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Stranded assets: it’s time to stop forecasting and start scenario planning

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Oil and gas companies face an existential threat from the transition to a low-carbon economy consistent with the Paris Agreement and its goal of a 1.5°C/2°C limit to global warming. The recent work of the FSB Taskforce on Climate Related Financial Disclosures, with its focus on the need for scenarios-based assessments of risk and opportunity, brings the challenges faced by these companies into sharp relief. Their financial heft means they are simply too big to be allowed to fail. Yet there is no doubt the industry does need to adapt and change and that ‘do nothing’ is not an option.

Choices are not straightforward. Five plausible, though not necessarily credible, strategies for these companies to evolve to become 1.5/2°C-compatible have been identified in a new report from E3G. ‘First one out’, ‘Last one standing’ and ‘Planned transformation’ are all credible responses to serious loss of demand due to climate policies and technology change. ‘Drift’ and ‘Ostrich’ – as the names imply – are not. Planned transformation – both to renewable energy and to services tie up with national oil companies – are the only strategies that are representative of real diversification and carry with them the option of splitting the business.

For the privately owned international oil companies decisions must be taken in the face of significant uncertainties. To limit asset stranding risk, key questions need to be answered about over what timeframe, where and how should they respond to changing policy and market dynamics around the low carbon transition to maximise value to shareholders and to society. To say this is a contested space is a significant understatement. Some believe a lack of investment in oil development will restrict economic growth and generate disruptively high prices; others cite growing concerns about a global ‘oil glut’. Others still have concerns about whether investment outside the oil industry in renewables and demand reduction will accelerate stranding of oil and gas investments. The credibility of such scenarios will need to be considered as part of these companies’ responses to a post-FSB taskforce landscape in which growing number of investors are calling for oil and gas companies to align themselves with the low carbon transition embodied in the Paris Agreement. Answers are needed – and soon – if their concerns are to be addressed and shareholder value protected.

An additional layer of complexity the international oil and gas companies must navigate comes from the fact the strategies pursued by individual companies may be more or less beneficial in terms of shareholder value depending on what the national oil companies choose to do in a world adjusting to oil prices of around US $50/bbl. For example the Last one standing company may in reality be an national company (Saudi Aramco being the notable candidate), not an international oil company, by dint of having access to the lowest cost productive reserves. As such a key early conclusion is that the risks of each strategy need to be considered with a view on whether early or late energy transition is more likely – and against a backdrop of national oil company dynamics.

Ostrich is clearly not a credible option given the headwinds facing the industry. Chevron, the most ostrich-like of the internal oil and gas companies has recently posted its first loss in 37 years. Decisions on which of the alternative strategies they might pursue will need to be taken in as robust as fashion as possible. The energy outlooks used by the businesses need to be improved to better inform analysis and discussion of the energy transition choices. The recent World Energy Outlook published by BP for example has come under criticism for barely adapting its forecasts, despite the fact the Paris Agreement has now come into force. Sophisticated decision-support tools are likely to be important to support robust and timely decision-making.

Whatever strategy international oil and gas companies choose to adopt management teams will need to hold their nerve and be willing to adapt as events unfold – and have a strong story to tell both to investors and government.

This blog post first appeared in Environmental Finance

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