- A Funny Thing Happened In Europe On The Way To Net Zero
- Are You Confused By The Language Of Carbon And Climate?
- Turmoil In The Oil Patch Continues; Any Resolution In Sight?
- Renewables In U.K. Show Inability To Power The Grid
Musings From the Oil Patch
December 15, 2020
Allen Brooks
Managing Director
Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
A Funny Thing Happened In Europe On The Way To Net Zero (Top)
Our title borrows from the Broadway musical, which later was made into a movie, “A Funny Thing Happened On The Way To The Forum.” The story of the play and movie was inspired by the farces of the ancient Roman playwright Plautus (251–183 BC). It tells the bawdy story of a slave named Pseudolus and his attempts to win his freedom by helping his young master woo the girl next door. The European climate change movement has been engaging in similar farces when they suggest that restructuring the continent’s economies and societies can be done with little cost and even less disruption. Of course, part of this push necessitates that the oil and gas companies headquartered in Europe shift away from their core business and embrace renewable energy. Surely no one will suffer from that move – right?
On the way to net zero – both for the European Union (EU) countries and its oil and gas companies – inconvenient truths emerged. For the EU, it was that not all countries were willing to tear apart their economies, throwing millions of workers out of jobs, and raise taxes to fund questionable clean energy investments. Two of the EU’s 27 members, Hungary and Poland, who are poorer countries in the organization and depend on fossil fuels not only to power their economies, but also for jobs, people’s incomes, and government taxes, are opposed to increasing the emissions reduction target.
The EU was scheduled to vote late last week on its new 7-year budget, €1.8 ($2.1) trillion, and its €750 ($875) billion pandemic recovery plan, as well as an increase in the emissions reduction target to 55% from 1990 levels compared to the current 40% target by 2030. There is another internal EU battle involving these two countries, which is over the EU’s “rule of law standard.” Hungary and Poland have conservative governments that have taken actions that appear to restrict the freedoms of its courts. The countries cite recent court rulings against the governments as proof this is not an issue. A compromise was negotiated that gained approval of the budget and recovery plan, in return for governments being allowed to challenge the rule of law standard that likely delays its implementation for months or even years.
On the climate front, Reuters reported a softening by the EU about its emissions reduction target. The EU would seek its member countries to endorse the “at least 55%” target. It would ask the European Commission (who administers the EU) to make cash available to help poorer countries to invest in clean energy. Rather than allow countries to “choose the most appropriate technologies” to cut emissions, the EU’s target is to become a collective goal, and not a mandate for each country. These changes will help coal-heavy countries such as Bulgaria, Czechia, Romania, Slovakia, and Poland to deal with the emissions reduction target.
What we are seeing play out in the EU (forget about the Brexit negotiations) is the clash between idealism and reality. The economic cost and social disruption facing countries as they strive to reduce their carbon emissions is often much greater than they can bear. Poorer countries are particularly at risk of needing more help and more time, something the “climate emergency” mindset doesn’t allow. Just as France and Chile have seen riots over small increases in fuel taxes or mass transit fares to battle climate change, we should be prepared for more pushback as the targets force greater changes. This is not only true for countries, but for companies as well.
Moving energy companies from their traditional business focus is a case in point. The first major clash over green energy strategy emerged last week at transnational oil and gas company – Royal Dutch Shell. The media is reporting that the company lost its top four clean energy executives due to internal differences over the pace of the company’s green energy shift.
The departures come less than 60 days before the company’s management is due to spell out how it plans to transition from an oil-and-gas-focused company to one championing green energy. Not only must management show the specific steps they plan to undertake, but also demonstrate the cost. This latter point may be the greatest stumbling block to a rapid transition, which we perceive from the media coverage of the executive departures to be at the heart of the dispute.
According to the Financial Times, “Marc van Gerven, who headed the solar, storage and on-shore wind businesses at Shell, Eric Bradley, who worked in Shell’s distributed energy division, and Katherine Dixon, a leader in its energy transition strategy team, have all left the company in recent weeks.” Reportedly, “Dorine Bosman, Shell’s vice-president for offshore wind, is also due to leave the company.” The newspaper also says that other clean energy top executives plan to depart in the coming months.
The challenge seems to be that these executives see the potential for clean energy, but don’t find that the mindset exists among senior executives for a radical restructuring of Shell. Ben van Beurden, Shell’s chief executive officer, has said investment into lower-carbon businesses such as biofuels and solar power “needs to accelerate,” but he has also said that oil will continue to be a huge cash generator and the company will expand its natural gas division. His statement at a recent financial conference probably rankled the clean energy executives. He reportedly told the audience, “There is going to be a place for our upstream [oil and gas] business for many decades to come.”
The Financial Times article contained quotes from anonymous executives about the internal upheaval. “I don’t know how we are going to transition without wholesale change at Shell.” “We don’t have the culture or that level of flexibility to do it.” “I wouldn’t be surprised if we see more high-profile departures.” These quotes suggest a much more deeply divided management team, raising questions about how rapidly Shell can move forward transitioning.
The article offered the following commentary. “Some top executives at Shell are concerned about investing larger sums into greener businesses that are not as lucrative as traditional fossil-fuel divisions. They also believe that the company has already moved aggressively and only needs to communicate better.” The latter point is an opinion open to interpretation. The former point about investment returns echoes comments made earlier this year by Bernard Looney, CEO of BP plc, when he was introducing the new clean-energy strategy for his company. He specifically warned pensioners, presumably loyal retired BP employees, who own BP shares for its dividend payments that green energy businesses have financial returns that are roughly half those of oil and gas, thus it will be a challenge for management to raise returns as it invests in these new businesses. The message to investors, in other words, is don’t expect dividend payments to grow (this was before the cuts due to the impact of Covid-19 on the business).
Finally, as we reach the five-year anniversary of the Paris Agreement, a study by Climate Action Tracker, an organization monitoring the progress of 32 countries that signed onto the Paris Agreement as they establish and work toward the Agreement’s goals, shows disappointing progress. The current levels of emissions would result in a temperature increase of between 2.4° and 4.3° Celsius (4.3° to 7.7° Fahrenheit), with the most likely outcome about 3.2°C (5.8°F) by 2100 without any intervention — more than double the actual goals for global warming limits set forth by the Paris Agreement. Not a good anniversary present.
Only two African countries – Morocco and Gambia – have efforts that would be sufficient to keep global temperature increases under 1.5°C. Maybe these countries have succeeded because they don’t have nearly the infrastructure of a developed industrial nation, thus minimizing the effort needed to curb carbon emissions. Morocco is building the largest concentrated solar power plant in the world, while also weening itself off fossil fuels. The country projects getting 42% of its energy from renewables this year. Gambia, meanwhile, has established a plan to limit its emissions, as it develops a reforestation project to combat soil erosion.
A handful of countries are on a pace to limit global warming to 2°C. None of them – Bhutan, Costa Rica, Ethiopia, and the Philippines – are major polluters. There is optimism about the success of India in reducing its emissions, which would be significant, as the country is the world’s biggest polluter. But much remains to be seen about India’s success going forward in curbing emissions.
Maybe the lack of progress by the signatories to the Paris Agreement is due to countries awaiting the U.S. jumping back on board and beginning to fund its share of the $100 billion a year in transfer payments to poorer countries committed by developed countries. The problem is that none of the developed countries that pledged the financial support has made a payment.
The 11th annual Emissions Gap Report from the United Nations Environment Program offered good and bad news. Although from 2010 to 2019, greenhouse gas emissions grew by an average of 1.4% a year. The wildfires in 2019 caused emissions to increase at a faster pace. Despite a 7% reduction in emissions this year, the report found it will have a “negligible” impact on the global warming trend. The report is optimistic that many large polluters are seemingly getting on board with net zero emissions goals.
The polluting rich countries need to reduce their carbon footprints by a factor of 30 to avoid the worst of the climate forecasts. The report says it can be done, but it means reducing food waste, making buildings more energy efficient, and taking public transit rather than cars, and trains instead of planes. Will these large polluters walk the walk after talking the talk?
We will be watching with great interest to see the outcome of the EU meeting, as well as next February’s Shell presentation on its strategy to become a green energy company. In the meantime, we expect to be barraged with media stories about the U.S. re-entering the Paris Agreement, and our government’s commitment to decarbonizing our electrical system. We don’t expect many solid cost estimates about these moves.
Are You Confused By The Language Of Carbon And Climate? (Top)
In today’s world, where opinions become facts and people who profess to be in the news business, where accuracy counts, find that concept hinders telling stories in a manner that has the most impact on their readers, how does one find the truth? The language of climate change, energy transitions and ESG is dominating the conversation, but often without all parties fully understanding the meaning of those terms. ESG has become the overarching framework driving much of what is going on in the world. While we are all familiar with the terms – environment, social and governance – without a standard definition, conversations can become like ships passing in the night, especially in the world of environment.
We were prompted to consider the “E” when we responded to an email from an energy-related professional asking us if we could explain the difference between carbon neutral and net zero. Are they the same? If not, how do they differ? Moreover, do other people know the difference? These questions reminded us of Lewis Carroll’s comments about language, which was part of his wonderful Alice’s Adventures in Wonderland story.
“’When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’
“’The question is,’ said Alice, ‘whether you can make words mean so many different things.’
“’The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all.’”
So which word is the master? Since nations, society and companies are striving to transition to a lower-carbon economy, words and terms are employed to motivate people to act in ways that achieve the goal. Selecting the most impactful words and phrases is key to motivating people. Orators throughout history have motivated people to act as they wanted, driven by words and phrases selected.
Wading into the language of climate made us feel like we had fallen down the “rabbit hole” along with Alice into a fantasy land. We started by trying to understand the difference between “climate” and “weather.” We accessed the National Aeronautics and Space Administration (NASA) web site that had a 2005 article discussing the distinction. According to the article, “The difference between weather and climate is a measure of time. Weather is what conditions of the atmosphere are over a short period of time, and climate is how the atmosphere ‘behaves’ over relatively long periods of time.” This seems pretty straight-forward, except that the amount of time in each definition is unspecified. If it rains one day and is sunny the next, we assume that is weather. But, if it is hot and humid most days of the year, that is climate. Is it two days versus 365, or what about three months versus a century?
The difference between the hot and dry conditions of Arizona and the humidity and heat of the Gulf Coast is generally thought to reflect climate differences, and not weather. What confused us was when NASA then suggested: “In most places, weather can change from minute-to-minute, hour-to-hour, day-to-day, and season-to-season. Climate, however, is the average of weather over time and space. An easy way to remember the difference is that climate is what you expect, like a very hot summer, and weather is what you get, like a hot day with pop-up thunderstorms.”
Wait a minute. We thought NASA just said in the beginning of that quote that going from “season-to-season” was weather, but then they said a “very hot summer” is climate. So, which is it? If we go from a cool spring to a hot summer is that weather, or climate? We are confused. We’ve lived through hot and cold summers, rainy and dry ones, as well as warm and bitter cold winters. We’ve had to shovel snow all winter, and then barely at all in other winters. We always treated those differences as weather and not climate.
Add to this quandary, is the changing description of what is happening with the climate. According to research, the term “global warming” was introduced into our lexicon in the 1950s. However, in 1896, Swedish scientist Savante Arrhenius put forth the idea that global warming existed and it could be attributed to human behavior. For the next century, as scientists continued measuring the temperatures of the oceans and recording the rising levels of greenhouse gases in the atmosphere, they began to accept this view of global warming and human’s contribution to its existence. But supposedly, no one paid attention until 50 or more years later.
The concept of the atmospheric heating phenomenon of the greenhouse effect was first described by Joseph Fourier in 1827, although the term wasn’t adopted until the early 1900s. Carbon dioxide and methane in the atmosphere were acknowledged to be capable of retaining and magnifying heat, much like how heat is trapped inside a greenhouse, the reason why they are prime locations to grow crops during wintery weather.
According to dictionary.com, the term global warming went mainstream in 1988 when Dr. James Hansen of NASA told a Congressional hearing that “it was 99 percent certain that the warming trend was not a natural variation but was caused by a buildup of carbon dioxide and other artificial gases in the atmosphere.” He further stated that there was no “magic number” that showed when the greenhouse effect was actually starting to cause changes in climate and weather. But, he warned, “It is time to stop waffling so much and say that the evidence is pretty strong that the greenhouse effect is here.” Dr. Hansen’s talk was held in a super-heated hearing room in June, as the talk’s sponsors had kept the heat on high all night to deliver a subtle message about heat.
How did we move from global warming to climate change? Many people assumed it was due to the inability of climate scientists to establish that average temperatures were continuing to rise. While it was true that average temperatures plateaued for a while, scientists decided they desired to highlight other climate phenomena they wanted people to associate with a warming planet. Rising sea levels and increasing precipitation were two of those phenomena. The use of the term climate change had been used as far back as the 1850s, and in research papers in the 1950s, but it gained greater notoriety during the 1980s, especially when NASA scientists began using the term almost interchangeably with global warming. Since then, climate change is the default description of weather extremes.
As part of our research, we learned the interesting history of the U.S. Weather Bureau. As early as 1849, the Smithsonian Institution supplied weather instruments to telegraph companies enabling the establishment of an extensive observation network. It grew to over 500 observers before being interrupted by the Civil War. The observers telegraphed their observations to the Smithsonian, where weather maps were created and eventually distributed to the Washington, D.C. newspapers.
In 1870, a Joint Congressional Resolution required the Secretary of War “to provide for taking meteorological observations at the military stations in the interior of the continent, and at other points in the States and Territories…and for giving notice on the northern lakes and on the seacoast, by magnetic telegraph and marine signals, of the approach and force of storms.” President Ulysses S. Grant signed it into law, and a new national weather service was created within the U.S. Army Signal Service’s Division of Telegrams and Reports for the Benefit of Commerce. This was the origin of the U.S. National Weather Service.
Interestingly, in 1898, President William McKinley ordered the Weather Bureau to establish a hurricane warning network in the West Indies to help protect shipping and coastal areas. This network contributed to the Weather Bureau being able to forecast the Hurricane of 1900 that destroyed Galveston, Texas, but it failed to forecast the storm surge, which is what wiped out the city and killed more than 6,000 residents. From then on, the nation has enjoyed continuous improvements in forecasting the weather and in distributing the information to the people.
Over this long history, the Weather Bureau’s ability to forecast the weather and to track and predict the movement of tropical storms improved. Up until 1954, hurricanes were assigned numbers sequentially throughout the year. This system created problems for ships who often received garbled messages about the storms. It was especially a problem when more than one storm existed. It was thought that by assigning a hurricane a name, initially all female names, people would be able to identify it easier, while it also made the storms more personal and notable. By 1979, both male and female names were used for hurricanes both in the Atlantic and Pacific basins. According to Neil Frank, former Chief Meteorologist of KHOU-TV Houston and longest serving former Director of the National Hurricane Center, names were often not given to hurricanes unless they made landfall, further distorting the past count of storm activity. Additionally, in earlier years, short-duration tropical storms were not named as they are now, assuming they were even identified. Remember that until the existence of extensive weather satellite coverage of the oceans, knowledge of storms depended on ships encountering them or they reached land.
The claim that 2020, with its 30 tropical storms, was the most active year in history is not correct. It was only the most active year in modern history, since the late 1960s, which is the period since the existence of weather satellites and short-duration storms being counted. The National Oceanic and Atmospheric Administration (NOAA) has estimated tropical storm activity in the pre-satellite era, on the same basis as storm counts are now conducted, and found there has been a very slight increase in the annual number of storms since 1879. However, the increase is not statistically different from zero, suggesting there has been no pattern of rising hurricane activity in recent years due to global warming or climate change.
Despite this study, the environmental movement has used the climate/weather phenomena of the last decade or so to fuel the debate over how important it is that society change how it lives and works if the planet is not to become uninhabitable. Naming storms – now including snowstorms and forest fires – is a way to personalize the damage and suffering people experience from climate change. The idea of naming snowstorms and forest fires have different origins. Snowstorms are named by The Weather Channel (TWC), a practice briefly followed by the National Weather Service but eventually stopped. TWC names the storms to attract viewers since that is how it earns revenue. Wildfires, on the other hand, are named by first responders based on the fire’s initial location. This provides additional responders with a secondary confirmation of the location of the fire.
The most recent development in climate language is the shift from climate change to climate emergency. The new terminology is often linked with the phrase “existential threat,” intended to increase the pressure on people to act according to the wishes of environmentalists or face the prospect of a devastated planet. The terminology shift, and then linking it with threats over the long-term damage to our planet by failing to conform to the prescribed action plan, is due to people not falling in line. The failure of society to acquiesce to the environmental movement provides government leaders with the political cover to enact mandates for how you will live and work.
Exhibit 1. Environment Concern Of Americans Over Time
Source: Gallup
In the recent Gallup poll asking: “What do you think is the most important problem facing the country today?” In the Non-Economic problem category, Environment was #8 with a 3% weighting, as the November poll. That was an improvement of one position (#9) and an increase of two percentage points (1%) from the May poll, taken during the height of the Covid-19 pandemic. As can be seen, the Environment weighting barely moved during seven months of polling, and it hardly registers as a concern of Americans.
Environment’s low rating in this poll contrasts with other surveys which rank it higher. The difference comes from how the surveys are taken. For example, the Yale Program on Climate Change Communication along with the George Mason Center for Climate Change Communication produce periodic polling data about people’s understanding of the climate change issue. But their survey questions are asked with an introduction. Surveys administered in that manner will always elicit a higher rating for the issue being considered. However, when an open-ended question is asked, i.e., the blank piece of paper model, only those issues of greatest concern will be noted. The latter surveys are more telling of Americans’ true concern over climate change. This is the problem the climate change movement has in motivating people to act in accordance with the dictates being proposed – they don’t consider it a serious threat. Notice in the survey results below (only some shown) that all responses are positive for the environmentalists, except the one about climate change hurting “me personally.”
Exhibit 2. How The Public Views Climate Change
Source: Yale Program on Climate Change Communications
Another survey approach is Gallup’s questioning how people perceive the seriousness of global warming. As shown in Exhibit 2, the rating “Generally correct” fell to 22% in 2019, down by a third from the view held in 1999. At the same time, “Generally exaggerated” rose by slightly more than 10% over the time-period. Climate change proponents will point to “Generally underestimated” at 42%, up from 25% in 2010, as particularly significant. However, the increase has all occurred in the past decade, as 2010 marked the category’s low point of the 20-year period. In fact, until 2018 and 2019, when the category reached the 40% level, it had been up to 38% twice, suggesting this might be the most volatile category, and possibly influenced by weather events and media coverage.
Exhibit 3. How Serious Is Global Warming?
Source: Gallup
With no overwhelming rush to back the environmental movement, its response has become shriller. Society must change its behavior and not just slow the increase in carbon emissions but drive them down! Armed with climate models showing the devastating impact on the planet by allowing carbon emissions to grow unchecked, the United Nations’ Intergovernmental Panel on Climate Change (IPCC) has convinced some people of a cataclysmic future without draconian changes to how we live and work. This had led to the programs to make world economies carbon neutral or achieve net zero emissions.
What is the difference between carbon neutrality and net zero emissions?
When we were asked this question, we answered: Carbon neutral involves action to offset one’s carbon footprint. That can include buying environmental credits when flying or funding the planting of trees. Net zero emissions means actively engaging in methods to collect and remove the carbon emissions created by your activity. This means altering the activity to utilize renewable energy or hydrogen to eliminate the carbon emissions produced or by capturing the carbon emissions and sequestrating them. While these are not scientific definitions, they reflect, in our view, the nuanced difference between the two terms. That’s why we question whether the terms are interchangeable?
It turns out that carbon neutrality is defined by an internationally-recognized standard – PAS 2060 – prepared by the British Standards Institution (BSI). The standard sets out requirements to quantify, reduce, and offset greenhouse gas emissions. Accordingly, the definition of a carbon neutral footprint is a “condition in which during a specified period there has been no net increase in the global emission of greenhouse gases to the atmosphere as a result of the greenhouse gas emissions associated with the subject during the same period”. In a report by Carbon Clear, when it was introducing the initial carbon neutral standards, it used the following graphic to illustrate how carbon neutrality was achieved.
Exhibit 4. Getting To Carbon Neutral
Source: Carbon Clear
In Europe, the carbon neutrality effort is well ahead of the rest of the world. Starting in 2008, BSI introduced the first life-cycle assessment – PAS 2050. It was like ISO 14064-1 or the GHG Protocol. With the support of numerous non-governmental organizations such as the Carbon Trust and EcoAct, to name a couple, the drive to create one standard with specific measurement steps began. The pitch was that with a standard and a methodology for achieving it, companies could be persuaded to embrace the standard to gain an advantage against competitors without the designation. As society began to recognize and prioritize the goal of keeping carbon emissions low, business would flow to those companies who achieved and maintained their PAS 2060 designation, as explained by the following chart.
Exhibit 5. How Carbon Neutral Helps Companies
Source: Carbon Clear
The steps to meet the standard involved measuring, reducing, offsetting and then documenting and validating the results. Measuring the emissions means identifying all of them associated with a company’s operation. The measurements should include 100% of Scope 1 and Scope 2 emissions plus all Scope 3 emissions that contribute more than 1% of the total footprint.
Scope 1 includes all emissions from GHG sources owned or controlled by the organization. Scope 2 includes the emissions from the generation of imported electricity, heat, or steam. Scope 3 includes emissions which are consequences of an organization’s activities but arise from sources that are owned or controlled by other organizations. This includes the consumption of the product or service, and the disposal of the product at the end of its use. In effect, these three emission scopes constitute a hierarchy of emissions, and reflect the challenge in measuring them. Scopes 1 and 2 are relatively easy for organizations to measure, as they fall within the control of the organization. Scope 3 requires collecting the GHG emissions from all consumers and/or users of an organization’s product or service, which is much more difficult.
Exhibit 6. The Pyramid Of GHG Measurements
Source: Carbon Clear
What we found interesting was stumbling over a distinction between carbon neutral and net zero emissions. To meet a net zero target, one must include the global scope of 1, 2 and 3 emissions of the organization, whereas carbon neutrality for an organization only requires scope 1 and 2, with scope 3 emissions encouraged but not mandatory. Furthermore, a carbon neutral claim can refer to a specific product or service instead of encompassing the whole organization, as is the case for net zero emissions.
The reduction in reported emissions required to reach these two definitions differs. Net zero targets must align to the 1.5°C science-based target offered by the IPCC, whereas the level of emissions control to achieve carbon neutrality is not specified. Additionally, the approach to residual emissions differs, with specific greenhouse gas removals required for net zero targets, whereas carbon offsets are accepted for carbon neutrality.
If you are confused about the language surrounding carbon emissions, don’t feel alone. While the standards would appear clear, reaching carbon neutrality or net zero emissions is more complicated. That complexity is compounded by the difficulty in measuring GHG emissions. Scope 1 and 2 emissions are within the control of the organization, even though they may not own their entire value chain of products. Therein lies the complicating factor, as measuring the emissions of non-owned as well as Scope 3 emissions requires a deep dive into the workings of suppliers and customers. That requires a dedication and a willingness to expend potentially significant time and money seeking the necessary information, at the risk of possibly alienating those parties, something organizations may be reluctant to do.
Given the complexity of carbon emissions and the political pressure to embrace the low- or no-carbon economy, it is probably ok to use carbon neutral and net zero emissions interchangeably, since few people will know, or can determine the difference. But if called out by someone, at least you can say you are aware that there is a difference – which many people are not.
Turmoil In The Oil Patch Continues; Any Resolution In Sight? (Top)
As we slog our way to 2021, the memories of this year will be gladly wiped from our thoughts. This has been, by any measure, a terrible year. For the energy industry, 2020 introduced conditions never thought possible, but more importantly, they have set the industry on a different tack. With a global economy that appeared to be humming along as we entered this year, the emergence of Covid-19 and the resulting government and social reactions crushed economic activity, along with oil demand. Who would have ever thought, even with those actions, crude oil prices could turn negative – even briefly? But what that price shock did was signal we needed to reassess the industry’s future, and not with rose-colored glasses.
The turmoil that beset the oil industry this spring caused many energy forecasters and practitioners to question when things would return to “normal,” although no one was quite sure what normal meant. Like the blind men trying to describe the elephant, everyone recognized that societies and economies were undergoing behavioral changes that would alter their structural aspects, but by how much and over what time period were unknown. What changes would become permanent, and which ones would be rejected once a vaccine appeared or herd immunity was established, confounded the ability to simply run forecast models and determine reasonable conclusions.
The energy turmoil provided a fertile ground for environmental activists to lobby for a radical restructuring of economies and society to become carbon-free. If governments were looking for financial stimulus steps to boost their economies, rebuilding them on the foundation of electricity and renewables is seen as both stimulative, as well as job creating. Ending the Age of Oil has been embraced by a large segment of the world’s population, providing a new mantra for the future. Clean energy rather than growth in energy output is becoming the new measuring stick for economic progress.
Exhibit 7. Crude Oil Prices Demonstrating Positive Outlook
Source: EIA, PPHB
Last week, crude oil prices managed to squeeze out a sixth consecutive weekly increase, helped by optimism about the arrival of the Covid-19 vaccines. This tied the previous six-week positive increase span that happened after oil prices fell into negative territory this spring. The recent price rise reflects the market’s response to the OPEC+ group being able to negotiate a compromise that sees only a small (500,000 b/d) increase in oil supply starting in January, as opposed to the prior plan to add four-times as much. The fact it took extra days to negotiate the OPEC+ agreement was a surprise and upset oil prices. However, the time needed reflects the friction between those members needing additional income but lacking more oil to export, and those capable of exporting more oil but worry the most about another oil price crash. The agreed-to outcome gives the market additional time to see what the recovery of 2021 may look like in light of the arrival of coronavirus vaccines. Reducing that uncertainty should help the future oil price trajectory.
With oil prices crashing this spring, as oil inventories mushroomed when economic activity was shut down due to Covid-19, OPEC+, with the aid of President Donald J. Trump, agreed to a significant supply cut. That agreement envisioned a rapid recovery in world economies and oil demand that would justify adding more oil to the market as we headed into 2021. Therefore, the plan envisioned adding two million barrels per day (mmb/d) back to world supply starting January 1, 2021. The new agreement just reached calls for only adding back 500,000 barrels per day (b/d). What remains unclear is whether the Russian Oil Minister’s comment that OPEC+ will add 500,000 b/d of supply back to the market every month during the first quarter, such that by April the full 2 mmb/d supply addition originally planned will have been returned to the market, is accurate, or that only the initial increment will be added.
Rather than reliving the pain and suffering experienced by the oil industry this year, we will only focus on the most recent events and how they may influence the oil business in 2021 and in the future. While ignoring the question about the health of oil demand next year and long-term, this uncertainty remains a backdrop for much of what will be impacting the industry going forward. Recent events will help shape the industry, regardless of what happens to oil demand.
An aspect of the demand backdrop for the oil and gas industry is the push to reach a net zero emissions target. Whether the push is done via incentives or mandates will prove key to how they impact the oil and gas industry. What these goals do is highlight the eventual peaking in global oil demand, which will appear first in the developed world, and later in the developing world. Those two worlds may diverge sooner than we expect, and the divergence may prove much greater than we anticipate. The divergence will affect energy companies in various ways.
The most visible impact on the industry came via the recent announcements by Exxon Mobil Corp. and Chevron Corp. that each company was reducing its long-term oil price forecast. Those reductions are a directly tied to the slowdown in oil consumption growth. It means the companies are planning to produce less oil and gas, and therefore they will not need to spend as much in finding and developing new reserves. Both oil giants operate with very long-term investment horizons, so making major changes to their assumptions about the future environment in which they will operate is significant. ExxonMobil’s and Chevron’s moves will have repercussions throughout the oil industry, especially for the future volume of work available for the oilfield service industry.
The change in the trajectory of long-term oil and gas prices, coupled with the increased pressure to embrace the green energy movement, has led Denmark to stop offering new licenses in the North Sea and phase out the country’s production by 2050. The announcement was hailed by environmentalists as “what climate leadership looks like,” in hopes other countries, such as the U.K. and Norway, might follow. The move by Denmark marks the start of ending a history extending back for six decades, when the government gave exclusive exploration and drilling rights to A.P. Moller-Maersk A/S. The company subsequently shared these rights with a handful of oil majors such as Chevron and Royal Dutch Shell plc. Last year, Denmark produced 103,000 b/d, or 3.5% of North Sea crude oil output. Even the loss of Denmark’s production today would not have much impact on the global oil market. Thus, the government’s announcement to end its North Sea oil business is really a statement of principle rather than an act with major economic consequences.
A similar event was the announcement by Canada’s Bank of Montreal (BMO) that it is exiting its U.S. oil and gas investment banking and lending businesses. The bank will focus on its oil and gas loans and banking business in Canada, although it is reducing its lending exposure to energy there, also. What we discern from the BMO announcement is that its large loan losses in the U.S. oil and gas business reflects the downturn that has devastated the shale sector. At the end of its fourth fiscal quarter ending November 30, 2020, BMO reported C$457 ($356.7) million of impaired loans to U.S. oil and gas companies compared to only C$93 ($72.6) million to Canadian companies. BMO’s U.S. oil and gas loan book of business was about C$7.0 ($5.5) billion as of July 31, 2020, making up half of its overall oil and gas loans.
While BMO may be adjusting its strategy based on having been burned by its participation in the U.S. energy market, other commercial banks are being pressured by environmental activists and shareholders to stop financing the oil and gas business completely. As we know, the oil and gas business is very capital intensive, especially the shale sector. During the shale boom, securing capital for explorers was relatively easy since investors were actively seeking opportunities to make profits on energy investments to counter the extremely low rates of return offered by bonds and dividends. With the U.S. oil and gas business on a trajectory that would take the nation from being a significant oil and gas importer to a leading exporter, virtually every energy project assumed generating meaningful profits. As we know, when oil prices dropped in 2014, profitability of the shale sector disappeared, and has led to a significant number of bankruptcies.
Environmentalists fighting to end the use of oil and gas detected that the industry was vulnerable with respect to getting production to market. Initially, the battles were fought over the granting of pipeline permits, often resulting in battling over the scope of environmental studies supporting the permit approvals. The most high-profile pipeline battle in recent years involved granting of the cross-border permit allowing construction of the Keystone XL pipeline. Often, even after permits are awarded, environmentalists have fought the actual construction of pipelines, such as the Dakota Access Pipeline project. The pervasive thing is that by blocking pipelines, the safest form of hydrocarbon transportation, companies resort to trains and trucks, which are less safe and more costly.
The environmental movement has now identified access to capital as a key vulnerability of the oil and gas industry. Forcing commercial banks to stop lending money, investment banks to stop raising money in the stock and bond markets, and institutional investment managers to sell their energy debt and equity holdings, are all actions gaining steam, and becoming potentially major hurdles for the oil and gas companies. By attacking the transportation of oil and gas output, along with restricting the funding for finding, developing, and moving fossil fuels, environmentalists hope to slow the growth of the energy business, and pressure the company managements to shift their business strategies away from oil and gas and toward renewable energy projects.
The restructuring of the energy industry is ongoing as bankruptcies continue, although many of these filings are pre-packaged bankruptcies to formalize, under court protection, previously negotiated balance sheet restructurings. At the same time, mergers and acquisitions are driving consolidation, primarily among the smaller companies within various industry segments. We expect both bankruptcies and M&A to continue into next year, which will be an important ingredient in the industry’s restructuring.
The new Biden administration’s financial team will be led by Treasury Secretary-designee Janet Yellen, assuming she is confirmed. Ms. Yellen, former Chair of the Federal Reserve Board and Chair of the White House Council of Economic Advisors, is well-known as a climate hawk. Given her close association with current Chair of the Federal Reserve Board Jerome Powell, the Biden administration is likely to use all its wide-ranging regulatory and oversight powers to push a green agenda on the banking industry. Whether that would extend to encouraging commercial banks to redline certain non-green industries such as oil and gas remains to be seen. This is a reason the Trump administration is pushing regulations to prevent the banking industry from such redlining.
According to reports, Ms. Yellen plans to lead the U.S. into the Network for Greening the Financial System, a 75-member club of central banks focused on climate change. The impact of such a move, combined with the close working relationship with European central banks and governments, may push the regulatory system into requiring a critical assessment of climate risks related to commercial lending, including possibly using the tools of the Federal Reserve. A recent column by Walter Russell Mead in The Wall Street Journal highlighted the potential risks for the economy from such a move.
“Regulating the world’s complex and ever-evolving financial markets is as difficult as it is critical. Adding an extra layer of requirements, even if justifiable on climate-policy grounds, can make it impossible for finance ministers and central bankers to fulfill their essential roles. Not only will climate activists promote mandates with grave and poorly understood economic consequences; special interests will seize a golden opportunity to entrench subsidies and biases into the heart of the financial system.”
One merely thinks of the Law of Unintended Consequences to conjure up scenarios in which businesses are prevented from acting in the best interests of their stakeholders, because of social policies that distort economic realities. While climate will be the initial thrust of Ms. Yellen’s agenda, we fully expect it will be expanded to embrace other social agendas. Deploying the powers of central banks and financial ministries to engineer social change is a primary goal of activists. The risk, as Mr. Mead sees it, was spelled out in his concluding paragraph.
“Massive waves of social regulation proliferating through the world’s financial markets may, in the short term, satisfy activists and allow politicians to bask in their approval. But decades of climate policy failure suggest a new wave of climate-based global financial regulation will most likely do more to slow global growth than the sea’s rise.”
The turmoil that has engulfed the energy industry this year looks like it may moderate as we move into 2021. Don’t be fooled, however, as the winds of change continue to blow, and there are few obstacles preventing them from reshaping significant portions of our federal government, its key agencies, and our international associations. Failure to acknowledge the disastrous social, economic and regulatory policies of the past will be a mistake. We envision that the people who point to them will be waved away as scaremongers or do-nothings. The wisdom of mobs may take us on a journey we currently cannot envision.
Renewables In U.K. Show Inability To Power The Grid (Top)
The goal of decarbonizing our economies and running them totally on electricity struggles with the reality that wind and solar are intermittent power sources, which complicates managing the electricity grid. When electricity grids were powered entirely by fossil fuels, their operators were only stressed to ensure that the power plants operated 100% of the time and the output could be adjusted to meet fluctuating electricity needs throughout the day.
Confronting the reality of renewables intermittency requires adopting different operating strategies. In the case of solar, everyone knows it isn’t produced at night since the sun doesn’t shine. That daily timeframe can be planned around by using other power sources not impacted by the time of day. The problem for solar comes when cloud cover develops – intermittently when clouds drift across the landscape blocking the sun temporarily, or on cloudy days when sunlight is blocked all day or for multiple days. Improvements in weather forecasting allow grid operators to plan power source switches to counter the loss of solar power due to clouds. There is little that can be done to offset the power lost from drifting clouds, but hopefully the time and magnitude are minimal.
Managing wind intermittency presents different challenges. Meteorological knowledge enables us to anticipate when the wind will be blowing and likely how strong it will be. People often don’t appreciate that wind turbines can work at low wind speeds, but above certain speeds, they must be shut down to prevent them from being damaged. Again, weather forecasters can usually predict when those times may happen. The problem is when the wind stops blowing unexpectedly. The uneven warming and cooling of land can make onshore wind much more variable than offshore wind. Offshore wind is not only more stable, but it also tends to be stronger, allowing the harvesting of greater amounts of power.
Despite all the operational and forecasting improvements, depending on renewables remains a challenge. The problems of wind and solar in the United Kingdom were noted in a blog from Paul Homewood. As a retired accountant, Mr. Homewood is fascinated with numbers and adept at extracting data from massive government databases. As a result, he often posts government or energy industry charts that highlight problems with renewables that their proponents often overlook or minimize. His latest blog highlighted what happened to the electric grid in the U.K. during the weekend of December 5-6. He published a chart showing electricity supplied to the U.K. grid, by source, during half-hour increments. The data came from the BMRS system for the Balancing and Settlement Code overseen by Elexon Ltd. The company compares how much electricity generators and suppliers say they will produce or consume with actual volumes. Elexon works out a price for the difference and manages the payments. This process involves taking 1.25-million-meter readings every day.
That chart highlighted the loss of wind power, which can be seen by tracking the large dark blue section of the columns from the early morning hours of December 6, as they shrank during the day. The second chart showed the solar power output, which was impacted by it being a cloudy day. At peak generation of 1.68 gigawatts (GW) during the noon to 1:00 pm time-period, solar power’s contribution to meeting overall power needs was approximately 4.3%. At this point in the day, solar should be contributing at its maximum. For the second quarter of 2020, solar generating capacity accounted for 27.7% of total renewables capacity, or 13.4 GW. The peak solar output this day was 12.5% of total solar generating capacity. Interestingly, a 2020 European Union energy publication, based on 2018 data, showed that the U.K. had the third largest solar generating capacity among the 28 nations.
Exhibit 8. Wind Disappears During December 5, 2020
Source: Paul Homewood
Exhibit 9. Solar’s Weak Contribution To Power Grid
Source: Paul Homewood
We went to the Elexon web site and collected the data for December 6 through part of December 7 (Exhibit 10, next page). This allowed us to extract the actual amounts of electricity produced by fuel source during each half-hour segment. As can be seen by the dark blue sections of each column, wind was present in the early morning hours of December 6 but virtually disappeared by late afternoon. Wind subsequently returned stronger in the mid- to late-afternoon of December 7, as shown by the larger dark blue sections.
Exhibit 10. Electricity By Source and Fuel During Two Days
Source: Elexon
We focused on the first half-hour (12:00 – 0:30 am) and the 35th half-hour (5:00 – 5:30 pm) to see how the power supply changed. We know from the columns that wind power, which was evident in the early morning, had largely disappeared by the late afternoon. In fact, wind power went from 1,564 megawatts (MW) to only 381 MW. As a percentage of total energy produced, wind’s share fell from 5.5% to only 0.9%. What can be seen in the afternoon time period is the emergence of coal power (black at the bottom of the columns).
Coal was not needed in the early morning hours, largely because total power needed was only 28,574 MW. In the afternoon, total power increased to 43,820 MW, a 53.4% increase. The mix of power supplies was also interesting. The amount of power imported from abroad (Belgium, the Netherlands and France) along with “Other” power sources increased by 9% between night and day. Imported power’s share of total power fell from 14.6% to 10.3%.
The fact that the U.K. relies on imported power for roughly 10% of its power needs is often overlooked by people when suggesting how the country can power itself just with renewables.
While the wind power contribution in the afternoon represented about a quarter of what it contributed at night, hydropower nearly doubled its contribution, and pumped storage contributed 3.9% of total power needs in the afternoon versus none at night. Nuclear power’s contribution was steady all day, while biomass increased by nearly 27% its contribution during the afternoon. The key power contributor in both time segments was natural gas, which contributed 47% of the power at night, and then increased its output by 80%, to contribute 55.3% of total power needs in the afternoon. You will notice that solar’s contribution was so small it failed to register.
To further note the intermittency of wind, we compared the amount of electricity produced from wind at specific time periods on December 6 and December 7. One can see how strong the wind was blowing during the early morning hours of December 6, but how that rapidly fell off by afternoon. The low wind during the afternoon of December 6 continued through the night and into the early morning hours of December 7. In contrast to the prior day, instead of declining further, wind’s contribution picked up significantly by the afternoon of December 7. If grid operators are unprepared for such variability, they would be left scrambling to secure other power sources. Alternatively, they might decide that power users need to be cut back. In those cases when there is too much wind, the grid operators are forced to pay the wind providers to avoid having to take their output. Through the first half of 2020, National Grid, the operator of the U.K. electricity grid, had paid wind developers over $1.3 (£1.0) billion not to supply their wind electricity to the grid. That is a cost that electricity customers are forced to pay.
Exhibit 11. How The Wind Blows And Doesn’t Blow
Source: Elexon, PPHB
The U.K. government’s plan to convert its economy to electricity and to decarbonize its power grid will need to overcome the realities of the intermittency of renewables. Battery storage and a restructured electricity pricing structure to encourage more off-peak electricity usage will help. In the United States, one electricity company has just received approval from its regulator to introduce hourly pricing to enable them to attempt to convince customers to shift their power needs. Neither battery nor variable power pricing are capable of handling renewables intermittency adequately, which is why power usage mandates will be relied upon until hydrogen power becomes a viable fuel supply option. It is more likely that the grand scheme for decarbonizing the U.K. economy will be pushed out beyond the currently hyped near-term targets.
Contact PPHB:
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Main Tel: (713) 621-8100
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www.pphb.com
Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.
