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Fuel for Thought: IEA’s path to net-zero keeps Big Oil guessing over pace of green pivot

Highlights

Oil supplies would slump after immediate drilling halt

Risk of backlash seen over pace of energy transition

CCS, carbon prices key to future role for oil

The International Energy Agency issued a stark warning to the global oil industry last month that the time for new oil and gas projects has passed.

If the world wants to achieve net-zero emissions by 2050, all new upstream developments are effectively surplus to requirements, and the only spending needed is to keep oil and gas flowing from existing fields, the IEA said in its Net Zero 2050 (NZE2050) report.

Coming from the body created in response to the 1973 oil crisis, it's difficult to overstate the report's significance for decarbonizing energy supplies.

In a stroke, the world's most influential energy watchdog has undercut the rationale for finding any more oil and gas globally. Not in five or 10 years' time, but from today.

More radical than its Sustainable Development Scenario needed to meet Paris climate goals, the IEA's NZE2050 brings forward the deadline for achieving net-zero emissions by two decades. For oil, the net-zero pathway would see demand collapse by 76% to 2050, with annual average declines of more than 4%.

Saudi Arabia's energy minister likened the roadmap to the romantic comedy blockbuster "La La Land," while green campaigners have jumped on the report to highlight oil's role in the climate emergency.

Achievability aside, the scenario has already emboldened calls for more bans on exploration, the scrapping of licensing rounds, and hard cutoffs for producing fields. That's a major blow to oil and gas hopes in Africa and other upstream hot spots such as Suriname, Guyana, Mexico, Brazil, and Australia.

With deepwater projects subject to long lead times to production, the IEA's warning casts further doubt over their payback in a more carbon-constrained world.

Shorter-cycle shale drilling could survive longer if players can secure financing for fracking and lower emissions. But with oil prices seen sliding to $25/b by 2050, the NWE2050 report provides little hope for a long tail to shale developments either.

"As international players retreat from exploration, so their funnel of new projects gradually narrows, and they move towards a model where they rely on their best performing existing assets to fund any new supply investments," the IEA said in a June 2 report on energy investment.

Transition backlash

The NZE2020 model will ratchet up pressure on integrated oil majors to decarbonize faster and drive more investment dollars into renewable energy. While the IEA's bill for a faster energy decarbonization will double to $5 trillion a year, upstream spending will shrink more than threefold in the coming decades.

European integrated oil majors such as BP and Shell have already started shedding upstream assets under their pivot to lower-carbon, renewable energy. ExxonMobil's recent loss of board seats to activist hedge funds suggests US Big Oil could soon start moving in the same direction.

But as Western energy majors accelerate upstream divestments, it's unclear how much of their oil and gas resources will simply be transferred to smaller, private companies and state-run national oil champions less exposed to climate scrutiny. An unintended consequence of this process will be more oil resources being operated by companies "almost certainly dirtier" than the original IOCs owners, according to Christof Ruhl, BP's former chief economist.

"This is a warning sign, if it proceeds, that will lead to a concentration of oil investments away from IOCs and shale to the OPEC and NOC countries which do not face these kinds of restrictions," Ruhl recently told Gulf Intelligence.

State oil giants such as ADNOC, Saudi Aramco and China's CNOOC and PetroChina have already announced either higher capital budgets or upstream expansion plans since the start of the pandemic.

With the Middle East's OPEC producers also dominating the world's supplies of low-cost, low-carbon crude, a more powerful producer cartel also could spell higher future prices, he said.

Ruhl, currently the senior research scholar for global energy policy at Columbia University, also sees the potential for investors to start shunning green energy players if they are concerned over earnings from lower-margin green power investments.

"Expect some kind of backlash against this energy transition because investors will not stupidly run into ESG funds if they see there is trouble on the horizon ... that we don't have enough oil," he said.

Carbon capture

But with the total production from the six top IOCs at around 13 million b/d, or about 13% of pre-pandemic global production, the risk of any sudden collapse in global supplies is unlikely, according to S&P Global Platts Analytics. Indeed, even if the production from the world's biggest IOCs were to go to zero, oil supplies would still need to contract by another 28 million b/d by 2050 under Platts Analytics' scenario to meet a less-ambitious 2-degree global warming target.

The trajectory of oil supplies in a net-zero world will also depend heavily on carbon prices from either carbon taxes or emissions trading schemes.

Many oil companies are banking on large-scale, commercial carbon capture and storage (CCS) plants to keep their cleanest barrels flowing while hitting net-zero targets. With Western energy majors at the forefront of commercial-scale CCS, higher carbon prices and lower abatement costs may be key to their future supply role.

Bank of America estimates the carbon cost of keeping all fossil fuels below ground at around $200/mt, well above the implied carbon costs reflected in IOCs' share prices.

Energy transition at the speed and scale of NZE2030 may be more than just a tough challenge. Russia's energy minister has warned of skyrocketing future oil prices due to an impending supply crunch as producers ditch fossil fuels.

Oil industry reservations over the path to net-zero don't bode well for its achievability. As the IEA notes, any delays to slashing emissions today effectively kicks net-zero by 2050 out of reach.

Platts Atlas of Energy Transition