Squeezing one last drop from Big Oil: The great climate debate shaking Australia’s energy sector

Not long ago, the only pressure for oil and gas companies to clean up their act came from the protests outside their office towers. Next it was at their investor meetings, from activists taking over question time or lobbying for larger emissions cuts. These, too, could often be ignored. But now, the winds of change are blowing in boardrooms.

Last month – in May 2021 – Big Oil’s climate reckoning made history. It was “potentially a watershed moment”, UBS Australia’s energy analyst Tom Allen says.

At America’s ExxonMobil, the $US265 billion ($343 billion) behemoth that for many years was the most valuable company on Earth, activist investors ousted three directors deemed out of step with necessary climate action and installed green-leaning replacements instead. At Chevron, the same day, shareholders defied the board and supported demands for the company to take account of its customers’ carbon emissions footprint. And in Europe, a Dutch court ruled in favour of environmental groups in forcing Shell to commit to a vastly stronger decarbonisation plan by 2030.

“Black Wednesday”, as some are calling it, had been approaching for a while. Governments, investors and the public have become increasingly attuned to the risks posed by global warming, focused on hitting net-zero emissions targets by 2050 and demanding of producers to accelerate change. Australia’s Woodside Petroleum and Santos felt the force of this last year, with huge shareholder uprisings in support of climate activist motions. But May 26’s thumping boardroom and courtroom defeats for three of the so-called “super majors”, from Houston to The Hague, showed how far further things have come.

The shock is reverberating industry wide. And for Australia – as one of the world’s biggest exporters of liquefied natural gas – the implications could be severe.

“They are different jurisdictions, but it is amazing how these things have coincided,” says Greg Bourne, the former president of oil giant BP’s Australian operations. “Things are ratcheting up.”

In essence, what the events marked was a rebuke of the industry’s long-held mantra: that the world will need lots of oil and gas for a very long time, and that its traditional business case is iron-clad.

The immediate fallout, says global ratings agency S&P, may be pressure on producers’ core cash engines from stakeholders including their own investors.

“Anyone who tries to go for a final investment decision on a new field in this year, 2021, needs their head looked at.”

Greg Bourne, former president of BP Australia​

But there is also a bigger picture. Just recently, the International Energy Agency determined the world should avoid funding any new oil and gas fields in order to achieve the Paris agreement’s aspirational goal of limiting temperature rises to 1.5 degrees. And lying just ahead, there is the prospect of even more ambitious climate action being announced at the next UN summit in Glasgow in November.

“Anyone who tries to go for a final investment decision on a new field in this year, 2021, needs their head looked at,” Bourne says. “There are too many things monotonically taking us toward a geopolitical effort to decarbonise really fast.”

While a dark cloud hangs over the long-term outlook, the threat to oil and gas is far from immediate. Ironically, there appear to be some decidedly good years ahead, especially as supply is more likely to take the hit from climate pressure rather than consumption. As countries emerge from the worst of the coronavirus pandemic, the world is ravenous for oil and gas.

Already, pent-up demand is combining with a curtailment in supply after new drilling was halted last year and some wells shut in. Benchmark Brent crude, which last year suffered its steepest and fastest demand crash in decades, is now trading back above $US70 a barrel, its highest level since January 2020.

Some investors like big superannuation funds that hold stocks long-term are rethinking oil and gas holdings, just as they have done with thermal coal amid historic pressure to confront climate change.

Others, however, are staying loyal or buying them up, in what they say could be a lucrative opportunity before the electric vehicle revolution and wider decarbonisation efforts start to bite harder and, eventually, drown out fossil fuels for good.

If the industry truly is seeing the beginning of the end, asks Credit Suisse analyst Saul Kavonic, could it be a “very profitable last hurrah?”

In the Californian city of San Mateo, fund manager Franklin Templeton’s vice president Fred Fromm lives and works at the centre of the electric vehicle boom and the transition to a low-carbon world.

Here, the local community has benefited from the state’s aggressive policy to reduce emissions, Fromm says, with cleaner air meaning schools are no longer shut down because of the city’s smog.

“The fact of the matter is oil and gas is probably the number one thing that has improved living conditions around the world since the history of humankind.”

Franklin Templeton investor Fred Fromm

While he has noticed more Tesla electric cars on the roads, Fromm, who manages more than $886 million in a global resources fund, says this has not translated to falling demand for oil.

He believes politicians and some business leaders have become prone to exaggerating the speed of the transition, overlooking the complexities at play by calling the end of an era without thinking about the implications.

“The fact of the matter is oil and gas is probably the number one thing that has improved living conditions around the world since the history of humankind,” he says. ”

While he is well-aware the energy transition is on foot, it will likely be at a “slower pace than the more aggressive estimates”, he predicts.

In Australia, investment firm Allan Gray holds shares in Woodside, the ASX’s biggest producer of LNG

While oil and gas companies have become increasingly taboo to own, the fund’s chief investment officer Simon Mawhinney believes current share prices are out of joint with their value.

He says there has been a “buyers’ strike” on oil and gas, where the number of sellers has outstripped buyers, which has pushed down share prices, further accelerated by the fossil fuel divestment movement. But he has doubled down on the stocks, incrementally increasing his exposure in anticipation of a rally.

“[Oil and gas] have a future … I think the question is how bright is that future?” he says. “Most people would acknowledge it’s not bright at all but I think the share prices of these companies say the future is completely dire.”

Ausbil Investment Management’s global resources manager Luke Smith agrees, and is seeking to cash in on an expected rebound as the COVID-19 vaccine is rolled out.

“Clearly the commodity is structurally challenged on a longer-term basis, there is no question about that whatsoever,” he says. “But in the near time, we see one last bull cycle.”

“Clearly the commodity is structurally challenged on a longer term basis, there is no question about that whatsoever. But in the neartime, we see one last bull cycle.”

Ausbil’s Luke Smith

At investment bank UBS, head of Australian energy and utilities equity research Tom Allen has a “buy” rating on the entire local energy sector.

As climate upheaval deepens, however, his clients have begun querying whether decarbonisation risks have been priced in.

“We found, after a lot of work, we didn’t think there has been an ESG [environmental, social, governance] de-rating applied to oil and gas stocks just yet, which obviously begs the question: if it hasn’t just yet, when might it apply?” Allen says.

What would become increasingly important, he adds, is for producers to ensure the “next wave” of growth projects are in line with the energy transition and include a clear decarbonisation pathway.

“It can’t just be more of the same,” he says.

Ask Australia’s big oil and gas producers about the demand outlook, and they point to numbers that tell a markedly different story to what the IEA’s latest headline might suggest.

Demand for their commodities in Asia – the top consumer of Australian product – is tipped to increase sharply by 52 per cent by 2040, they say. Cargoes of LNG, in particular, are likely to remain highly sought-after as more Asian nations turn to the fuel for a cheap, reliable and comparatively less-emitting alternative to coal.

Andrew McConville, chief executive of the Australian Petroleum Production and Exploration Association, says that the IEA’s latest modelling related only to one possible scenario out of about 90, and should be taken with a “grain of salt”.

Crucially, he says, the modelling did not adequately take into account the enormous future potential of negative-emission technologies like carbon capture and storage – such as Santos’s Moomba project in South Australia – and how it could offset carbon for other industries. LNG companies are investing in hydrogen, too, which could give natural gas a new life if it takes off as a fuel for manufacturing or heavy transport, or is blended with gas for heating and cooking.

“There are many ways to get to net zero,” McConville says. “The IEA just looked at one narrow formula.”

Saudi Arabia’s energy minister Prince Abdulaziz bin Salman has gone further, likening the IEA’s 1.5-degree scenario to “La La Land”.

On whether it’s a “watershed moment”, opinions are mixed. But either way – as Michael Irving, a senior executive at Australian gas pipeliner Jemena, explains – last month showed the “wave has started to break”.

“The moon, the tide, the wind … they have all aligned all of a sudden,” he told a Credit Suisse conference on Thursday.

“Some of the bigger players may become fish bait and hit the rocks … For some of the smaller players, this is a great opportunity to become those little groms who surf down that wave in the new environment, with a new ESG focus, and aren’t weighed down by the legacy assets that we see with some of the oil majors.”

Way out at sea, in the oil fields off the coast of Brazil’s Sao Paulo, an emerging Australian energy company is preparing to develop just its second ever oil production project.

On track to become the ASX’s fourth-largest energy producer, Melbourne-headquartered Karoon Energy gave the investment go-ahead late last week to tap the promising new field, known as Patola, which it expects to generate up to 10,000 barrels of crude oil a day.

Karoon’s managing director Julian Fowles, says new fields will remain vital to replacing existing output as other reserves dry up to meet the world’s energy needs for the “next decade and more”.

Still, for a company just starting out in oil production, the longer-term risks around climate loom as an important consideration. The IEA’s latest report seemed to Fowles to be the agency “raising the flag” that ambitious 2050 net-zero emissions targets set by a growing number of world governments are presently in danger of not being met. Karoon is in the process of developing a road map for its own carbon footprint.

“Without a doubt,” Fowles says, “now and into the future, we will see pressure on companies like ourselves.”

Extracted from The Sydney Morning Herald

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