Dan Gardiner
Head of Transition Research
Soaring renewable spending and the first explicit mention of fossil fuels in the COP28 text signpost challenges ahead for the oil and gas industry. Yet at a national level, policy signals remain inconsistent. Ahead of this year’s proxy season, we consider the issues at hand for investors and the resources available to help them navigate these conflicting trends.
The oil and gas industry typically represents the largest and most concentrated source of transition risk for investors, and the closing months of 2023 provided several important signals for the sector. We saw the first mention of fossil fuels in the final text from COP28, with world leaders also pledging to triple renewables capacity and double energy efficiency by 2030, consistent with two of the International Energy Agency’s (IEA) ‘five key asks for COP28’.
Market signals add to this momentum. Clean energy investment is now outpacing fossil fuel spending at a ratio of 1.7 to 1; renewable capacity additions grew nearly 50% in 2023; and electric vehicle sales rose over 30% despite a slowdown in some markets. The IEA suggests global energy-related greenhouse gas emissions could peak as early as 2025.
Yet in contrast, the UK government granted new North Sea exploration licenses and scaled back climate ambition in the key demand sectors of buildings and transport. Even as more European countries committed to a net zero power sector by 2035, Brussels rolled back on its agricultural climate ambitions in response to rising political pressure. Outside Europe, Brazil assumes the role of G20 President and will host COP30 as it continues to invest in fossil fuels.
These mixed policy signals are likely to continue, particularly in ‘the year of elections’, adding to the complexity that investors navigating the transition to net zero face.
“Let go of the illusion”
In late 2023, the IEA released a special report on the role that all oil and gas companies, state-owned and listed, could play in the transition and the opportunities for them in a low-carbon world. The urgency of the issue is made clear – the IEA forecasts a 45% drop in demand for oil and gas by 2050 under the ‘announced pledges’ scenario, which becomes 75% if energy policies are strengthened to align with 1.5°C.
The report firmly dismisses the notion that the industry can rely on carbon capture utilisation and storage (CCUS) technologies to maintain production. Doing so under a 1.5°C scenario would require the capturing of 32 billion tonnes of carbon by 2050, an almost 1,000-factor increase in investment annually, and using more electricity than current global demand.
“The industry needs to commit to genuinely helping the world meet its energy needs and climate goals,” said Fatih Birol, the IEA’s Executive Director: “Which means letting go of the illusion that implausibly large amounts of carbon capture are the solution.”
Important and profitable
The IEA report includes a four-part framework to evaluate the alignment of oil and gas companies’ strategic response to this challenge, with the first element focused on cutting operational scope 1 and 2 emissions. These emissions must decline by 60% by 2030 for an oil and gas company to be considered aligned with the ‘net zero by 2050’ (NZE) scenario, according to IEA estimates.
Methane is the "single most important measure that contributes to the overall fall in emissions from oil and gas operations." (IEA)
Action on methane is vital to any success here. The IEA describes methane reduction as the “single most important measure that contributes to the overall fall in emissions from oil and gas operations”, highlighting that many of the actions required would also be profitable for companies. Industry action is accelerating in response - COP28 saw 50 oil and gas producers, accounting for 40% of global oil production, commit to limiting upstream methane emissions to near zero as part of a pledge to reach net zero operational emissions by 2050.
However, methane disclosure remains notoriously unreliable, making tracking progress difficult. We recently published a detailed member consultation paper specifically to provide further support for investor engagement on this topic.
Other components of the IEA’s framework include whether a company has committed to stop investing in long lead time conventional oil and gas production and, for companies looking to diversify, the share of investment in renewables rising to 50% by 2030. These are supplemented by qualitative assessments of disclosure, use of offsets and disposals.
Overall, the IEA framework represents a very valuable tool to assess oil and gas companies, with all topics covered in our Net Zero Standard for Oil and Gas.
Scope 3 debate
One area of debate mentioned by the IEA is scope 3 emissions, which comes as media suggests that the US SEC is likely to drop requirements to disclose scope 3 from its climate disclosure rules. The IEA acknowledges that scope 3 can be useful to assess the transition strategies of oil and gas companies but does not include it within its framework, citing concerns about double counting, responsibility for reductions, and the risk of distracting the focus on operations.
Simply put, overlooking scope 3 in oil and gas is not an option for most investors.
While not without merit, in our view these concerns are substantially outweighed by the importance of scope 3 in helping investors to identify transition risk within their portfolios.
Scope 3 accounts for 80 to 95% of emissions in the oil and gas value chain – any company that achieves operational net zero still faces substantial transition risk. Its reporting and use in sectors such as automotive and mining is already widely accepted. Data does need to improve, which our scope 3 discussion paper sets out in more detail but, simply put, overlooking scope 3 in oil and gas is not an option for most investors.
A recent court decision in Norway serves as a specific example. Legal action prompted by Greenpeace and Friends of the Earth overturned approval for three oil fields after the case concluded that the emissions from the consumption of oil and gas extracted – scope 3 - had not been specifically addressed in the field assessment process.
Oil and gas companies represent a significant source of transition risk for most investors, who will therefore continue to assess that risk in the context of their individual net zero commitments - taking into account these complex, contradictory market and policy signals. There are now a growing number of resources to help.
If you’d like to take part in our working groups and help to shape the outputs of our resources, why not speak to our investor relations manager today to find out more about becoming a part of IIGCC?