Oil is one of the world’s major energy sources. Yet, the demand for oil is falling, not only as a result of the pandemic, but more importantly, as a result of the move by countries to focus on zero-carbon energy sources.
Why it matters: The majority of the global transportation system, about 60 %, is powered by oil. Due to less travel and tourism, this past year’s decline in oil consumption destabilized the industry, causing many US producers to go bankrupt and producers around the world to rethink their production plans. There is also the possibility that we have hit “peak oil” as we now have a surplus, and due to technological advancements, we are able to extract more oil than first thought. All of these factors are contributing to oil giants, BP and Shell, reshaping their business strategies to adapt to a world with reduced oil demand. With 19 countries and the EU targeting 2030 to 2050 to have net-zero emissions, the world will need to transition away from oil and other fossil fuels while they are abundant and inexpensive.
In addition, if technologies and pollution rules improve, the drop-off in oil demand will be even more swift.
By the numbers: In early 2020, oil demand was falling due to the US/ China trade war, and prices were dropping as a result of over-production. To make matters worse, a standoff between Saudi Arabia and Russia sent prices lower and by March the demand for oil fell dramatically. The International Energy Agency (IEA) has said that it expects that the 2020 fall in oil demand could be the largest in history.
- Global oil demand fell by as much as 30 million barrels per day at the onset of COVID.
- As of September 2020, oil prices have fallen by 40%
- Exxon suffered its largest loss ever between April and June of $1.1 billion, with a total deficit of $48 billion through next year. In addition, after 92 years on Dow Jones Industrial Average Index, Exxon Mobil was dropped in August of 2020.
- For the first 5 months of 2021, there will be a surplus of 200 million barrels.
Between the lines: Big oil companies are losing their appeal to investors who are questioning their financial viability, environmental performance, and the role they play in climate change.
- Many investors are using the Environmental, Social and Corporate Governance (ESG) criteria to evaluate businesses or companies they may want to invest in.
- According to Reuters, over 50 banks and other financial institutions launched the Partnership for Carbon Accounting Financials (PCAF), an industry-wide effort to standardize how companies measure their investments’ carbon footprints.
- Powerful investors are limiting their exposure or forgoing high-carbon investments.
What’s Happening: Most major oil companies are focusing on transforming their business model to survive and thrive in the future of net-zero emissions.
- By 2030, BP has plans to increase investment tenfold in the next decade to $5 billion a-year in green businesses while simultaneously cutting oil and gas production by 40%.
- Shell and Eneco have teamed up to develop an offshore wind farm in the Netherlands, which will include floating solar technology, “green hydrogen” generated by electrolysis, and “short-term battery storage.”
- Oswald Clint forecasts that the large oil companies would expand their renewable-energy businesses (wind, solar and hydrogen) by 25% or more each year over the next decade.
The Impact: Due to shareholder activism and political pressure big oil companies will need to realign their business strategies to include reducing fossil fuel emissions or run the risk of getting regulated out of business.
- There is the challenge of reducing a high-margin business for a lower one, while still generating cash to fund the transition.
- Where there were once policies in place to support oil production, there has been a shift in policies that are disincentivizing fossil fuels, including carbon pricing.
- Oil companies will face heavy competition in areas where other companies have more experience. To succeed, they will need to adapt as fast as their surroundings and not only support low carbon energy efforts but lead them.
External Obstacles: There are 4 major factors that oil companies are faced with when looking to expand into the business of renewable energy. These factors: regulatory, economic, social, and technological affect the outcomes of penetration and deployment of renewable energy.
- For renewable energy initiatives to attract a higher level of investment, government policies need to align at the national and state level. It will be more difficult to penetrate those markets/countries that have complicated procedures.
- Because fossil fuels are cheap and abundant, they are hard to give up. There is also a high capital cost required for renewable energy projects along with a high pay-back period. And even though findings indicate that renewables offered higher total returns over fossil fuels over the past decade, oil companies are still evaluating financial performance, as well as the level of risk.
- Oftentimes large-scale renewable energy plants require vast areas of countryside and face public opposition due to landscape impact, environmental degradation, lack of community consultation, and not understanding the financial and environmental benefits.
- To achieve large scale commercialization of renewable energy, oil companies will need to compensate for limited availability of infrastructures, unavailability of standards as they relate to technological performance and energy storage to balance supply and demand.
Internal Obstacles: Shareholder pressure is mounting for the big oil companies to transition from a global economy that depends on fossil fuels for 80% of its energy to a renewable energy company. The biggest obstacle for the transition will require a workforce that is skilled in the various disciplines of design, build, operation, and maintenance of a renewable energy plant.
The Course Correction: Many of the big oil companies are taking steps to shift their business into renewable energy sources. As non-fossil fuels comprise a larger portion of the energy mix, oil companies are looking for a competitive position as an energy provider that will allow them to become more sustainable over time.
The Bottom Line: “What the world wants from energy is changing, and so we need to change, quite frankly, what we offer the world.” Bernard Looney, a 29-year BP veteran.
