The Oil Industry’s Bright Green Energy Future

By Mike Newman, Director, Parhelion Underwriting

Special to The Digest

The Oil industry is under pressure on many fronts in the climate change era and faces an existential threat from alternative, renewable sources of energy – but the industry is also best-positioned to win the Prize in energy’s green future.

It’s “code red for humanity” as the UN’s Intergovernmental Panel on Climate Change shouted last month in only the most recent dire climate report, and the Oil industry is under pressure on many fronts in the climate change era, not least of which is from their shareholders.

First, the background, from the investors’ perspective. Over the past 15 years, the annual total returns to shareholders (TRS) for the average oil and gas company has lagged the S&P 500 by seven per-centage points. Oil stocks, accounting for more than a tenth of the bellwether index barely a decade ago, now account for just 4% of the S&P 500. This suggests the sector’s traditional business model has been under stress for some.

Then, add to that the existential threat posed by the sort of competitor that the industry has never faced in the past – an industry based on renewable sources of energy, an alternative to fossil fuels, that is being heavily supported by governmental carbon emissions reduction mandates around the world.

It’s not hard to foresee a world where renewable energy will increase, and fossil fuels decline – the prediction by BP Energy’s Outlook 2020 [Figure 1] – so Investors are putting the Oil Industry under the microscope and are increasingly seeking out positions that reduce their exposure to climate change as well as the risk of stranded assets.

Figure 1. The world’s energy transition. BP Energy: Outlook 2020/Financial Times

It’s even changing the concept of financial resilience. Financial resilience has historically been judged by the position of oil and gas assets on the industry cost curve. As the physical risks from a changing climate are better understood, and transition risks (such as societal pressure, technological disrup-tion, or shifting consumer preferences) become more widespread, financial resilience is increasingly becoming a function of climate resilience.

At last year’s UN climate summit, an alliance of the world’s largest pension funds and insurers (repre-senting $2.4 trillion in assets) committed themselves to transitioning their portfolios to net-zero emissions by 2050. Now investors are pushing companies to disclose consistent, comparable, and reliable climate data.

A new breed of activist shareholder challenges oil majors on their climate policies and emissions-reduction plans. Earlier this year, climate change hedge fund investors managed to elect three new directors to ExxonMobil’s board in a rebuke to Exxon’s oil-centric investment plans.

Compounding the issues for Oil companies, according to the Winds of Change report from S&P Global Ratings, is the real possibility they may be held legally responsible for their role in climate change.

Yet the Oil industry has natural advantages in this time of transition. The global economy still relies on fossil fuels for 80% of its power and the transition to those alternatives will happen over time. And there is a big chance that Big Oil will own this transition, as well as the renewable future that follows. By playing to core strengths.

So, what does this mean and what might it look like?

To begin with, Oil companies have existing infrastructures, resources, and technologies that give them advantages in a green present and future. While there are competitors from other sectors en-tering each of these markets, the Oil industry has natural advantages that will allow it to leverage capabilities, adjacencies, and investments to date, which will put them in a leading role.

Here we identify seven areas where the Oil Industry has inherent natural advantages.

Wind. Oil companies and the oilfield service businesses that support them have unique expertise in how to build and operate in an offshore environment, which are key to this type of power. The instal-lation of wind turbines in the sea, especially in deep waters, is pretty similar to installing oil platforms, especially floating platforms.

The latest research shows that within the renewable power sector, solar and wind energy are ex-pected to show the highest growth rates over the next ten years. Wind energy projects are an oppor-tunity to develop new energy service markets and even activate idled onshore and offshore infra-structure. Oil companies will increasingly invest in these sectors as a way to reduce their carbon in-tensity energy mix.

Solar. Oxy, EOG Resources, ExxonMobil and Chevron have all added solar energy projects in recent years. Many oilfields, such as the Permian Basin in Texas and New Mexico, are coincidentally well-suited to renewable energy, with lots of cheap, flat land, good irradiance and a regulatory framework favorable to project development, whether oil and gas or renewables.

Figure 2. An oil pump operates in the Permian Basin oil field near Carlsbad, New Mexico.

Joe Raedle | Hulton Archive | Getty Images

Hydrogen. Hydrogen production through the electrolysis process has become both more technically advanced and less expensive than most of the alternatives. Bloomberg New Energy Finance esti-mates that the cost of hydrogen could drop as much as two-thirds by 2050. Using renewable energy rather than steam methane reforming (SMR) to power the electrolysis could offer refineries a way to utilize and re-purpose existing technology, equipment, and physical plants while at the same time reduce emissions. Further, the Oil industry has decades of experience with petrochemicals, the in-house expertise to support the development of hydrogen-related innovations and knows how to build energy production at scale. The industry’s existing pipeline infrastructure is adaptable to transport hydrogen.

Biofuels. The appeal of stacking the $1-per-gallon biodiesel tax credit on top of California’s Low Car-bon Fuel Standard credits, while reducing RIN exposure for those that have it, has encouraged a race for renewable diesel production capacity in the Oil industry that will likely transform America’s bio-mass-based-diesel industry over the next few years.

The federal tax credit is guaranteed only through 2022, but that’s enough for developers to continue transforming half a dozen U.S. oil refineries into renewable diesel plants, even as two existing renew-able diesel producers proceed with massive expansions. There are currently four operational renewa-ble diesel plants in the United States: the two expanding facilities, capable of producing 365 million gallons/year (mg/y) prior to upsizing; and two newly-commissioned plants that will produce another 190 mg/y.

That existing 553 mg/y of capacity will soon be eclipsed by six more renewable diesel plants under construction, plus the expansions. This first big wave of construction represents over 2 billion gallons of biobased-diesel capacity. What’s poised to come next could be even more extraordinary. At least five additional proposed renewable diesel facilities—including oil companies Marathon Petroleum and Phillips 66— represent another 3.3 billion gallons of potential capacity. Altogether, this is nearly 5.5 billion gallons of new or potential capacity, which is double the U.S. biodiesel industry’s current size.

Government support has created the low carbon fuel markets that are developing rapidly across the country. Not only are these markets proving to be profitable for oil refineries that have preexisting production infrastructures equipped to deliver qualifying fuels but also the currency of these gov-ernment markets – LCFS credits and RINs — are increasingly valuable assets and often provide the income stream that enables renewable project finance (albeit with the risk of regulatory change).

Carbon capture, utilization and storage (CCUS). This is a natural fit for the Oil industry and it’s where it can reduce its carbon footprint while at the same time qualifying for decarbonization credits and getting government support. CCUS has also offered a politically appealing opportunity to reach con-sensus on climate change: The energy industry and many Republicans who oppose other solutions

support carbon capture and storage, as do unions that represent people who work in the fossil fuel sector.

To accelerate CCUS development the U.S. offers incentives like the Blenders Tax Credit (BTC) and the 45Q tax credit that power plants and industries can take for either storing or using captured carbon.

The Oil Industry was one of the earliest adopters of CCUS technology, beginning in the 1970s. The industry originally developed and used many of the techniques integral to CCUS: separating CO2 from natural gas is required before it can be transported by pipelines, and separated CO2 is occa-sionally pumped back into geological formations to reduce the emissions intensity of operations or into reservoirs to enhance oil production.

Figure 3. Carbon Capture and Sequestration [California Air Resources Board website]

Offshore Metals and Minerals. The International Energy Agency calculates that an electric car needs six times the mineral content of one with an internal combustion engine. Manufacturing wind tur-bines, electric vehicles, solar panels, and batteries for energy storage requires resources, often scarce metals like cobalt, copper, lithium and nickel. The reality is that the clean-energy transition is not possible without taking billions of tons of metal from the planet – both onshore and offshore.

Offshore exploration gives the Oil Industry a clear advantage and the seafloor holds great riches. It has been estimated that the ocean seabed contains six times as much cobalt, three times as much nickel, and four times as much of the rare-earth metals as there is on land.

Geothermal. Producing geothermal energy involves deep-well drilling, just like oil and gas. But in-stead of producing hydrocarbons, geothermal wells release steam that is captured, funneled into pipes to spin turbines that generate electricity, then pumped back underground. The only emission is water vapor, while carbon-free electricity is generated around-the-clock.

Geothermal power plants currently account for a small portion of U.S. electricity generation, but a surge is underway. The U.S. Department of Energy projects that the share of electricity produced by geothermal plants could swell to 16%, rivaling the aging U.S. nuclear sector as well as all renewable energy sources combined.

Achieving that kind of growth could put drilling rigs and oil field service companies to work almost overnight and for the long-term, free of the boom-bust cycle dictated by the global oil market. It would also catalyze $200 billion in new investment, roughly the same amount of money invested by U.S. fracking companies over the last 10 years.

Oil companies have a long history of innovative drilling advancements and the experience they pos-sess could be a difference-maker in bringing deep dry rock geothermal systems to market.

Embracing change will push the oil industry to tap into the vast pool of knowledge, skills and indus-try expertise gained over more than 150 years.

Daniel Yergin, the Oil industry’s historian, the author of The Prize: The Epic Quest For Oil, Money & Power and now IHS Markit vice chairman, said it’s an important turning point for the fossil fuel sector, which has been anticipating big changes with President Biden’s climate-focused, clean energy poli-cies.

“The oil and gas industry is calibrating itself to what has become the new benchmark — net zero carbon by 2050. There’s a lot of variation in strategies and thinking about what the new map will be to get there,” said Yergin. “But the themes that jump out are hydrogen, carbon capture, innovation — and the need for large companies with engineering capabilities that can operate at scale — which is where the oil and gas industry happens to be”

The Oil Industry should play to its strengths and use its natural advantages to position itself to win energy’s green future. The best opportunities are a short stretch from the industry’s core competen-cies and will be critical for some key capital-intensive clean energy technologies to reach maturity. The resources and skills of the industry can play a central role in helping to tackle emissions from some of the hardest-to-abate sectors.

About the Author

Mike Newman is a consultant and Director at Parhelion Underwriting, a risk finance company insur-ing non-traditional risks impacting investment into clean energy, climate finance and environmental commodity markets. (www.parhelionunderwriting.com).

Mike can be contacted at [email protected] or by phone at +1 (323) 459-5346.