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Carbon Tracker Initiative publishes independent 2˚C stress test study of oil and gas majors



A new study has been released today by the Carbon Tracker Initiative. Sense & Sensitivity: Maximising Value with a 2˚C portfolio, combines low-carbon demand scenarios with oil price and discount rate sensitivity to quantify how reducing exposure to high-cost, high-carbon projects can increase the value of their upstream interests. This analysis is believed to be the first independent 2˚C stress test published of upstream spending on new oil and gas projects.

The study shows that the upstream assets of the world’s seven largest privately owned listed oil and gas companies – ExxonMobil, Shell, BP, Chevron, ConocoPhillips, Eni and Total – could collectively be worth $100 billion more if they aligned their investment plans with the 2˚C target.

The Carbon Tracker Initiative study finds that pursuing a business as a usual growth model will only make more financial sense than a smaller, lower cost 2˚C project portfolio, if oil prices exceed $120 per barrel for a significant period of time.

The report also warns that projects that rely on high oil prices are more risky, and once a ‘fossil fuel risk premium’ is added, prices would need to reach unprecedented levels of $180 per barrel – more than double the Organisation of the Petroleum Exporting Countries’ (OPEC) long-term average assumption of $80 a barrel – for the BAU case to be more attractive.

Shareholders have filed resolutions asking for ExxonMobil, Chevron and other US energy companies to undertake stress tests to ensure they maximise value and don’t just pursue a BAU strategy in the face of stronger regulation and weakening fossil fuel demand as economies transition.

The boards of Royal Dutch Shell and BP decided to support similar resolutions last year that were carried by strong shareholder majorities. The international Financial Stability Board has set up a task force on climate that has just consulted on how this kind of sensitivity analysis could reduce climate risk.

James Leaton, Research Director at Carbon Tracker, said: “A simple carbon sensitivity analysis shows that oil majors pursuing volume at all costs can deliver lower shareholder value than a more disciplined approach. That is why financial regulators need to make 2˚C stress tests standard practice for the energy sector to help avoid companies wasting capital.”

The carbon sensitivity analysis compares the BAU value of the oil majors’ combined upstream portfolio with the value of a portfolio of only those lower projects needed to satisfy demand in a 2˚C world.

Mark Fulton, Adviser to Carbon Tracker and Co-author of the report, said: “In a 2˚C world, the major oil and gas companies will need to manage declining demand for oil. However, this can still prove to be a value-add proposition if they simply avoid developing high-cost, high-carbon projects.”

The research introduces the concept of a Fossil Fuel Risk Premium (FFRP) for companies that assume high future demand will deliver ever higher oil prices, because they run the risk of sanctioning “higher risk, lower return” projects.

Typically those riskier carbon-intensive projects are Canadian oil sands, extra heavy oil typically found in Venezuela and some deep-water projects.

This risk premium represents the greater risk associated with pursuing high-cost growth projects, compared to a lower cost portfolio that would satisfy 2˚C demand. The resulting higher discount rate only strengthens the case that a 2°C portfolio can be worth more to investors today, unless future oil prices rise to very high levels on a sustained basis.

Paul Spedding, former Global Head of Oil and Gas Research at HSBC and Adviser to Carbon Tracker, said: “Oil majors have had phases of prioritising value over volume in the past, but that has to become permanent, as the risk premium for pursuing high-cost projects is increasing.”

OPEC’s outlook averages around $80 a barrel to as far off as 2040, while the International Energy Agency’s (IEA) 450 scenario has oil prices averaging less than $100 a barrel to 2040 – well below the levels needed to justify a BAU strategy.

Shareholder resolutions have been asking for stress tests against the IEA scenarios. This analysis shows that a 2°C path can be good news for investors if company management make the right decisions.

Andrew Grant, Financial Analyst at Carbon Tracker, said: “Prudent capital expenditure can have a positive outcome for shareholder value – executives can deliver the best results for investors by running their companies as if preparing for a lower demand world, whether they personally believe it likely or not.”

The report argues that it is wise for oil majors to make conservative assumptions about future demand, noting that that a small amount of oversupply – roughly two per cent – led to the current era of price volatility and $380 billion of capital expenditure cancelled or deferred by the industry between late 2014 and the end of 2015. A significant portion of this is known to have been high-cost production.