Dramatic exits have been the story of World Cup 2018. Historical domination of the football pitch has meant nothing as Argentina, Spain, Germany and Portugal, amongst others, have been dumped out of the competition in double-quick time. We don’t expect a similar fate to befall the upstream oil and gas sector any time soon.
Even so, E&P companies want to build portfolios that will stand up to intensifying investor scrutiny of carbon emissions and are robust at the low commodity prices that the energy transition may, in time, bring.
Traditional performance metrics focused on growth or returns are no longer sufficient.
Investors, and the companies themselves, need to integrate financial and non-financial data points into the decision-making process. The Task Force on Climate-Related Financial Disclosures guidelines last July has made it even more important to satisfy these demands. The wider range of metrics will include sustainability metrics.
Our new carbon efficiency indicator, NPV/tonne, assesses the financial implications of corporate carbon emissions. Analysed alongside ‘cash margins’, we’re able to compare the relative exposure of upstream portfolios to carbon costs and lower hydrocarbon prices.
Some company portfolios contain one or two large, mature assets with exceptionally high emissions intensity. The analysis shows how emissions intensity rises as assets enter late life and production starts to decline. Why? Production and processing units may still operate at peak capacity, with the same power requirement, but declining hydrocarbon production. Or perhaps enhanced recovery mechanisms such as water, gas or chemical injection are needed. Prudhoe Bay is a great example.
Remove this one asset from company results and the overall NPV/tonne score jumps.
There are assets with high CO2 concentrations in the gas stream which needs extraction and venting. The PM3 CAA field in Malaysia is over 50% CO2. Again, this alone can weigh heavily on a company’s upstream portfolio’s performance on our carbon metric. The devil really is in the asset-level detail.
2. Portfolio composition matters.
Resource theme, maturity and geographic location can have a significant effect on corporate resilience. Deepwater assets tend to have relatively low emissions intensities. This reflects their offshore location and typically strong natural reservoir drive that limits the need for intensive recovery mechanisms. They also have some of the best unit valuations on average with high upfront production generating strong margins (that rise over time).
So deepwater assets have the highest NPV/tonne of emissions produced on average – nearly four-and-a-half times higher than conventional onshore assets.
Oil sands, in contrast, perform worst on our metric amongst the resource themes and are the most emissions-intensive on average.
They also suffer from weak valuations that reflect large up-front capital costs and through-life spend.
3. Few companies excel in both categories.
Some NOCs with very mature, emissions-intensive and low-value legacy assets, are most exposed on these metrics. At the other end of the scale, companies like Anadarko or Petrobras are among the most resilient, with portfolios concentrated in high-value, low emissions-intensity unconventional and deepwater assets respectively.
Improving resilience will require difficult decisions around portfolio mix and asset sales.
Companies need a strategy of sustained portfolio high-grading, and to manage the resource theme mix. Curbing flaring, mitigating methane emissions, reducing costs and increasing yields will also play a part in boosting resilience.
Hybrid models are emerging, integrating upstream E&P with low carbon energy. It’s not an option in all cases, but offshore platforms can be powered by electricity generated by zero-carbon hydro or renewables, lowering emissions intensities to below 1 gCO2/MJ.
Despite increased awareness of the need to rise to the challenges ahead, most companies still have much to do to reposition their portfolios. The sector’s strengthening finances opens the door to take on the challenge. You can watch us discuss the subject on woodmac.com or listen to the podcast.