Current trends and future outlook for the oil and gas sector in the context of climate change
Module 2b

What makes the market for oil and gas?

Demand: short term and expectations for the long term Supply: short term and expectations for the long term Availability and Cost of Finance Climate Change Commitments, Current and Future

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In the short term

Demand: Economic growth (e.g., China), global inflation leading to rising interest rates Supply: OPEC++ constraining supply to support the oil price, US shale starting to grow again Impact of sanctions on Russia: selling oil at a discount Investment response is muted despite price and energy security signals Higher interest rates and inflation increasing costs

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Climate change, all change? Transformation, not transition, is needed

Not just the oil and gas industry Agriculture, Buildings, Concrete, Steel, Ammonia, Textiles, Plastics, Glass, Ceramics. Everything we make, eat, wear, use, live in needs to be reconfigured Which will impact oil and gas demand, as will financing the transformation

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Substitution

Fossil Fuels are being, and will be replaced by renewables (wind, solar, hydro, bio diesel) Driven by falling costs More so when system scale storage is available Finance moves away from Oil and Gas

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Efficiency

In the IEA Sustainability Scenario, 80% of what limits warming to 1.5C is efficiency Reconfiguring every product, every process All business opportunities, very few if any for the oil and gas industry Finance moves away from the oil and gas industry

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Finance: climate change commitments

Many financial organisations in the private sector have made commitments to be 1.5C compliant Banks are less willing to lend Investors are putting pressure on oil and gas companies Many International Bodies are less willing to fund or insure oil and gas development

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Emerging norms around no new oil and gas

Influence of the IEA Net Zero report in 2021 Key conclusion that there is no room for new oil and gas development beyond projects committed to in 2021 if we want to stay within 1.5 degree warming. This would leave no room for NPG countries at the exploration stage to enter the market. Consensus has shifted New red lines New projects face increasing headwinds

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This pressure is likely to increase

Oil and especially gas are long term investments Cost recovery in the early years of a project means that governments are particularly bearing the risk of tightening climate change regulation/taxation/demand reduction

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Amid the gloom

There will be demand for oil and gas before and even beyond 2050 How much will depend on the success of mitigating technologies such as CCUS and credible offsetting Also political will which is unpredictable Mitigation versus adaptation

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What does this mean for emerging producers?

Not a lot of space for new investment, especially in exploration and early stage because of new uncertainties: Time: duration to recoup investment Policy changes: cost of carbon, trading rules, incentives to change demand, incentives for competition from clean alternatives

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Industry is changing

Capital markets look at emissions intensity Trading rules are changing, and climate intensity of oil and gas supplies is becoming a new benchmark Almost all listed international oil companies and many NOCs have set net-zero emissions targets by 2050, causing portfolio reassessments. Investment decisions already made with internal carbon price. Companies seek low carbon barrels – which means: Infrastructure to capture and use associated gas (no flaring) Short export routes Lighter crudes, non-sour gas Access to renewable grid energy Incentives for emissions management Reserves that don’t need enhanced recovery

Most international oil companies have set net-zero emissions targets by 2050, causing portfolio reassessments. Flaring, maturity and long export routes increase project emissions, making North America, Middle East and major LNG projects more attractive (Wood Mackenzie, 2020). Higher oil and gas prices since the war in Ukraine led to an increase of 12% of global upstream capital expenditure in 2023 from the previous year (Kimani, 2023). The bulk of this investment is directed to basins with existing discoveries offering ‘advantaged barrels’ – lower cost, lower emissions production that can be delivered quickly. As the industry turns away from exploration in undiscovered acreage, the prospects for the sector dim significantly in NPG countries such as Lebanon, and especially Somalia where there is no active drilling.

Trading rules are also evolving, and the climate intensity of oil and gas supplies is becoming a new benchmark. The European Commission’s carbon border adjustment mechanism introduces a levy on imports of natural gas that do not meet the EU carbon intensity standards. Trading platforms are using carbon intensity as a variable in crude price formulation (Rushforth, 2021). Some NPG countries could be advantaged in carbon-costed trading systems when compared to legacy producers with assets that have fugitive methane emissions (notable super-emitters are Turkmenistan, Russia, the United States, Iran, Kazakhstan and Algeria (Lavaux et al., 2022)) or those that require GHG-intensive enhanced recovery methods in older reservoirs (Lavaux et al., 2022; Masnadi et al., 2018).

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Flaring and methane intensity of oil and gas producers in the NPG and selected referent countries varies greatly

	Sources: V Marcel, D Gordon, N Ogeer, E Omonbude (forthcoming). Authors’ calculations using Skytruth data for gas flaring, EIA 2020 data for crude oil and lease condensate production, EIA 2019 data for dry gas production, except Norway, PNG, Saudi Arabia and USA: EIA 2020, IEA Global Methane Tracker 2021 data for methane emissions from oil and gas production. Note: PNG and Timor-Leste calculated as an equal proportion of 34 “other Asia-Pacific” countries.

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The opportunity for new producers: to take the lead and protect their projects from stranding

Changing an established petroleum sector, designed for different standards, is difficult. New producers may design their laws, regulatory systems, monitoring regimes and projects to minimise GHG emissions. Emissions intensities vary widely; using existing technologies and best practice can enable new producers to be at the low end of those ranges. Doing so should make their projects less likely to become stranded as climate change related restrictions tighten.

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Challenge: Finance and technical assistance in decline

OECD withdrawing support for the petroleum sector. Most countries contributing development finance have pledged to no longer fund oil and gas projects abroad – including the US, Europe, and the UK. Multilateral banks are therefore constrained (AfDB alone in wanting to finance gas projects). TA projects withdrawn (reputational risks). Countries struggle to obtain support for managing resource curse risks, transition risks, and emissions. Hard to do it alone.

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Is the sector rebounding post-Ukraine?

New interest in energy security. Higher oil and gas prices since the war in Ukraine led to an increase of 12% of global upstream capital expenditure in 2023 from the previous year. But that’s a modest increase. And most investments going to basins with existing discoveries offering ‘advantaged barrels’ – lower emissions but also low-cost oil/gas that can be delivered quickly.

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The importance of advantaged assets

Just as there is a cost curve for projects There will be a carbon and methane intensity curve The difference between the best and worst is significant The opportunity is to be low on both curves

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Break-even price range aggregated at the country level for selected NPG countries

Price to consumers will be higher, reflecting carbon taxes – collected by importing countries

Source: V Marcel, D Gordon, N Ogeer, E Omonbude (forthcoming). Author calculations using Rystad Ucube data

Note: The horizontal line in each box indicates the median cost; the ends of the box are one quartile away from the median; the ends of vertical lines show projects that are at the 5^th and 95^th percentile away from the median; dots indicate outliers. Investor hurdle rate assumed to be 10%.

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Climate change challenges petroleum development

Space for development is smaller Challenges to development are larger Uncontrollable factors: geology, geography Controllable factors: above ground emissions intensity, cost control, regulatory quality, inter-agency coordination, political stability Some opportunities remain for advantaged assets

Thank you
UNEP-Norway Partnership
United Nations Avenue, Gigiri PO Box 30552 – 00100 GPO Nairobi, Kenya	www.unep.org

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