Oil, gas firms face up to financial, regulatory, social challenges in decarbonization age

With decarbonization efforts growing across the globe to counter climate change, oil and natural gas companies are struggling to overcome tighter financing conditions and ever-evolving regulatory frameworks while playing a positive role in social development.

It was a theme that emerged again and again on the opening day of the inaugural International Energy Week (IEW), formerly known as International Petroleum Week, one of the largest gatherings for the energy industry in London during pre-COVID times.

The name change itself reflects the shift of the event's focus to climate science, decarbonizing fossil fuels, and broader fields of energy, according to IEW's host, the Energy Institute.

During panel discussions 22 February, industry participants admitted an eventual transition to a low-carbon economy would be necessary but stressed that decarbonization projects need to be financially and technologically feasible.

Douglas Johnston, a partner in EY's climate change and sustainability practice, observed that financiers have been pushing oil and gas firms to make stronger climate commitments since COP26 last November.

During the UN climate summit, the 450 banks, pension funds, insurers, and asset management firms in the Glasgow Financial Alliance for Net-Zero renewed their pledges to a net-zero world by 2050.

Among the recent pledges, London-based bank HSBC committed to a 4% reduction in absolute financed emissions on its balance sheet for the oil and gas sector by 2030.

While the United Nations Environment Programme Finance Initiative, the UN's sustainable development partnership with banks, recently suggested financial institutions are not doing enough to limit global warming, Johnston said there are already strong market signals for borrowers to reduce their emissions.

As financiers seek to put their loan books on a net-zero trajectory, oil and gas producers, refiners, and pipeline operators are facing a "very challenging" environment in terms of access to capital for fossil fuel projects, according to industry observers.

"Probably, the most material [impact] has been the commitments made by the financial services sector," Johnston said. "The big change is the attitudes of some banks and some of the commitments coming after COP26 in relation to certain sectors that they would back away."

Mounting concerns

But some energy executives warned against what they described as an unrealistic expectation about decarbonization of the energy sector in the near future.

To assume that there is "a magic solution" that can quickly swap fossil fuels' 80% share of the current energy mix for renewables would be "a bad approach," Eni Chief Financial Officer Francesco Gattei said.

Oil, coal, and gas prices have hit multi-year highs in recent months, and some market participants blame the development on lower investments in replacing oil and gas reserves, as companies pulled back on their spending due to COVID-19 and also to a redirection of more assets to renewable energy.

Italy's Eni has been expanding its biofuels output and renewable power generation capacity while developing energy efficiency and carbon capture and storage projects for traditional upstream assets.

Gattei said the company prefers a "sustainable" and "realistic" approach that can support economic development, control inflation, and maintain geopolitical security during the energy transition, rather than making a claim that it is "entering a new world."

Mathios Rigas, CEO of London-listed exploration and production firm Energean, warned that overzealous climate policies at the current point in history could hamper economic development in places like Africa.

Much of the developing world has faced slow rollouts of renewable energy due to limited financial resources. During the COP meeting in 2009, rich nations promised to deliver $100 billion per year to developing countries to help deal with climate change. But the Organisation for Economic Co-operation and Development said the target will likely only be met in 2023.

"Gas undoubtedly is going to play a role [in the future energy mix]," said Rigas, whose company focuses on gas fields in the eastern Mediterranean. "We have to think about security and of supply. We have to think about affordability.

"The transition has to be just. It has to be fair to the rest of the world. Because ESG [environmental, social, and governance criteria] is not just 'E,' there's also an 'S' part, which is the social impact that we have," he added.

Sara Akbar, CEO and chairperson of OILSERV Kuwait, an affiliate of upstream services provider OILSERV, called for more regulations to incentivize low-carbon infrastructure and increased research and development (R&D) spending on new technologies.

"The area of regulation needs to be strengthened … to arrive at a scenario where decarbonizing becomes economical and beneficial," said Akbar.

According to International Energy Agency estimates last year, another $65 billion in R&D spending was required to line up demonstration projects for low-carbon technologies by 2030 so they can be adopted commercially in time to create a net-zero world by midcentury.

"We need to do more R&D. We need to really invest and research in order to make these [emissions reduction] processes really cost efficient and smooth," Akbar said. "It shouldn't be eating from the revenues. It should be adding actual value to what we do."

In addition, she observed increasing pressure on companies to disclose their decarbonization plans to existing and potential investors.

Countries like China, South Korea, and the UK are ushering in new regulations to shed light on listed companies' performance in countering climate change. In the US, the Securities and Exchange Commission is expected to soon propose new disclosure rules for climate risks.

"If you go to the market, [the details of your actions] will be requested. There are huge demands for every single company to show how they are managing their carbon emissions," Akbar said. "We have to demonstrate … our carbon footprint, how much emissions we are generating in our operations."

EY's Johnston said traditional oil and gas assets could stop receiving the required funding from the private sector to stay in operation sometime in the next five years.

"What that might do is have the unintended consequence of driving most of the production to national oil companies (NOCs), who aren't as reliant upon private finance to deliver their ambitions," he said.

NOCs' responsibilities

On the other hand, senior employees from Abu Dhabi National Oil Company (ADNOC) and Nigerian National Petroleum Corporation (NNPC)—two large NOCs—suggested their companies are fully aware of their obligation to pursue decarbonization while taking socio-economic development into account.

The United Arab Emirates, which owns ADNOC, has foreseen strong renewable and hydrogen business prospects at home and abroad while seeking to achieve net-zero emissions by 2050. Nigeria has set a net-zero goal for 2060.

Samar Al Hameedi, vice president for sustainability at ADNOC, said the country sees climate action as "a pillar of its domestic and foreign policy" aimed at promoting national economic growth.

"We are a firm believer in economic opportunity and climate not being at odds," she said.

NNPC CEO Mele Kolo Kyari said his country's decarbonization pathway will not be straightforward. He estimated 70% of the Nigerian population uses biomass to cook—a phenomenon that results in continued deforestation, as the biomass, often in the form of charcoal, is made from tropical forest wood.

To rectify the situation, NNPC plans to develop gas supplies for households to use as a clean cooking fuel, Kyari said.

"There are far more [climate] disasters coming from desert encroachment," he said. "The entire financing world is resistant toward investment in fossil fuels, but that probably is not meeting all the realities on the ground today."

Carbon intensity matters

Separately, experts believe there will be an increasing focus on cutting GHG emissions per unit of fossil fuel production via advanced technologies, operational improvements, and better field selection in the energy industry.

Even in the more aggressive decarbonization scenarios, fossil fuels are still expected to make up 20% of the world's energy mix in 2050.

But those fossil fuels will be held to a higher standard, with opportunities for companies that can demonstrate below-average emissions. "We've seen a real shift in the debate … to [whether] a premium can be potentially commanded for hydrocarbons that can demonstrate that they've been produced with lower carbon intensity," Johnston said.

A growing number of LNG sellers are buying carbon credits to offset emissions during production and transportation so they can label their cargoes carbon neutral. In a similar crude deal, Oxy Low Carbon Ventures—a subsidiary of New York-listed Occidental Petroleum—said it acquired carbon offsets for the lifecycle emissions for a 2-million-barrel shipment from the US to India last year.

"When you are offsetting those crudes, offsetting those LNG [cargoes], or offsetting any energy product, you can be very precise about the advantage of having a low-carbon product—it costs you less to offset it," said John MacArthur, group climate change officer at ADNOC.

With so many net-zero pledges in the corporate world, Deb Ryan, head of low-carbon market analytics at S&P Global Platts, warned that there won't be sufficient offsets to provide such carbon neutral status to all fossil fuels. Already, evidence of a tightening market can be seen in rising prices for carbon credits in voluntary trading.

"When we look at the voluntary offset market, looking at the credits available, there are simply not enough carbon credits to offset the entire supply chain," Ryan said. "We really need to drive the investment in reducing carbon intensity ... So, the final bit of emissions, it doesn't cost that much to offset them."

S&P Global, parent company of Platts, is expected to close its merger with IHS Markit—which publishes Net-Zero Business Daily—by the end of March.

Posted 23 February 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability