Oil and gas companies have previously measured their success by how good they are at finding new sources. The ruthless rule according to which they were valued was the “reserve replacement ratio”, an indicator of how successful a company is in replacing extracted oil and gas with new supplies. Today, this view is being reversed. Bernard Looney, CEO of BP, believes that the future lies in the production of fewer hydrocarbons. He wants BP to cut oil and gas production by 40% over the next decade, the Financial Times said in an editorial.
This ambition reflects the profound change that has engulfed the energy industry. Big oil companies must rediscover themselves if they are to survive in a low-carbon world. BP said this week that it believes global oil demand could peak in the next few years and that consumption may never recover from the pandemic. Such a grim assessment by one of the world‘s largest oil companies would have been unthinkable just a few years ago.
The world was changing before Covid-19. Climate change has entered the public spotlight. Pressure on the oil industry to adapt has come from all sides, although companies have not yet figured out how to generate revenue from the low-carbon business. Investors are more vocal and urge BP, Royal Dutch Shell and others to take into account the financial impact that global warming could have on their operations.
At the same time, banks and governments are more inclined to finance action against climate change – the debt market for environmental projects is booming. Goldman Sachs predicts that next year, renewable energy costs will exceed oil and gas exploration and production for the first time. The change is due to the growing difference in the price of capital – up to 20% for investments in oil and gas, compared to 3% to 5% for renewables.
These trends only accelerated during the pandemic. The quarantine imposed by governments to limit the spread of the virus has forced millions to work from home. The change in people’s behavior as a result of the realization that working from home is possible has long-term consequences for economies built on fossil fuels. Some governments have rightly introduced stricter regulations and incentives to promote green economic recovery. The European Commission is pushing for a new climate plan until 2030.
Among the leading companies in the industry, BP and its European rivals are at the forefront of the revolution, but success will be slow. The scale of investment needed by large oil corporations to shift to renewables is huge – analysts at Rystad Energy estimate that the new targets announced so far, including BP’s to build 50 gigawatts of renewable capacity by 2030, will require an investment of $ 200 billion. US competitors, notably ExxonMobil, have so far refrained from reducing hydrocarbon investment, but may eventually need to change course. Not surprisingly, national companies, which are responsible for more than half of world oil production, are reluctant to change the line.
The nature of future oil demand remains unclear. Consumption can remain stable at tens of millions of barrels per day for decades, even in the most dramatic transition to cleaner energy. The world also still relies heavily on oil as a raw material for other products, especially its derived chemicals. Some analysts predict that in the next few years there may be a shortage of supply, which will raise prices and lead to growth in new investment. Low cost manufacturers will continue to pump as long as they can. But the beginning of the end begins.