How great a financial risk do carbon costs pose to upstream oil and gas companies?

The question of how carbon risk will affect corporate financial valuations is at the forefront of the industry’s and investors’ minds. There are widely different views in the market today, mostly built around two basic elements:

• Demand: the demand for hydrocarbons in a low-carbon future and the impact on future commodity prices.
• Supply: the impact of carbon-related costs on upstream project economics (such as a carbon tax).

Can a carbon price alone have a material impact on value?
In our new study, Positioning for the future, we look at the potential ‘value at risk’ from the industry’s direct upstream operations.

We have developed a standardised approach and leveraged our extensive database of over 31,000 oil and gas fields to generate an asset-by-asset forecast of upstream emissions and estimate of each asset's potential value at risk.

Our analysis also uses Verisk Maplecroft's bespoke Upstream Oil & Gas Carbon Policy Risk Index to evaluate the likelihood that countries will impose a carbon cost.

Using this framework, we see the effect of a carbon price can be significant for certain resource themes and for specific assets. However, the impact is likely to be more limited on an overall corporate basis.

What carbon price?
The chart below shows the total potential value at risk associated with an upstream carbon cost for 25 of the biggest international oil and gas operators. We have applied a range of carbon prices to our forecast of their future carbon emissions.

Today, 38 countries are taxing or trading carbon and a further 78 plan to do so as part of their Paris Agreement commitments. Despite this, we seem to be a long way off from developing any kind of global carbon price.

We see only 35% of global carbon emissions from upstream oil and gas assets between 2016 and 2025 arising in countries with a high or even extreme upstream carbon policy risk. (In other words, where the government would be both willing and able to impose a cost associated with carbon emissions from the upstream industry.)

In the absence of a global carbon price and using what we believe to be the most likely fiscal and regulatory treatment in each country, even at US$90/tonne the impact on total upstream asset value is below 4%.

Even when a carbon price is applied universally – and, in the most extreme case, we assume there is no offset against any corporation or production-related taxes – then it is only beyond US$60/tonne that the value at risk rises above 10%.

How do companies and assets compare?
The aggregate picture masks a substantial variation between companies and across their assets.

The percentage value at risk associated with a given carbon price is impacted by three factors:

• The emissions intensity of assets
• The existing profitability of each production stream (that is, the remaining NPV10 per boe)
• The policy risk associated with the countries of operation (in other words, how likely a carbon cost is to be implemented in each country where production occurs).

Our asset-by-asset emissions forecasts can be used to drill down. For instance, in which countries, or in which resource themes or assets, are the different companies most exposed to financial risk from carbon? How does the value at risk for the largest oil and gas companies compare?

Adopting a US$40/tonne carbon cost and using a likely tax and regulatory scenario, we see the corporate (upstream) value at risk among the 25 companies ranges from 1% to 4% (see chart below).

And if we assume the carbon cost is applied equally in all jurisdictions and no tax offset is allowable, the potential impact on value stretches from 4% to 15% at US$40/tonne.

Although these percentages on a corporate basis are still relatively low, the value at risk at an asset level shows considerably greater variance (Chart 3). For example, some assets lose more than half of their current value as a result of a $40/tonne carbon price.

From the 25 companies examined in the study, we identified over 30 individual assets where the loss in value is greater than 50%. We also found more than 140 assets where the loss is greater than 10%.

So while corporate upstream value at risk from carbon costs may be small compared with key value variables such as the oil price, the devil is undoubtedly in the detail.

With carbon prices in the US$40 to $60/tonne range, the focus of attention for both the companies and investors must be on those assets and resource themes with the most to lose. Only with carbon prices in the hundreds of dollars range does the value at risk present a more generic and wide-ranging issue for the upstream sector.