Climate change, business, and the business of oil: Yes, it’s a big deal

Doing business is complicated. Successful leaders need to master or oversee a wide ride of capabilities, such as finance, marketing, and innovation. They also have to protect their firm’s reputation and oversee relationships with regulators, government, suppliers, shareholders, and employees.

Is it time to add dealing with climate change to that long (but still non-exhaustive) list? Yes, say two of my colleagues in a recent commentary, “Earth to CEO: Your Company Is Already at Risk from Climate Change” for Fortune magazine. “Climate change is here,” write Dickon Pinner and Kevin Sneader, McKinsey’s global managing partner. “Its economic impact is real and growing, and action now is essential.”

I think they have a point. Coping with the complexities around climate change can—and will—touch on just about every aspect of business, from recruiting and supply-chain management all the way to paying out dividends and writing the annual report. It’s that big a deal. As my colleagues put it, “Business leaders can no longer ignore the physical effects of climate change, at least not without peril.” Then they go on to detail specific things companies can do as they face a future in which they can no longer assume there will be a stable and relatively predictable climate: examine and plan for potential risks; protect assets; decarbonize operations; and make climate intelligence a core capability.

The common thread is adaptability. And that means deploying a core skill: managing. Climate change presents two kinds of challenges. One is how to react to big events, such as storms. The other is how to deal with increasing climate regulation.

I have spent my career in the oil and gas industry—one of the sectors the authors single out as needing to engage. So if we accept that climate change matters, and that it will matter to business, where does my industry fit into the debate about the future?

Right in the middle of it.

I make this case on three observations. The first is that climate change—and the global response to it—could represent a once-in-every-few-generations shift for the O&G industry.  According to McKinsey research, if aggressive and effective efforts are made to meet the Paris climate conference goals, that could accelerate “peak demand” for oil from the early 2030s to as soon  as 2025, reducing consumption to about half of today’s level by 2050. If that happens, margins across the value chain could change drastically. Some investors are already wary.

Oil-and-gas companies therefore need to make it a high priority to adapt their operations to protect against a changing climate. That means preparing their refineries, chemical plants, and production operations to operate reliability in more extreme weather. My hometown of Houston has had three “once-in-500 year” storms since 2014.  Refiners will need to do more ensure their plants are protected from floods.

Second, carbon regulation is likely to come—or more precisely, to intensify, as there has already been a good deal of it. A price for carbon will probably be more widely applied, either implicitly (through mandates) or explicitly (through carbon trading, a carbon tax, or carbon incentives). As that happens, the relative cost position of oil and gas will change for the worse. That will increase the pressure to reduce greenhouse-gas (GHG) emissions throughout the supply chain—production, processing, pipeline, and refining. Eventually, that could extend to reducing emissions in the industry’s products.

My third observation is that the oil-and-gas industry is not going away anytime soon—and that is a good thing. Access to low-cost, reliable energy is essential to economic development; oil and gas will continue to be part of that equation. The International Energy Agency, for example, estimates that, given current policies, in 2040, coal, oil, and gas will account for more than 70 percent of global primary energy demand. Under the IEA’s Sustainable Development Scenario, which assumes more aggressive action, fossil fuels still account for more than half. Even as demand peaks and begins to decline—whenever that happens—enormous capital investment will be required to keep up. Management will need to ensure high returns are generated from this investment, even as they are transitioning into an entirely new energy industry.

Add it all up, and it implies a very different kind of future. If some of the pessimistic cases presented by scientists turn out to be correct, the world will need the engineering and management capability of oil companies to help decarbonize the industrial sector, for example through carbon capture use and storage (CCUS). CCUS could be a huge opportunity—for both the climate, and the industry. O&G operators have  the expertise; in fact, they already use stored carbon for enhanced oil recovery.

If the industry could be incentivized to galvanize its resources to take on the task of capturing and storing CO2 in a big way, that could play an important role in containing temperature increases and bringing the climate into a new equilibrium. Of course, that assumes that there is an O&G industry to do the work. The industry also can play a role in the development and deployment of hydrogen and of negative emissions technologies—meaning ways to store and/or suck emissions out of the air. Examples are direct air capture and carbon storage (DACCS) and carbon mineralization.

How likely is the O&G industry to change? I think it’s certain to. For one thing, many companies are already investing in resilience to reduce the operational risks of climate change, for example by building sea walls and berms to protect Gulf Coast refineries and petrochemical plants. In addition, almost all the majors, as well as many smaller operators, have set a goal of zero flaring by 2030 and are working on cutting methane emissions. Many have set internal carbon prices and GHG reduction targets.

In short, I believe that the O&G industry is not only part of the problem of climate change, but also part of the solution.

All views are mine and not those of McKinsey & Co.