What should oil companies do about climate change?
26th February 2015
Imagine you are chief executive of a major oil company. Your economic forecasts tell you that the world remains stubbornly on a fossil fuel path for decades to come. The world is going to need you. But your forecasts also tell you that the result will be emissions that push up way beyond the level that your scientists tell you will limit global warming to two degrees. The world is on a path to burn all the oil you can find, and your oil will contribute to serious global warming. What do you do?
This is exactly the scenario painted in BP’s latest Energy Outlook 2035. It is not very different from Statoil’s outlook, or indeed that of almost all the independent oil majors.
What are your options? There are quite a few. First, you could try the “ostrich strategy”: denial, shored up by questioning the science. That would sow seeds of doubt, whether well founded or not. You might finance sceptical scientists. You might organise lobbyists, and try to match those of your opponents. It is what some oil companies did a decade ago, especially in America, and it is what some of the more authoritarian oil-rich governments continue to do. But it didn’t work and it’s pretty dumb as a strategy. Your investors would see through it pretty quickly. You might also offend your staff, and good people might not want to work for you.
Second, you might do the opposite, and say that this means you have to get out of oil, and jump on the renewables bandwagon. You might conclude that your company is doomed if it stays with polluting carbon-intensive resources and push hard for bio-fuels, and even start building wind farms. Or a bit of both to hedge your bets, as DONG has done – drilling for oil and erecting offshore wind turbines. This is the “revolutionary strategy”.
Lots of green NGOs are advising you to do this. They say you are doomed if you stick your head in the sands, and that a glorious cornucopia of profit opportunities stands in front of you, if only you repent of your sins. But you can quickly see the obstacles in front of you – both for your company and for the wider world. For your company, you would have to completely change the skill sets. Most of your staff are oil and gas people. It is hard enough to get them to move from conventional oil and gas to fracking. Why would they be any good at the sorts of innovation and deployment of largely small-scale technologies? Even with the most flexible of staff, you should ask yourself the following question: supposing you decided to build a renewables company from scratch, would you hire primarily from oil and gas company employees? Some years ago, BP tried to convince the world that it was in the business of “beyond petroleum”. It didn’t work; it sold its “alternative” business; and it quietly buried all the PR claptrap that went with it.
DONG may be able to straddle the divide, but then it is a state-owned and a relatively small company, with effectively two distinct parts, and the commonality is the offshore bit. Shell, BP, Exxon, Chevron and Statoil are rather different: they deliver complex large scale projects, harnessing the key skills of geology, seismic information technology, drilling, pipelines, refining and in some cases also retail transport fuels. What have any of these skills got to do with installing solar panels?
You might also take a look at what has happened to companies that have a closer tangency with renewables. Take traditional electricity utilities. At least they know about generating, transmitting, distributing and supplying electricity. But renewables have not been a particularly happy experience for most of them. Think of E.ON having to recognise that conventional nuclear and coal are not the same managerial challenges as renewables. The rationale its chief executive gives for splitting E.ON down the middle is that its management can’t ride both horses. Whilst part of the split in E.ON might be about writing off the huge losses that the energiewende has imposed upon it, its chief executive has surely taken the right decision. That indeed is the view that shareholders have already taken. By contrast, RWE has been left partly floundering in its lignite coal base, one of the dirtiest fuels, with obvious consequences to its tarnished corporate reputation.
Whilst miracles happen, and you might be a great leader of your company, it is hard to see the future renewables industry led by the current large oil companies. You should conclude the revolutionary strategy is unlikely to work, even if your shareholders give you the benefit of the doubt (which is unlikely).
This leaves you with a deep problem. Neither the ostrich strategy nor the revolutionary strategy is a practical runner. So you are stuck with what you are good at. But that does not get you off the climate change hook. A third option is probably very tempting: make a sharp distinction between what you do and what governments do, and say it is the job of governments to set the rules and for you to maximise profits within those rules. Weapons manufacturers do it all the time. Governments decide what weapons companies can manufacture and to whom they can sell them. Indeed, governments often go further and help the sales by lobbying foreign governments on their behalf. Governments know they need weapons to defend themselves – and in many cases – to invade their neighbours. The weapons manufacturers make money out of meeting their wishes – within their rules.
The analogy with guns and tanks is perhaps unsettling, but it has lots of lessons for you in thinking about what you should do about climate change. The fact is that economies are going to need energy, the fact is that no government in the world is really doing much about climate change, and it is hypocritical to blame you when the politicians do so little. You might note that China intends to carry on growing its deadly coal emissions until 2030, and India for longer. In Europe, whilst political leaders keep trotting out speeches about how they are tackling climate change, you know that it is mostly smoke and mirrors, and that carbon consumption has gone up a lot, even if de-industrialisation has made the Kyoto-measured carbon production paint a better story. You know all about Germany’s dirty secrets – its lignite, its move from nuclear and gas to coal. You may even have read my Carbon Crunch book, which explains how so much cost and political capital could have been deployed to so little effect.
Mindful too of your fiduciary duties to shareholders, you might argue that you are entitled to just keep on doing what you are good at, and do it within the letter of the law. You know anyway that others will take this path. Most oil is in the hands not of companies like yours, but state-owned giants. Governments own most of the oil reserves, and they licence it. Governments can decide not to develop their resource base.
Think of the irony – or perhaps one should say hypocrisy - of Alex Salmond telling the Scots of the importance of de-carbonisation and at the same time basing most of his economic case for Scottish independence on the money from keeping North Sea oil and gas going. Think of the SPD and the CDU in Germany happily presiding over its lignite production, and closing its low carbon nuclear thereby making room for more coal. Its not just Saudi Aramco, Gazprom and Rosneft that are hell bent on maintaining their fossil fuel production – it’s the British, Norwegian, and German governments too. Even the Irish would probably be delighted to find and develop lots of fossil fuel resources.
This “sticking-to-the-law strategy” has other superficial merits too. Once you and your peers start to view your role in terms of public rather than private interests, the eye tends to go off the management ball. You have seen others decide to mount the public stage and suggest that what they do is really all about “doing good” rather than making money. More seriously, you are not elected. It is not for you to decide the future of the world, or even its climate. Once companies start to blur this distinction they risk ending up with the sorts of behaviours all too familiar in the likes of Gazprom – following political pricing to support Putin’s interference in the behaviours of his chosen targets. And it works the other way around too. Think of Gerhard Schroders’ conduct in respect of Putin, the route of Nord Stream around the outside of the Baltic states and Poland at Putin’s request, and his chairing of the company immediately after stepping down as Germany’s Chancellor. You have no democratic credentials and no democratic right to decide policy. You have a right to be heard, but not to decide.
So why not just “stick-to-the-law”? You will immediately have seen the flaws. Modern corporations exist in a wider institutional context. The modern corporation is a legal entity with lots of responsibilities. You may have read my colleague Colin Mayer’s excellent book Firm Commitment. You can’t just stick your head in the sand, and in any case if you take the hard-nosed line, your shareholders may think it damages your reputation. And you know reputation counts. Next time you bid for a licence from some government, you will know that this may in the ministers’ minds – and will certainly be in the voters’ minds. And your shareholders know this too.
Besides you want your company to be proud of its reputation. Recent campaigns to disinvest have been taking their toll. You will recall South Africa and the boycotts. Barclays certainly does. The price-earnings ratios for a number of oil majors are disturbingly close to ten. When the world’s leading universities start to turn their backs on fossil fuel companies, that hurts your reputation. It might even inhibit your ability to recruit good staff in future.
What do you do? The answer is none of the above: the ostrich strategy is going to pummel your reputation and you risk your company becoming an international pariah. The revolution beloved of the greens won’t work either. Sticking to the law is better and though a number of oil companies have tested its limits, it is not much more than an obvious constraint. It too easily slips back into the ostrich strategy.
So though it will be messy, the answer is somewhere in between. You should focus on two things: doing what companies can within the fossil fuels, where their expertise lies; and advocating efficient ways forward for governments that want to meet their carbon targets.
The climate change problem is not going to get solved by going immediately straight to renewables. Closing down oil and gas production today would be revolutionary – and it would lead to widespread poverty, famine and revolution. Anyone serious about climate change has to recognise that a transition is needed, and that the first, cheapest and largest contribution must be to get out of coal fast. If the Chinese and Indians do what they say they are going to do, then there will be over 1000 GWs of extra coal-fired electricity generation by 2030, and the climate cannot stand this. A transitionary strategy of coal-to-gas is affordable, do-able, and would halve the emissions that would have come from the coal. It would buy some “breathing space” to get on with solutions that really might work – like next generation renewables.
Oil and gas companies have a key role to play here. This is where you could contribute to reducing the growth of emissions in the short term. Better still, you have the skill set to do it. Oil companies tend to be good at gas too, but coal companies are not necessarily any good at gas. Mining coal and handling and transporting it are mining company skills – closer to mining iron ore and copper than they are to drilling for oil and gas. You could contribute to an all-out assault on coal businesses, continue to focus on profits, and make a difference.
You will of course know why this is not happening. It is because there is no carbon price that closes the gap between cheap coal and gas in the electricity markets. So you could campaign for an efficient – and as far as possible global – carbon price. Many of your peers think they are doing just that. But in Europe this often defaults to promoting the EUETS. Sadly, as I explain in the Carbon Crunch, the EUETS has produced a short term, low and volatile price. Worse still, its very idea – fixing the quantity and allowing the price to be determined in the market – is now being undermined by the European Commission’s policy of ex post interventions to doctor the market. You know all about politicians who intervene but promise not to do it again. You know too much about the political opportunism and interference in oil taxation to be taken in by this wheeze.
If then you are minded to recommend a carbon price, a carbon tax is the only credible strategy. As the Carbon Crunch explains, it may start low, but it needs to rise stably through time. It must be big enough to undermine coal. It can start in Europe and get to grips with Germany’s lignite (the second largest producer in the world). It should be adjusted at the border, a tricky but necessary exercise if it is not to undermine international competition. Given the German obstacle, a limited approach might be to have a floor price to the EUETS and let that floor gradually take up the strain. So much financial and political capital has been wasted on the EUETS already that it is unlikely that it will go away anytime soon.
There is one more thing you can do. Your company probably has great scientists and great R&D and innovation capabilities. It was the oil companies that have managed to invent offshore drilling and fracking. These skills have a wider application. Oil companies know about hydrocarbons and they know about petro-chemicals. There are lots of ways in which the new material sciences will in any event bear upon your business. Graphene, nano-technologies, 3D printing are all things your team should know about. New materials, new solar film and new biofuel technologies should be on your radar. They need to be, for if there are sufficient scientific breakthroughs to crack the climate change problem, your oil and gas reserves will not be so necessary for the world’s economy. Current technologies either cannot or will not crack the problem. But new ones might, Cars might be electric, and electricity might be solar. This will leave conventional oil companies stranded. You might not be installing and applying solar film to buildings, but there is no reason why you might not be doing the chemical engineering and manufacturing. It will be beyond your term of office, but at least the seeds of the future of your company can be sown. This could be evolutionary, rather than revolutionary, growing out of the things your company knows about, rather than leaping to things it does not.
Then there is CCS. If as your economists tell you the fossil fuels are here to stay for a long time, the carbon is going to have to be stored. This is very much your territory. Oil and gas companies know about wells, about storing gas, about pipelines, and about the chemistry. Whilst governments have dragged their feet on finding the money for CCS, it is not impossible for the industry to pool its talents and resources and drive a very serious programme to develop the technology. You know that waiting for governments to give you the money is not going to work: it is for companies like yours to take the initiative, get on with it, and do some serious demonstration projects.
This is what you can and should do – attack coal with gas, make the case for a serious carbon tax, get on with R&D, and do the CCS. These are the responsible things to do, and they are things you can credibly tell your shareholders, your staff and your customers about.
There will of course be implications. If the science progresses, and if the next generation of renewables come, then the oil and gas age will gradually come to a close because there are other better and cheaper ways of getting the energy we need. The faster the new technology comes, and the higher the carbon price, the lower the oil and gas demand relative to your economists’ forecasts will be. We will probably end up leaving some of the oil and gas (and hopefully most of the coal) in the ground. Demand may indeed soon peak, and oil prices may stay low and eventually fall further over the next couple of decades. You may be in what is ultimately a declining market.
But contrary to what many green NGOs think, your world will not end anytime soon, and as the companies are demonstrating the industry is already coping and adapting to a sudden halving of the oil price. Adapting is what the oil and gas industry is historically good at. Anticipating is more challenging, but unless you want to question the science, adapting is what you will be forced to do anyway. When your grandchildren ask you what you did about climate change, you will need a good answer.