 tons of CO2, a ~100 USD/ton CO2 price by 2030 implies a ~43 USD surcharge per barrel. While this price level would still be far too low compared to the ultimate costs of carbon to human societies, even a share of it would already provide consumers a with powerful incentive to switch to lower cost low carbon solutions — of which many are already commercially available — and substantially reduce the universe of economically feasible fossil fuel reserves. This is why increasing mandatory carbon price levels (alongside a robust global carbon market) is such an important and much needed intervention. It would reduce supply and demand simultanously, by shifting the equilibrium, while avoiding perverse price incentives that might arise if either supply or demand are cut disproportionately. Indeed, the key to an accelerated decarbonization is accelerating the decline in fossil fuel demand and incentivizing low carbon substitutes while at the same time driving down fossil fuel IRRs by increasing the cost of carbon until it starts to reflect its social costs.
