Political and social changes across the globe impacting the O&G leadership decisions

Climate change

?The world is in a climate emergency – “a code red for humanity” according to the UN Secretary-General. The concentration of greenhouse gas (GHG) emissions in the atmosphere is wreaking havoc across the world and threatening lives, economies, health, and food. The world is far from securing a global temperature rise to below 2°C as promised in the Paris Agreement. With a baseline in 1990, some countries are emitting more, some the same and others are emitting less.

To limit global temperature, rise to below 2°C aiming for 1.5°C, as promised in the Paris Agreement, countries must cut 30 gigatons of GHG emissions annually by 2030. The necessary solutions exist yet currently more emissions are entering the atmosphere making it harder to keep the planet safe.

It is possible to stay below 2°C aiming for 1.5°C temperature rise as set out in the Paris Agreement using existing solutions. They include renewable energy, green hydrogen, and modern bioenergy — and government subsidies and support could be directed to push towards low-carbon and green policies. Scaling up green transition efforts and reducing GHG emissions fivefold is critical.

Worldwide, the oil and gas industry accounts for 45% of anthropogenic GHG emissions, according to the International Energy Agency. That significant contribution has led to increased pressure to decarbonize on NOCs, along with international oil and gas companies. Governments, investors, customers, and other stakeholders have declared their intent to reduce GHG emissions. Companies are competing to see who can decarbonize first.

One option is to implement initiatives that offset emissions by tapping into natural carbon sinks, including oceans, plants, forests, and soil; these remove GHGs from the atmosphere and reduce their concentration in the air. Plants and trees sequester around 2.4 billion tons of CO2 a year.

The Italian energy giant ENI has announced programs to plant 20 million acres (four times the size of Wales) of forest in Africa to serve as a carbon sink. Other companies are looking at how to fund these offset programs.

Changing power sources. One oil and gas company is using on-site renewable-power generation to provide a cost-effective alternative to diesel fuel. By replacing generators with a solar PV and battery setup, the company not only reduced emissions significantly but also broke even on its investment in five years.

Connecting onshore or nearshore rigs and platforms to the central grid (as opposed to decentralized diesel generation) can also work well: for example, in its drive for electrification, Equinor recently connected its Johan Sverdrup field, which lies 140 kilometers offshore, to the grid.

Reducing fugitive emissions. Companies can cut emissions of methane, by improving leak detection and repair (LDAR), installing vapor-recovery units (VRU), or applying the best available technology (such as double mechanical seals on pumps, dry gas seals on compressors, and carbon packing ring sets on valve stems).

One company replaced the seals in pressure-safety valves, which had been found to be a frequent source of leaks and was able to monetize these streams of saved or captured gas.

One operator found that 70 percent of all flaring emissions came from nonroutine flaring, mainly as a result of poor reliability. It focused on improving its operations—for example, by carrying out predictive maintenance and replacing equipment. These actions not only reduced emissions but also raised production. Best-in-class operators are making significant strides (paces) in reliability thanks to area-based maintenance and multiskilling.

Permian Basin, a record 661 million cubic feet a day (mcf/d) were flared in the first quarter of 2019. Addressing this challenge requires additional gas-processing facilities, as well as gathering and transport infrastructure.?The Gulf Coast Express natural-gas pipeline, which went operational in September 2019, will help.

Increasing carbon capture, use, and storage (CCUS). While this technology is projected to play only a minor role in the sector’s overall decarbonization, O&G players can significantly influence its adoption and development.

There are also a number of demonstration and pilot projects. Total CCUS capacity could increase by as much as 200 times by 2050. In this market, the oil industry is well placed to lead because it already uses carbon captured via CCUS for use in enhanced oil recovery (EOR).

Rebalancing portfolios. Operators are starting to take a close look at their upstream portfolio choices. The highest-emitting reservoirs are nearly three times more emissions intensive than the lowest. Therefore, they may become increasingly unattractive to develop in the future.

One company saved €15 million in capital expenditures by forecasting its required steam usage hour by hour and incorporating this into a thermodynamic model to determine the required specifications for replacement equipment.

Green hydrogen. Hydrogen production through electrolysis has become both more technically advanced and less expensive. Bloomberg New Energy Finance estimates that the cost of hydrogen could drop as much as two-thirds by 2050.

Using renewable energy rather than steam methane reforming (SMR) could offer refineries a way to reduce emissions—a result known as “green hydrogen.” An alternative, “blue hydrogen,” uses SMR plus CCUS.

The attractiveness of the different technologies depends on the local economics—in particular, the availability of cheap storage capacity for CCUS or cheap renewable electricity.

Shell and ITM Power, a UK-based energy-storage and clean-fuel company, are building the world’s largest hydrogen electrolysis plant at a German refinery, with support from the European Union.

Revenue will come from selling hydrogen to the refinery, which will use it for processing and upgrading its products and for grid-balancing payments to the German transmission system. That business model justifies the installation.

Greener feedstocks. Replacing some conventional-oil feedstocks in refineries with biobased feedstocks or recycled-plastic materials would also reduce emissions. In an increasingly decarbonizing world, this may extend the lifetime of refining assets.

Investors are pushing companies to disclose consistent, comparable, and reliable data. Activist shareholders, for example, are challenging US- and Europe-based oil majors on their climate policies and emissions-reduction plans.

At the same time, renewable technologies have been getting cheaper. In the United States, the cost of solar—both photovoltaics (PV) and utility scale—has fallen more than 70 percent since 2011, and the cost of wind by almost two-thirds. By 2025, they could be competitive with natural gas–based power generation in many more regions.

To play its part in mitigating climate change to the degree required, the oil and gas sector must reduce its emissions by at least 3.4 gigatons of carbon-dioxide equivalent (GtCO2e) a year by 2050, compared with “business as usual” (currently planned policies or technologies)—a 90 percent reduction in current emissions.

Reaching this target would be easier if the use of oil and gas declined. But even if demand doesn’t fall much, the sector can abate the majority of its emissions, at an average cost of less than $50 per ton of carbon-dioxide equivalent (tCO2e), by prioritizing the most cost-effective interventions. Process changes and minor adjustments that help companies reduce their energy consumption will promote the least expensive abatement options.

The specific initiatives a company chooses to reduce its emissions will depend on factors such as its geography, asset mix (offshore versus onshore, gas versus oil, upstream versus downstream), and local policies and practices (regulations, carbon pricing, the availability of renewables, and the central grid’s reliability and proximity).

Many companies have adopted techniques that can substantially decarbonize operations—for example, improved maintenance routines to reduce intermittent flaring and vapor-recovery units to reduce methane leaks (Exhibit 3). Cutting emissions is not necessarily expensive. An onshore operator found that about 40 percent of the initiatives it identified had a positive net present value (NPV) at current prices and an additional 30 percent if it imposed an internal carbon price of $40/tCO2e on its operations.

The oil and gas sector will play an important role in the global energy transition; how it will face that future is a matter of strategy. As transparency increases, so may expectations. Customers, employees, and investors are already starting to distinguish the leaders from the laggards. Oil and gas companies that get ahead of the curve could find themselves better positioned for change.

Socio-demographic change

The oil and gas industry has faced a talent shortage for years due to an aging workforce, limited new/young talent entering the industry, and growing competition for talent with the technology industry. This difficulty in getting and retaining talent, which may pose significant issues for the future of the industry, can be attributable to several factors:

The negative perception of the industry: The industry is often cast in a negative light by the media. As a result, many talented individuals tend to shun the industry – although this is by no means universal.

That’s why oil and gas companies continue to rely on the experienced crews who often come back after retirement as contractors.

What’s more, there may be a need to “import” foreign employees from India, China, and Russia, for example, to help fill the breach. But that also may entail a host of political, immigration and security issues.

Lack of employees with the “right” skills:

India has been leading the world in awarding bachelor’s degree equivalent science and engineering (S&E) degrees, followed closely by China. The United States is a distant third with the largest percentage of S&D degrees awarded in the field of social sciences and behavioral sciences, a stark contrast to other S&E producing countries who tend to award engineering or physical, biological, mathematics, and statistics degrees (PBMS).

Employees with engineering and PBMS degrees are exactly the type of skills needed to develop technology and operationalize decarbonization investments in the oil and gas industry.

Oil and gas companies have to make sure they get and retain the necessary talent by reviewing their recruiting and retention efforts. They also need to find ways to upskill or retrain their current workforce, which is what over 92 percent of energy companies plan on doing to address this climate skills gaps.

The oil and gas industry is regarded as a relatively staid, conservative one. But to successfully compete for talent these days, oil and gas industry may have to become more flexible and adapt to the new realities of the modern workforce. Due to the COVID-19 pandemic, many companies permitted or accelerated remote and more flexible working arrangements for their employees whenever possible. This is a change that can help energy companies connect better with the values of coming generations.

As the workforce diversifies, managers should seek to expand their understanding of how to work with people from different backgrounds. This may include acknowledging and embracing the increased importance of ESG and diversity, equity, and inclusion demographics (e.g., race, gender) and values. This should be done at both the workforce and board levels.

Oil & Gas companies should consider crafting a value proposition that resonates with younger employees and potential recruits. Money isn’t everything, particularly for millennials; they tend to want challenging experiences that help grow their capabilities. Different groups and different generations may require different value propositions and also have different learning styles and communication styles that should be considered.

For example, one oil and gas company found that it was losing many of the millennials it had recruited. They were using the same onboarding procedures that had been used successfully for decades, with dozens of written forms, endless pages of orientation materials, and hours of classroom sessions. They decided to switch to a more virtual, mobile, and automated training process, which resulted in a much higher retention rate.

Tips for improving employee recruiting and retention:

Ramp up (or reinstate) summer internship programs.

Sponsor (or increase your investments in) scholarships, prizes, fairs, and afterschool programs that focus on STEM disciplines.

Organize business-school conferences and job fairs.

Forge stronger relations with universities and other training institutes.

Promote interest in the STEM disciplines among high school (or younger) students with campaigns and programs designed to appeal to this audience.

Political Change

In 2022, we are seeing the results of a supply shock with a tight oil supply and supply disruptions driving prices well north of $100 / barrel to near record highs. But there is a scenario where we can see a situation with excess supply later this year or early next. Volatility will likely be with us for some time.

The potential oversupply scenario happens if OPEC makes good on its commitment to continue unwinding the supply cuts it made in 2020.

If these events occur, organizations may end up with an oversupply of oil, with as much as an extra 6.4 million barrels per day late this year.

Add to that a potential new nuclear agreement with Iran and the volume of new oil coming onto the market this year will be even higher; some estimates have Iranian exports growing by up to a million barrels a day within a few months if a new pact is struck.

On the flipside, is Russia’s invasion of Ukraine, and the risks that it will lead to a further curtailment of Russian oil exports – including more drastic measures from Europe.

Outrage over the invasion has led to some self-sanctioning by western buyers; the US has already initiated a ban on Russian oil, and the European Union (EU) is actively contemplating one.

The IEA currently predicts as much as 3MM BPD (up to 3 million barrels in a day) of Russian exports could be taken off the market. On to the demand side, higher energy prices from the Ukraine crisis could have a knock-on effect on international economic growth.

Meanwhile, China is sticking with its “zero COVID” policy, which includes severe lockdowns and other business-limiting measures. President Xi's economic and environmental policies may slow down China’s economic expansion, and therefore decrease its demand for oil.?

Reductions in Russian sales of gas to Europe in late 2021 contributed to an energy crunch and record natural gas prices in the EU. How this crisis plays out in the longer-term will have significant implications for the energy mix in Europe over the next 5-10 years. Europe may delay implementation of some of its key “green transition” energy policies to avoid short-term pain.

On the other hand, many believe that this vulnerability will motivate EU countries to d accelerate the pace of their transition to renewables and clean energy to decouple from reliance on Russian gas. This will likely have a big geopolitical impact in terms of Russia's leverage over Europe, and also in terms of where Russia would sell its oil and gas supplies.

For example, Germany has said that, in light of the Ukraine invasion, it will not certify the Nord Stream 2 gas pipeline, which was designed to deliver more Russian gas to the EU.?

The bloc is also taking steps to displace some Russian gas with supply from the U.S. and Qatar until its transition efforts are further along and bear more fruit.

Fallout from the Ukraine crisis may accelerate the EU’s “Fit for 55” proposals, which aim to reduce greenhouse gas emissions by at least 55 percent by 2030.

Meanwhile, China forges ahead with its emission reductions. It turns out that in some parts of the world, energy transformation and energy security are seen as being synonymous rather than disruptive.

Activist investors shifting more of their investment dollars toward green energy.

Another game changer has been the expansion of social media platforms and new technology that provides activists with the ability to get their message out more widely to the general public and also more directly to corporate executives and board members. Climate activists are taking to the courts; although the results have been mixed, the potential liability and bad publicity it generates creates great uncertainty and risk for the industry.

As a result, oil and gas companies are feeling intense pressure to respond in terms of capital allocation decisions and strategy out of fear of damage to both their corporate reputation and bottom lines.

A surprising development that may come out of the private sector continuing to shift its investment focus toward green energy and away from oil and gas is that national oil companies (NOCs) may end up with even more power – at least in the short term.

Regardless of what happens in the long term, worldwide energy needs are not decreasing.

While some oil and gas firms may gradually get squeezed out of the market, it may lead to even greater reliance on the NOCs for their production. And this may give them greater political leverage.

ESG &CSR considerations

ESG is an acronym that stands for Environmental, Social, and Governance (also known as "ESG investing", “socially responsible investing,” “impact investing,” and “sustainable investing”) refers to investing which prioritizes optimal environmental, social, and governance (ESG) factors or outcomes.

Environmental

ESG issues with regard to the environment are largely driven by climate change. Many companies in the energy sector have begun to address these concerns with more efficient production methods and technology designed to reduce carbon emissions. These efforts can lead to cost savings as well as public goodwill towards the company, and ultimately value creation for all stakeholders of the business.

Social

Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates.?Social concerns can include such things as human rights issues, such as child labor or unfair wages. Most companies address these concerns through corporate social responsibility (CSR) programs, which may include company-wide policies that prohibit the use of child labor or encourage ethical business practices.

Governance

Governance can refer to several issues with regard to corporate management (i.e. leadership, executive pay, audits, internal controls, shareholder rights, etc.) . This can include transparency and conflict of interest policies, as well as internal structure and external relationships. For example, companies typically have internal conflict of interest policies to prevent the company's management from awarding contracts based on personal ties rather than merit.

Why is ESG important in the oil and gas industry?

According to an EPA press release from November 2021, one third of the warming from greenhouse gases today is due to human-caused emissions of methane, a potent greenhouse gas 30 times more powerful than CO2 in trapping heat in the atmosphere over a 100-year period.?Methane is a primary constituent of natural gas, and oil and gas industry is the largest industrial source of methane emissions.???

Increased scrutiny of the upstream carbon intensity associated with the production of fossil fuels (oil and gas) has prompted investors, consumers, and producers to seek new and innovative ways to reduce their carbon footprint and methane intensity.

Due to public and governmental pressure, some major oil and gas companies such as ExxonMobil, Total, and Shell are proactively supporting efforts to combat climate change. These efforts include reducing carbon and methane emissions in their own operations, as well as promoting research on renewable energy sources.?This has caused many other oil and gas operators to develop short-term and long-term goals and objectives around ESG.

Oil and gas and energy companies that ignore ESG will find themselves at a competitive disadvantage and subject to regulatory penalties.?A lack of an ESG strategy will ultimately affect a company’s access to the public and private capital.?This lack of capital will become a value destroyer.

Every business must understand its position against the ESG framework. That analysis and evaluation will drive the development of ESG corporate goals and objectives, and ultimately policies and procedures that are tailored to these ESG commitments.?As companies meet their ESG goals and objectives value is created for the business and its stakeholders.

Major players in the industry and the shifting landscape

Over the past 15 years, the annual total returns to shareholders (TRS) for the average oil and gas company has lagged the S&P 500 [The Standard and Poor's 500, a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices] by seven percentage points. This suggests the sector’s traditional business model has been under stress for some time now.

The first response of oil and gas companies, therefore, must be to build a portfolio that is resilient to both lower commodity prices and higher carbon prices. There are two important steps leaders can take to strengthen their positions, beyond no-regrets decarbonization of their operations and supply chain.

With no carbon price, 90 percent of all defined oil-focused projects are projected to break even at or below $60 per barrel.

With a carbon price of $100/ton CO?e, this share drops to 80 percent overall.

With commodity prices below $30 per barrel, just a quarter of global projects break-even at a zero-carbon price.

This falls to less than 20 percent at $100/ton CO?e.

In conventional onshore and shallow water, which together are projected to comprise almost two-thirds of global crude production in 2030, 25 to 35 percent are viable with a carbon price of $100/ton CO?e.

For deepwater, ultradeepwater, and unconventional resources, this share drops to less than 5 percent.?

At $200/ton CO?e, only 3 percent of global oil projects break even on current economic forecasts at $30 per barrel.

Many oil and gas companies are currently reevaluating their strategic responses to the energy transition.

Among medium-sized companies, Lundin Energy is a notable example. Lundin Energy has carefully high-graded its hydrocarbon portfolio to meet competitive breakeven. Electrification of the Edvard Grieg and the Johan Sverdrup operations is expected to help drive their emissions intensity to below one kilogram per barrel by 2022, at the same time improving production reliability. Lundin Energy is also making select investments in regional hydrogen and wind projects to help reduce its future emissions.

Integrated energy players are looking to retain their profitable core while also capturing some of the large global opportunities now emerging in low-carbon markets, including renewable power, bioenergy, next-generation mobility, energy services, and hydrogen. Players are betting that they will emerge as the natural owners of some or more of these investment classes based on their capabilities, technologies, relationships, and other incumbent advantages.

Well-known examples include oil and gas supermajors such as BP, which recently announced its transition from an international oil company to an integrated energy company.

Low-carbon pure players are taking this thinking one step further. They are betting heavily on building future-proof, low-carbon businesses while divesting themselves of legacy, high-carbon portfolios which could create management distractions and present investment propositions that are too mixed for both equity and debt investors.

Several medium-sized companies have recently made this shift, including ?rsted and Neste. ?rsted, a Danish energy company, has stated its goal is to become the “first offshore wind major.” Neste, a Finnish energy company, has shifted its historical asset base from oil refining and marketing toward processing biofuels.

Growth momentum in low-carbon technologies

The UN Paris Agreement, signed by 196 countries in 2016, committed the world to limit warming to 1.5 to 2.0 degrees Celsius above pre-industrial levels. To achieve a 1.5-degree pathway, all sectors of the global economy will require dramatic emissions reductions over the next ten years.

For this to happen, low-carbon technologies will need to grow quickly. The primary technologies—renewable power; electrification of infrastructure; bioenergy; hydrogen; carbon capture, utilization, and storage (CCUS); negative emissions technologies, such as nature-based solutions and direct air capture; and carbon trading—all represent potential growth markets.

Voluntary carbon markets, for instance, could scale 15 times by 2030 relative to their current size, and become a $15 billion to $40 billion a year market.

To deliver these dramatic rates of growth, enormous capital investment is needed. According to McKinsey’s 1.5-degree-pathway scenario, over the next decade $750 billion is needed to flow to CCUS, $200 billion to EV infrastructure, and $700 billion to hydrogen-production capacity. Renewable power is another magnitude larger; capital expenditures of $8.5 trillion are required to build the solar and on- and offshore wind capacity required from 2020 to 2030.

The European Green Deal proposes €1 trillion in sustainable investments over the next decade. And the complementary Just Transition Mechanism aims to mobilize at least €100 billion from 2021 to 2027 in financial and technical assistance to all parties most affected by the transition.

At the national level, many policies have also been put in action. For example, France announced plans to spend more than $8 billion on a decarbonized hydrogen economy through 2030, starting with a European hydrogen project in 2021.

On the other side of the globe, South Korea announced plans to spend almost $100 billion on green investments to support their post-pandemic recovery.

Capital markets are already driving dramatic growth in the value of companies that are strongly aligned with the energy transition megatrend. Renewable and biofuel pure plays have seen their earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples increase by 15 to 20 percent in the past two years alone, as investors start to anticipate long-term growth in these sectors.

The combined capitalization of what the Wall Street Journal called, “the new green energy giants”—Enel, Iberdrola, and NextEra—has increased by more than 200 percent, growing from $110 billion to $350 billion over the past ten years.

Meanwhile, the largest international oil companies—BP, Chevron, ExxonMobil, and Shell—have seen their combined capitalization shrink by 40 percent, from $980 billion to $570 billion, over the same period.

Changing risk-reward trade-offs

The second question is whether low-carbon markets can offer returns comparable to the existing hydrocarbon core in oil and gas portfolios. The pattern of returns across different energy sources has shifted materially over the past ten years.

Projected returns in oil and gas have followed commodity prices materially downward over the past decade. Median forecasted project internal rates of return (IRRs) have declined from 30 percent during 2010–11 to 15 percent during 2019–20.

As in all sectors, the range in returns between the best and worst players is far wider than the spread of average returns between sectors.

History shows that knowing where to play is critical, but how companies play and perform is equally important, as evidenced by the spread in returns within company segments. Advantaged resources and superior technical and operating capabilities have created disproportionate value.

Oil and gas companies are now working hard to update their strategies and shift capital in the context of the energy transition. But are they doing enough to change their operating models?

As many current players become major net sellers of assets and others go bankrupt, with their assets recycled to the remaining natural owners.

For example, in North America, bankruptcies rose entirely in 2020, with nearly 85 Chapter 11 filings by industry players through October. Based on Rystad Energy projections, at West Texas Intermediate (WTI) prices of $40 per barrel and Henry Hub Natural Gas prices, 190 companies might face bankruptcy before the end of 2022.

Resource specialists must relentlessly improve their capital returns and their operating performances while squeezing their operational carbon emissions and neutralizing, or compensating for, their residual well-to-wheel emissions footprints.

In terms of those following the low-carbon pure play archetype, several medium-sized companies have opted for more accelerated transitions to new business focuses and corresponding organizations.

For example, ?rsted (Arsted) has divested its hydrocarbon positions to become the world’s largest developer of offshore wind. There are material risks to ?rsted’s all-in strategy, but so far, the market response has been positive.

Neste is now becoming one of the world’s leading producers of renewable diesel and jet fuel. Companies in this category need to build material new-business-development muscle; they will need to participate in shaping demand for their new low-carbon products and work with external stakeholders, in creating markets, scaling supply chains, or developing approaches to attract funding.

To put this into perspective, think of how the era of large US oil companies shaped the evolution of the car-based economy a century ago.

Oil and gas companies need to consider where they are best suited to compete in the various low-carbon energy arenas. Then, they need to reimagine their longstanding operating models and forge new capabilities, leadership, and cultures to enable these new businesses to grow under their ownership.

Oil and gas giants have capabilities that may be valuable for parts of a new low-carbon energy system. Leaders can frame their strategic choices around where to compete amid economic uncertainties, considering the attractiveness of different low-carbon sectors?

Likewise, growth into hydrogen production and sales relies on several traditional oil and gas capabilities, such as access to capital, managing engineering complexity, and operating infrastructure safely and efficiently.

Renewable power generation, by comparison, represents the largest scale opportunity among these items, but it is unclear whether today’s oil and gas companies can emerge here as winners, versus the development specialists and leading utility players, such as NextEra and Enel.

All oil and gas companies will need to quickly adapt their operating models to build carbon management capabilities. Each company needs to know exactly how much carbon it generates, how much is in its products, how to reduce its carbon intensity, and how to communicate this effectively with regulators, investors, and customers. They also need to understand investor sentiment on carbon and how it could impact valuations and access to funding.

Winning in new arenas requires building an agile, attacker mindset while also retaining the resilience and risk-avoiding mindset of the hydrocarbon resource specialist.

For example, BP has chosen to combine its legacy exploration and production and refining businesses into one unit and has grouped many—but not all—of its low-carbon growth businesses into another.

Each oil and gas company will evolve their strategy in different ways based on their starting point and aspirations.

As the CEOs associated with the Oil and Gas Climate Initiative, put it in an open letter in May 2020, “the COVID-19 crisis is further crystallizing our focus on what is essential: health, safety, and protection of the environment while providing the energy and vital products that society needs to support economic recovery.”

One of the lessons of economic history is that successful incumbents can be swept away as a new era emerges. The challenge for today’s oil and gas CEOs is how to adapt to a low-carbon era—where to place their bets and how to evolve their companies. Exploring the three foundational questions outlined above will hopefully put them on course.

The oil and gas (O&G) industry earned record profits in 2022, providing ample cash flow to fund their strategies in 2023. And while O&G companies recognize geopolitical and macroeconomic uncertainty in the year ahead, they have also been given a clear mandate to secure supply in the short term while transitioning to cleaner energy in the long term.?

As the world moves away from fossil fuels and adopts more clean and renewable energy sources, oil giants that have dominated markets for more than a century could be in trouble. Some of these giants will fall.

Companies like ExxonMobil, BP and Royal Dutch Shell all have seen their stock prices decline over the past five years — especially at the onset of the Covid-19 pandemic, which crippled demand for oil and resulted in huge losses for even the biggest oil and gas companies.

ExxonMobil, the largest oil and gas producer in the U.S., lost $20 billion in 2019. The company still sports a market value of $275 billion — but as countries like the U.S. shift their energy policies to fight climate change, and the automotive industry moves toward an electric future, investors are becoming increasingly dubious about the future of oil stocks.

Nevertheless, key stakeholders believe that oil prices will remain high in the short term. They also think that companies need to plan for the transition to cleaner energy.

Amid a backdrop of increasing commodity prices, investors are optimistic that the oil and gas industry can continue its recent streak of strong short-term shareholder returns. Yet they also want leadership teams in the industry to think through value creation during the looming energy transition to more environmentally sustainable options. Those are the key findings from a recent survey of 250 institutional investors in the O&G industry conducted by BCG’s Center for Energy Impact.

Strong optimism in the near term

Despite the global energy crisis, energy company stocks are rising —up 50% year to date through late October 2021—on the back of high commodity prices. One recent survey’s results show that investors expect prices to remain robust (strong, healthy).

Approximately 70% of respondents expect oil prices to remain above $60 per barrel through 2024. That is significantly higher than reported in last year’s survey, in which the majority of investors projected an oil price between $40 and $60 per barrel.

Investors are just as optimistic about natural gas; 85% agree that it will play a critical role as a bridge fuel between traditional hydrocarbons and renewable energy sources to help the world decarbonize, and 70% want O&G companies to pursue growth in natural gas.

For management teams seeking some clarity about how natural gas fits into their portfolios, these results are a clear signal of growing support for continued investment as part of longer-term capital allocation strategies.

The optimism regarding commodity prices translates into total shareholder return (TSR). Roughly 60% of investors expect a continued recovery in TSR over the next two years. Most respondents (68%) believe that to meet that expectation, O&G companies need to maintain strong capital discipline. They also need to focus on profitability over the next three to five years (according to 60% of investors).

If short-term sentiment is positive, the longer-term feeling among investors is decidedly mixed because of increased attention on environmental sustainability. Nearly two-thirds of investors say that peak oil demand will occur by 2030. Only 30% think that O&G stocks will take on an increasing role in their portfolios in the next decade. Nearly 60% feel pressure from their clients to reject their fossil-fuel investments.

Investors continue to seek clarity regarding emissions reduction in the industry, along with a clear strategy for the energy transition. The pressure on the industry will likely grow; only 39% of respondents currently factor climate risk into their valuations of O&G companies, but another 40% say they plan to follow suit.

Given the growing pressure, investors believe that companies need to take several steps:

Set and meet emissions-reduction targets (cited by 80% of investors).

Invest in clean energy to enhance their long-term value propositions (cited by 82% of investors).

Collaborate beyond the O&G sector to set cross-industry standards regarding emissions targets (cited by 73% of investors).

80% of investors want clarity on companies’ plans for the energy transition. Most acknowledge that O&G companies have taken some initial steps to improve their environmental performance. Yet those measures, while noteworthy, will not be enough.

Investors also want to see results—hitting emissions reduction targets and showing EBITDA growth from companies’ low-carbon businesses in the next three years.

Among specific types of low-carbon initiatives, investors are more likely to see the value proposition in accessible electricity sector segments like renewable power generation and battery storage.

Given the level of long-term uncertainty in the industry, the current period of high oil and gas prices and strong TSR gives companies a critical window to make changes.

This survey data gives management teams an indication of what investors believe is the right course for O&G companies today.