International oil majors must solve riddle of net-zero and net profits

The world's largest oil and natural gas companies face an existential crisis. As pressure from climate and investor activism escalates, legal challenges arise and investment patterns transform, they must square the circle of profits and emissions pledges. The shift from rebranding their identities to reassessing their business models is fraught with challenges for the oil and energy outlook.

The industry last month felt the force of climate activism in two areas where it hurts most: in the boardroom and in the courtroom. Chevron's shareholders voted May 26 to approve new reduction targets, while ExxonMobil's shareholders approved directors aimed at forcing the company to take more aggressive steps to combat climate change.

A district court in the Netherlands, also on May 26, ordered Shell to accelerate emissions reductions and cuts its carbon footprint by 45% globally by 2030, in a case brought by climate activists. Shell has vowed to appeal, but this shows the growing risk of climate litigation on energy companies and governments, especially ahead of this year's COP26 UN climate change summit.

S&P Global Platts Analytics said these events have tilted the power structure in the investment class toward greater activism and power, forcing these companies to reassess their long-term future.

"The recent pressures from the boardroom and courtroom on international oil companies and other fossil fuel producers will likely only intensify, raising the difficulty to satisfy shareholder demands for both profits and emissions reductions," Platts Analytics said. "Fossil fuel producers will be increasingly forced to balance maximizing shareholders' financial returns with pressures to decarbonize."

S&P Global Ratings added in a recent note that "the events raise the specter that oil and gas companies could possibly be held legally responsible for their role in climate change while executives who choose to ignore climate change or don't act quick enough, could stand to lose their positions."

Carole Nakhle, head of consultancy Crystol Energy, warns the Shell case "is a minefield and can backfire by simply delaying the transition."

Analysts also said the events signal international oil companies will face greater scrutiny from public stakeholder, potentially forcing oil majors to reconsider where to allocate and deploy existing and future resources. Several large European majors have already made strategic decisions to change business models to become more of an energy company rather than just oil and gas, with BP, TotalEnergies, Shell, Repsol and Eni all talking up their green credentials and vowing to reduce their carbon footprint.

Energy Sums

But while the pressure on IOCs to decarbonize will intensify, so far the sums don't quite stack up.

According to the International Energy Agency this week, the share of total capital investment by the oil and gas industry into clean energy, could rise to more than 4% in 2021, up from 1% in 2020. "Still a long way to go!" said Nakhle, who added "if companies delivered better returns, probably we wouldn't have seen the recent developments with Exxon for instance."

The IEA, which last month published an ambitious roadmap for the world's energy to become net-zero by 2050, said the $750 billion expected to be spent on clean energy tech and efficiency in 2021 remained "far below" what is needed to meet Paris Climate targets on global warming.

After slumping by 24% last year, Platts Analytics expects global upstream investment to recover by 8% in 2021, driven by higher oil prices and lower project breakevens due to ongoing efficiency efforts.

The correlation between oil price and investment is a close one, but analysts believe this link could well break given the push and pull to renewables and cleaner energy and raising questions about how growing demand for energy will be met.

BP, Total, ConocoPhillips, ExxonMobil, Chevron and Shell, considered the top six IOCs, produce around 13 million b/d of oil out of an approximately 100 million b/d liquids market, according to Platts Analytics, but their reach in terms of technical expertise and financial muscle goes much further and would be an even bigger blow to the sector. So while many analysts point to the fact that the Middle East and Russia would pick up some of the slack, the risk is a gaping hole that still may need to be filled.

Demand response

All this however will hinge on how global oil demand reacts to the accelerating pace of energy transition.

Platts Analytics expects that global oil demand will rebound from the pandemic-induced lows of 2020 into 2023, but will continue to grow structurally, albeit slowly, through until 2040 in its "most likely case" scenario.

Besides exiting from oil and gas, the IOCs will look to cut their carbon footprint by employing many strategies, such as reducing flaring, shifting to less carbon intensive production, creating more low carbons fuels, investing in carbon offsets, adding carbon capture, among other avenues.

For oil majors caught between climate goals and shareholder returns, the decision has been to appease both and neither. But until the demand side becomes clear, this awkward middle ground may last a little while longer.