Financing the global energy transition

Any oil and natural gas industry executive thinking about where to invest capital in the next year, five years, or decade is facing mixed signals, to say the least. Oil prices are strong today, but the long-term trends suggest oil companies must eventually build their portfolios of low-carbon and zero-carbon projects if they are to remain profitable in the net-zero world.

West Texas Intermediate (WTI) crude spot prices started 2020 in the high $20s/bbl, then plummeted below $12/bbl in April, recovered in May, and continued to climb for the rest of the year and through to today. WTI has been above $60/bbl every day in March 2021.

But this remarkable recovery must be seen in the context of what IHS Markit Vice President, North American Unconventionals Raoul LeBlanc called "an onslaught of announcements and pledges by countries and companies … for the energy transition" away from fossil fuels in the last year.

The oil industry and companies that invest in it are trying to manage for both the short term and the long term. As Steve Pattyn, chief investment officer of hedge fund Yaupon Capital Management, put it: "The story of 2020 was the recognition of a need to get to net zero and deal with the negative externalities of carbon in a meaningful way. This has created opportunities, but it requires infrastructure, government support, and a lot of investment, not just from energy investors."

Said Ben van Beurden, Shell CEO: "Net zero is both a moral imperative and an amazing business opportunity."

At the CERAWeek by IHS Markit virtual conference in the first week of March, many panel discussions considered the issues of where, when, and how that climate moral imperative will intersect with business opportunities. It's happening already, of course, with huge investments in renewable power, battery storage, and electric vehicles. But speakers agreed that it needs to happen to an even greater extent in the future to enable technologies such as carbon capture and storage (CCS) and hydrogen to reach the scale needed to balance the globe's carbon budget.

And yet huge questions remain, which industry executives and government leaders from around the world referenced over and over again: How much is needed? What are the most promising technology areas? Will the needed funds be available?

How much is needed?

On the "how much is needed" question, the numbers began with $10 trillion over the next decade cited by John Kerry, US Special White House Envoy for Climate Change, and moved up from there.

Pattyn and Jeff Currie, head of commodities research at Goldman Sachs, came up with the cost range of $15-$20 trillion by 2030, with Andrew Light, acting assistant secretary for international affairs at the US Department of Energy, mentioning $23 trillion.

Looking out to 2050, Samir Assaf, chairman of corporate and institutional banking for HSBC, floated the global investment need at $100 trillion. (A few days after CERAWeek, the International Renewable Energy Agency came up with the figure of $131 trillion by 2050.)

Whatever the number is, the reality is that investment today falls far short of that figure. Panelists such as Bobby Tudor, chairman of investment bank Tudor, Pickering, Holt & Co., pointed out that global energy transition spending is about $500 billion per year, well below the trillions of dollars needed annually.

Where should spending be directed?

In one panel at CERAWeek, Atul Arya, chief energy strategist at IHS Markit, led a discussion on the investment needed for strategies such as widespread electrification of heat and transportation, supplied by renewables and battery storage; emissions avoidance; CCS; and hydrogen.

Mass electrification is a prominent area for investors, said Peter Terwiesch, president of industrial automation at ABB. But the scale is daunting. "In terms of primary energy demand, the world is using something like 150 Terawatt-hours per year, largely coal, oil, and gas. If we translate that to the largest non-fossil sources of power, it's like 1,500 times the largest hydroelectric dams," he said.

Renewable generation installation capacity set a record in 2020, despite the COVID-19 recession, and 2021 is expected to set a new record, said Lara Dong, IHS Markit senior director, power and renewables.

It's a global phenomenon, with countries with growing demand for energy in the lead. China is the world's largest wind and solar market, Dong said. "Half of recent Chinese power additions were wind," she said, and China is using it to support growing demand, not just to replace fossil fuel assets.

In the US, Tudor said he sees strong interest from investors in the power industry's transition. Investors are seeking "high single-digit, low double-digit returns," he said. "A lot of projects … can do that. But there probably are not enough projects to … soak up all that capital."

But adding renewable power isn't sufficient, said panelists, issues of reliability are coming to the forefront. Looking just at the US, the electric power grid would have to triple in size by 2050, said Bill Gates in his first-day discussion with IHS Vice Chairman Daniel Yergin. "It has to stay reliable, and people don't want the price to go up…. what we have done so far is only a small subset of what [needs to be done]," Gates said.

Battery storage is part of that reliability story, and it's also growing at a record pace and attracting investors.

But power storage comes with its own issues, said Jeremy Weir, CEO of Trafigura, in discussion about investors' appetites for energy investments. For example, wind farms, electric vehicles, and solar power require about five times as much copper as typical electrification networks, he said. Goldman Sachs' Currie added: "Copper is the new oil."

Beyond copper, there's cobalt, nickel, and other minerals as well. Investors would be smart to watch where these key metals are being mined, Currie said. "Chile may become the new Saudi [Arabia]; the Democratic Republic of Congo may become the new Venezuela," he said.

However, several members of the US Congress and the Biden administration who spoke at CERAWeek expressed misgivings about labor practices in Congo, where key minerals are mined.

No discussion of the drive to net zero could exclude hydrogen. CERAWeek panelists said the hydrogen industry is making great strides, even as they also agreed with IHS executives Arya and LeBlanc that there's a risk that interest is reaching a point of "irrational exuberance" for investors.

For companies with access to inexpensive gas, "blue" hydrogen made from reforming gas and offset with CCS is attractive. It is less expensive today than "green" hydrogen made through electrolysis, said Soufien Taamallah, director of IHS Markit energy technologies and hydrogen research. Green hydrogen in locations with good availability of renewable power is around $4-$5/kg, or two to three times the cost of gray hydrogen.

"$2 per kilogram is the magic number; if you get there, you're in the money," said David Eyton, BP group head of technology.

Projects around the world are trying to make that figure a reality. Malaysian oil firm Petronas has embarked on a green hydrogen demonstration project with state-owned utility Sarawak Energy in the hope of driving down the cost of production to the $1-$2/kg range, Mahpuzah Abai, CEO for Petronas Technology Ventures, said.

Nel Hydrogen, an Oslo-based company that manufactures electrolyzers, believes it can get green hydrogen down to $1.50/kg by 2025, according to CEO Jon André Løkke.

Oil companies: emissions avoidance, carbon capture

One theme that emerged at CERAWeek from oil companies is that emissions avoidance is a time-tested strategy that continues to yield environmental benefits and at a low cost.

"We should shrink carbon emissions so sequestration should be the last solution," said Shell's van Beurden.

ExxonMobil has been focused on emissions reduction for a number of years, said Chairman and CEO Darren Woods. It has invested more than $10 billion in what he called "emissions reductions in our core business," and Woods said it will reduce the greenhouse gas intensity of its upstream operations by 15-20% by 2025, compared with 2016 levels.

"This will be supported by a 40% to 50% decrease in methane intensity, and a 35% to 45% decrease in flaring intensity" across the company's global operations, Woods said.

Quoting an International Energy Agency study, Roberto Castello Branco, CEO of Brazil's state-owned oil company Petrobras, said an estimated 37% of the oil and gas industry's contribution to meeting the Paris Agreement can be met through efficiencies and emission reductions strategies.

Carbon capture is just starting to reach its commercialization stage, panelists said, and the oil industry is poised to be the leader in this sector. CCS is critical to a zero-carbon future because it would be nearly impossible -- and far too costly -- to wring out all the carbon emissions from the global economy. Some will have to be captured and/or offset.

"There are many industrial applications with relatively concentrated [carbon dioxide (CO2)] streams that are far more thermodynamically and economically efficient" for removal, said BP's Eyton. "It would be a sin not to tap into them."

Construction began on or investment was approved for an estimated 100 million metric tons/annum of CCS projects in 2020. "That's about 100% growth since 2017. I've been telling investors to watch this space — because it's gonna be big," said Ahmad Al-Khowaiter, chief technology officer for Saudi Aramco.

Japan's energy users are looking at CCS for offsets, said Tetsuhiro Hosono, chairman and CEO, Japan Oil, Gas and Metals National Corporation (JOGMEC), which coordinates the nation's energy imports. "It's unrealistic to assume we can create a green energy world overnight," he said. "We must take a new mission: applying CCS to JOGMEC's upstream activities."

For Occidental Petroleum, its decades of familiarity with using CCS for enhanced oil recovery in the Permian Basin and elsewhere gives it a leg up to turn its technology into a new line of business, said Vicki Hollub, president and CEO. "We do not expect to be an oil company only in the next 10 to 20 years. We expect to become a carbon management company," she said.

Occidental has CCS projects underway with two ethanol plants in Texas and a gas-fired power plant in North Dakota, and it will soon begin working with a steel plant in Colorado, Hollub said. Also, it will invest billions in commercializing its technology, including a joint venture called 1PointFive that was started in 2020 with private equity firm Rusheen Capital Management.

From whom?

Some of the funding for the energy transition has been coming from banks, and they are poised to continue to seek opportunities. "Private banking wants to invest in [environmental, social, governance (ESG)] solutions," said Credit Suisse CEO Thomas Gottstein. "We have committed $30 billion for sustainable financing over the next 10 years."

At the same time, Gottstein said that Credit Suisse will "support traditional energy businesses" because it sees them as leaders in the energy transition.

HSBC's Assaf said the bank will reach net zero on its own energy use by 2030 and has set a goal of net zero on its "engagement portfolio" with clients by 2050.

Additional funds will come from oil producers. The top six oil supermajors are cumulatively spending about $20-$30 billion per year of capital investment, and about 20% of it is on the energy transition, by Pattyn's estimate. But that's "a drop in the bucket," compared with what's needed, he said.

Executives of oil companies affirmed at CERAWeek that they are watching their investments carefully. Sonangol, the national oil company of Angola, is cutting its capital spending by 40%, said Sebastião Pai Querido Gaspar Martins, chairman of the board of directors.

Suncor Energy, a leading producer from the Canada oilsands, is spending about 10% of its capital expenditure budget on energy transition investments, said Mark Little, president and CEO.

One issue for oil producers, especially in the US, is pressure from investors to distribute back some of the cash invested during the Shale Revolution a decade ago, said Brian Singer, head of Americas energy for Goldman Sachs. "For the first time in the Shale Revolution, returns now trump growth," he said.

Strong oil prices today create a paradoxical situation, Tudor explained. On the one hand, finding oil is an attractive investment for producers; on the other hand, that cash flow could be used to transition them for the future. Finding the right answer is the key. "We are now in an up cycle, and if capital is deployed smartly it will provide strong returns," Tudor said.

Investment in oil and gas makes sense, according to Aramco's Al-Khowaiter. All forecasts of global energy demand see considerable use of oil and gas for decades, he said. "The question is how to make oil and gas sustainable," Al-Khowaiter said.

Sultan Ahmed Al Jaber, CEO of the United Arab Emirates' national oil company, ADNOC, sees it the same way. "Our mission at ADNOC is to provide that oil and gas as responsibly as possible … [to be the] lowest-cost producer and lowest emitter," he said.

At the same time, the company is hedging its bets. ADNOC has three of the largest and lowest-cost solar projects in the world, he said, and it has significant investments in more than 30 solar projects around the world. Also, ADNOC teamed up with Emirates Steel more than four years ago on a CCS project. "We can capture 800,000 [metric tons] of CO2 and have plans to expand significantly in very near future," Al Jaber said.

Even better prospects can be seen for LNG, said some speakers, despite criticism by environmentalists that it is yesterday's technology, based on the production and processing of a fossil fuel. From the perspective of countries using LNG to replace coal-fired power, wood-burning stoves, or just to keep up with rising energy demand, LNG is a lower-carbon, reliable, affordable option, said several representatives of the LNG industry. They expect its growth for a significant period of time.

"There's huge demand growth potential in Asia right now," said Cheniere CEO Jack Fusco. "If you look at China's five-year electrification plan, they want to take their share of power from natural gas combined-cycle [generation] from 8% to 15%. If they are successful, that could be [the demand equivalent of] three more Chenieres. The demand is phenomenal for the product."

Government's role

When asked about where energy transition money will come from and when, speakers often mentioned the need for a strong government role as a direct financial supporter and also to raise private investors' confidence.

The US is stepping back into action under the Biden administration, with the high-profile return to the Paris Agreement being followed up already with extensions of tax breaks for renewables, approval of the nation's largest offshore wind power project, and the linkage of clean energy spending to the expected $2 trillion Biden wants to spend on his "Build Back Better" infrastructure plan.

The power outage in Texas in February added a new sense of urgency, US Secretary of Energy Jenifer Granholm told CERAWeek. "That's not a one-off [event]," she said.

US Representative Kathy Castor, Democrat-Florida, said that addressing climate and energy security simultaneously is a House of Representatives priority. She praised Biden's all-of-government approach to solving the climate crisis, adding that it "mirrors many of our policy recommendations from last summer."

Biden has said on several occasions that green investments will deliver jobs. Industries such as offshore wind could benefit, said Steve Dayney, head of offshore wind North America, Siemens Gamesa Renewable Energy.

Congress is moving towards a massive infrastructure bill this summer, which would include billions of dollars for energy-related climate initiatives, said Pattyn. Regulated utilities would likely be tasked with buildout and management the power grid. Compared with oil and gas companies, they are easier for the government to tax or to control through the ratemaking process, he pointed out.

It's more than spending, added ABB's Terwiesch. Government regulation of methane or a carbon tax would provide long-term certainty for investors seeking to reduce carbon emissions. He called this creating "predictable boundary conditions."

The American Petroleum Institute welcomes both regulatory certainty and the investment, CEO Mike Somers said. The industry has the skill set to help with the transition, particularly in CCS, Somers added.

The message from European leaders at CERAWeek is that they're already there — and they see an economic imperative, as well as a climate need. "With the European Green Deal we want to be the first climate-neutral continent by 2050, we want to benefit from the first-mover advantage," said Kadri Simson, commissioner for energy, European Commission.

The European Green Deal is the overall investment and regulatory plan to enable the EU to reach carbon neutrality by 2050. Of course, thorny issues still have to be worked out, such as a carbon border adjustment tax, said Niels Annen, minister of state for the German Federal Foreign Office.

Companies operating in Europe see where regulations are headed, and they are moving quickly down the net-zero path, said Anders Opedal, president and CEO of Equinor. "We cannot wait for the perfect solution, let's use the technology we have today," he said. The company is gradually adjusting its mix of traditional fossil fuels and renewables investments, including reducing its ownership position in hydraulic fracturing activity.

Iberdrola, the largest generator in Spain, has already closed all of its coal-fired power plants, said CEO Ignacio Galan. "Our goal is to double renewables assets to 70 GW by 2025," he said, as well as to expand its power grid operations.

But it's not just the US and Europe that are in the midst of this transition. Whether it's China and India trying to keep a lid on new coal-fired power, development of a new generation of nuclear reactors, or the aviation industry experimenting with biofuels, the investments are coming in every sector.

The public's understanding of the necessity is growing, lawmakers are responding, and far-sighted investors see unprecedent opportunities to do right, and do well.

As Jaime Caballero, CFO for Ecopetrol, the national oil company of Colombia, said, it's a "massive acceleration" in decarbonization "from reactive to a proactive carbon position."