Survival of the fittest

In exceptional times for the oil industry, I got a unique view through the eyes of someone running an oil company, Lundin Energy CEO Alex Schneiter. He talked to me about the journey to today's focus on cost-competitive, low-emission production in Norway, which is free cash flow breakeven above USD 17 per barrel, the aim to achieve carbon neutrality by 2030, and how the COVID-19 shock might reshape the oil industry. These factors will remain critically important for the energy transition and future for many years, and we could see a new upcycle in 2022 and beyond.

In 2017, the company focused on its Norwegian Continental Shelf assets, spinning off the rest. Has your view on doing business in more exotic locations in this industry changed in a sustainability context, or from any other perspective? Or are there mainly other reasons behind this focus on a Norwegian core?

Alex: We used to have operations across the world, in places like Malaysia, Vietnam, Africa and Europe. Over the years, two things happened. First, we have had great success in Norway, with greater growth than we have seen in any other locations. And we see fundamental reasons for us to want to stay in Norway and focus on our assets there. There are still plenty of opportunities to grow in the Norwegian Continental Shelf. We are there to stay. Another attraction is the way you do business in Norway. It is a very transparent society, and its regulations are very forward-looking. Norway arguably has the best offshore industry in the world when it comes to efficiency and regulations. The business is very transparent and competitive, and you get rewarded for the work that you do.

We have been very successful in other countries in the past, like in Malaysia, for example. But in my experience from having worked all over the world, Norway has been one of the best places to do business. Success is not determined by the size of your company, but by what you do and deliver. We were small when we started in Norway, but with a very good team of people, putting in a lot of hard work, we have been rewarded for what we accomplished.

Then there is the ESG side of things, which is becoming ever more important. There is a lot of talk today about CO2 emissions and carbon taxes. But Norway implemented CO2 taxes in the 1990s. This has made its offshore industry very efficient, with no or very limited flaring of gas, for example. Its emissions are low. I think newer facilities in Norway are among the best in the world, with both high efficiency and low cost per barrel. As an example, Johan Sverdrup is a clear testimony of what the Norwegian oil & gas industry is able to deliver at its best. In today's environment, Norway is a great place to be.

ESG and the environmental focus will only grow in the future. The best and most sustainable oil industry players will grow and prosper, as oil will be a major energy source for a long time. But the weakest and least sustainable players may not survive. The combination of potential for finding new resources and the status of the industry and the nature of its regulations are such that Norway is the place to stay in.

This year, you have published a strategy to reach climate neutrality for the company in 2030, and you changed its name from Lundin Petroleum to Lundin Energy. Has there been a major change in the company’s view on sustainability or on the outlook for oil demand? If so, what prompted it?

Alex: Of course, you always want to operate and develop things in the most responsible and sustainable way possible. Twenty years ago the main focus was overwhelmingly on finding and developing resources, and other considerations like CO2 emissions were present but unfortunately much more peripheral. These considerations are now much more central in new developments today than they were in the past. As an example, if you were going to develop in an area like deep water or heavy oil 20 years ago, it typically made sense, and you went for it. If you ask me today whether if I am keen to develop less efficient barrels with high costs and emissions, my answer would be no. Today it is not even obvious that these kinds of assets will survive. I think all oil industry players need to focus on this shift in quality, to ensure their long-term viability.

I am convinced that fossil fuels – like them or not – are here to stay. They account for 80% of the world's energy use today, split between coal, gas and oil. And it is striking that we are still using coal, in a big way. We are talking about transitioning from oil, and yet we have not even finished transitioning from coal. Transitioning from fossil fuels will take some time but new technology will come, efficiency will improve. 

If you look at different forecasts, including those from the International Energy Agency (IEA), the share of fossil fuels in global energy use may fall from today's 80% to 68-74% by 2040. There is no getting around the fact that fossil fuels will still be crucial for many years, so there needs to be a greater focus on who is doing the best job developing them with the least impact on the world's carbon footprint and the environment. We have not yet found a technology which offers an energy intensity that can replace oil.

We issued a press release in January in which we explicitly explain our Decarbonisation Strategy and our ambition to become carbon neutral by 2030. This was not about us suddenly having realised that the world has changed and that we need to do something in response. It was more about us deciding to formalise what we had been doing for a long time. In 2010, before the COP21 Paris Agreement existed, we invested in the Edvard Grieg field to allow for possible future electrification, and in 2015 when we submitted our development plan for the Johan Sverdrup field we went for full electrification. In 2019, our board approved the full electrification of Edvard Grieg, which those earlier investments made possible. 

We started our decarbonisation journey 10 years ago, knowing that it was important to be as efficient as possible. In addition to the obvious pure ESG aspects, there are also strong business incentives to go down this route, as CO2 taxes in Norway have doubled in that period. It is a better financial deal for shareholders that we make the investments to electrify Edvard Grieg, instead of running with turbines and paying much higher taxes on the emissions. I think this shows that the Norwegian regulations and incentives are working and creating opportunities. They are having a real impact.

From 2010 to 2022, Lundin Energy will have spent half a billion USD on electrification of its platforms. By then 90% of our production will be fully electrified, and our emissions will be below 2 kg of CO2 per barrel of oil produced. I would say a global average in the oil industry is close to 60 kg of CO2 per barrel of oil produced. By next year, Lundin Energy should be one of the lowest, if not the lowest, CO2 emission per barrel oil producers in the world. And this matters. Yes, many are arguing that irrespective of our own emission profile as a company, the problem is our product. Use of oil as a fuel generates emissions. But everybody has a responsibility to keep their own house in order. I know it is unrealistic but as an illustration, if everyone in our industry produced oil with the low emissions levels we do we would be able to cut CO2 emissions by two billion tonnes per year. That equates to the same emissions savings as removing 700 million private cars from the roads. Why wouldn’t you want the industry to do that if it can?

So, to be more sustainable, we electrify our platforms. And we use electricity from primarily renewable sources. Fortunately, Norway has been blessed with abundant hydropower. Using this renewable energy, however, means it is not then available through the grid for other uses, and so to compensate for this we also invest in new renewable energy projects. 

We are not aiming to become a renewable energy company, but we are investing in renewables on the basis of the energy we are consuming offshore. We have invested in hydropower in Norway and in wind power in Finland, and we will need another project to be able to replace all of the electricity we will be consuming offshore by 2022. Those investments are also a way for us to better understand the renewable energy market. One day the renewable energy technologies will have improved to make them more efficient and competitive than today, and we should be prepared for that.

Our emissions from operations may be very low but we want to do better and overall get to zero, so we have a plan for achieving carbon neutrality. We have committed to use natural carbon capture for our residual CO2 emissions, and are doing this by planting trees through a project in Spain. This will also allow us to offset our carbon emissions from certain scope 3 levels such as air travel (aircraft and helicopters).

Having this clear road map for where we want to be in emissions, and how to get there, we simply took the next natural step and decided to formalise it and communicate it publicly in January. We felt we should walk the talk, and make a clear, unequivocal commitment, outlining our targets to emit 4 kg of CO2 per barrel produced now, falling to 2 kg by 2022, and ultimately to zero by 2030. Our variable compensation schemes include achievement of these targets as a key metric.

Changing the company's name from Lundin Petroleum to Lundin Energy is not a major thing, but we felt 'Petroleum' did not quite do justice to what we are doing, including our involvement in renewable energy and carbon capture. We felt the name 'Lundin Energy' better reflects the totality of what we are doing. Our investments in the electrification of our platforms, together with our investments in renewable energy, add up to roughly USD 750m. This is significant for a company of our size. 

Our industry-leading low emissions profile for an offshore oil producer means we are now attracting ESG funds to invest in us. Banks have a role to play as well, and I am convinced they will have to make choices regarding which oil producers they are prepared to fund. They may find it difficult to justify backing less efficient oil projects with a high carbon emissions intensity, given their ESG characteristics. Our board and management have the view that you need to be among the best in the industry in efficiency, or you will not face a bright future.

In your open letter to shareholders of 23 March you highlight that Lundin Energy is more resilient in an environment of low oil prices than ever, and you estimate that you need an oil price of about USD 17 per barrel to be cash flow neutral before dividends and debt amortisation. Is there any risk of this not being sufficient in an oil industry where geopolitical factors potentially influence supply and demand more than in the past, as evidenced by the brief oil price war triggered by Saudi Arabia earlier this year?

Alex: The whole situation around the COVID-19 pandemic is complex with so many moving parts, so we have to acknowledge that none of us can be sure how it will play out. Before even starting to speculate where it will lead, I think the priority has to be to make your business as resilient as possible for whatever lies ahead. For the oil & gas industry, COVID-19 is completely new, but crises are something we have experienced before. 

Oil prices collapsed during the global financial crisis of 2008-09. In 2015 we saw the supply shock from Saudi Arabia trying to price US shale oil out of the market. At that time we were just submitting our development proposal for the Johan Sverdrup field, and needed to finance up to USD 5bn in the capital markets to fund our production ramp-up, at a time when the oil price fell to USD 28 per barrel. It looks like we get hit by a crisis every four to five years. We have learned important lessons from each of them. One critical lesson is that we cannot afford to be a high cost per barrel producer. 

We need to be able to weather the storms. What it tends to boil down to is when you start generating free cash flow. You need low operating costs and very efficient operations to have a low free cash flow breakeven oil price. What I described in my letter is the ability of the company to achieve free cash flow breakeven at an average oil price of USD 17 per barrel for the next seven years. So in today's market, we are still generating free cash flow, which is a great position to be in. Looking ahead, when we reach post-phase 2 in the Johan Sverdrup field towards the end of 2022, our free cash flow breakeven point will be below USD 10 per barrel which is a unique position to be in and also a very resilient one.

I am not an oracle. Sure, I have my views but today's world is moving fast and is very unpredictable. Our business needs to be resilient and able to cope with whatever challenges lie ahead. Edvard Grieg and Johan Sverdrup are recent discoveries developed with the very latest technologies and with a very high level of efficiency. We also have high degrees of digitalisation and automation, which reduces the levels of staffing and the number of helicopter flights.

COVID-19 has been dramatic, with an unprecedented demand collapse for oil. I think the consensus view is that global demand for oil fell by 25 million barrels per day in April 2020, which is about 25% of daily supply. The big driver for this demand reduction is transportation, which accounts for about half of the oil demand. Everyone is checking traffic data, looking for signs of improvement. The industry saw a disastrous combination of a pandemic-driven demand plunge and a supply shock from Saudi Arabia flooding the market with oil. Saudi Arabia and OPEC have now changed their position and reduced supply. There are early indications that April and May could have been the low point, and that prospects are looking better for July. 

I think a further oil price recovery from current levels of around USD 30 could take time and continue beyond this year. As a company, we need to be able to cope with this. I think a positive effect for the industry from this crisis is that the very inefficient oil & gas producing assets will likely not survive. We have seen shale oil production fall by millions of barrels. We have seen platforms in the North Sea shutting down. I don't think all of them will reopen. A shock like this will remove the weakest capacity from the industry. 

Everyone is focusing on capital spending discipline. So are we, despite the fact that we have a very low free cash flow breakeven oil price. The next few months will see weak players coming under further pressure, forcing them to act. There could be strategic opportunities opening up for stronger players.

COVID-19 is causing an unprecedented demand shock for oil, particularly due to collapsed demand from the transport sector. Do you think demand will recover to pre-COVID-19 levels when the pandemic is under control, or do you expect to see structural changes in demand from, for example, changed travel and trade patterns?

Alex: Will oil demand recover fully after the crisis? I think it will recover, demand will pick up. I don't think the world has fundamentally changed. There is still a growing middle class in developing countries that will want to have the things we have. This will drive energy demand. 

At the same time, in advanced economies our experience with remote working and videoconferencing is making us realise that we may have been travelling a bit more than we needed. We have looked at this in our company, and I would not be surprised if we end up travelling less than we used to going forward, even after the COVID-19 restrictions are lifted. We will surely not be alone in this. Will we, and others, allow more flexibility to work from home in the future? Possibly. These behavioural changes will affect oil demand, but I think it will eventually go back to 100 million plus barrels per day, mainly driven by what is happening in developing economies.

When I was born, and I am not that old, there were about 3.3 billion people on the planet. Today the figure is 7.7 billion, and this could rise to 9 billion. All of these people want energy, need energy. Oil & gas will be part of the solution and has an important role to play in this energy transition era, provided that we produce efficiently. But I think we also need to deal with coal. If we can replace it with other energy sources, that will do a lot for the world.

Oil is a commodity with a volatile price, but the industry’s major E&P companies have arguably been quite successful in offsetting this volatility by being consistently high dividend payers. This may not be possible to sustain if demand shifts faster to renewables, or there are lasting effects from the COVID-19 shock. How do you think oil companies can take on this challenge?

Alex: The world is moving faster, and has become a more volatile place. When asked what keeps you awake at night, a typical oil company CEO will probably answer safety in the company’s operations. The last time I was asked that I answered that I trust my people are on top of that, and that a bigger worry for me is the pace at which the world is changing. It sometimes feels as if there are new technological breakthroughs or geopolitical turns announced in the media every day. 

In our industry, where you make investments which will last 20, 30 or 40 years (Johan Sverdrup is planned to last 50 years), it is difficult when things are changing so fast. Rising geopolitical tension has brought uncertainty, as has the demise of the era of globalisation, turning into rising nationalism and protectionism. I still believe market forces rather than politics will determine the long-term direction. As an example, the Saudis were flooding the market with oil before the COVID-19 outbreak became a pandemic, to lower prices and knock out the shale oil industry. 

When demand collapsed from the pandemic, the economic impact from lost oil revenues and associated pressure on public finances got the upper hand over geopolitical aims to pressure competitors. Saudi Arabia and OPEC+ accordingly changed course and cut production, in tandem with the Russians, to adjust to lower demand and prop up the collapsed oil price. I think the eventual oil price recovery will be based on fundamentals, not geopolitics. But in between, geopolitics can add to uncertainty and volatility. 

I see a risk that you start thinking a bit more short term in a more volatile environment. You will perhaps be overly cautious when going into new projects, considering all possible outcomes and their financial impact before taking a decision to develop a new project. But there is a flipside for the industry. The global oil industry is probably slashing its capital expenditure by over USD 50bn this year. We will likely also see companies going bankrupt and companies shutting down platforms which may not restart again. The oil industry has a lot of inertia. The shale oil players might be able to react quickly, but offshore is different. The Edvard Grieg field was discovered in 2007 and came into production in 2015. Johan Sverdrup was discovered in 2010, and came into production in 2019. It takes a long time for new projects to start generating cash flow. When you are not investing, you are not making many discoveries, you are not replacing what you are producing. By the time you realise demand for oil is actually still there, supply may not be as abundant. I can see a scenario where we see the opposite in 2022, with demand back to pre-crisis levels but with reduced supply. 

ESG is a factor here, too, taking significant capital expenditure away from the oil & gas industry that is not available anymore for developing new oil & gas projects. You could describe it as ESG moving faster than the underlying industry fundamentals. A lot of money is being ploughed into renewables, but with today's technology their lower energy intensity means those investments will not be able to make up for the shortfall of investment in fossil fuels. There is a possibility that this could also cause an oil price spike. 

Most people are not that familiar with the fundamentals. They might think fossil fuels account for 40% or 60% of energy demand, when in fact it is today at 80%. If you know the fundamentals, you can make the right decisions as a policymaker. Take the example of Germany, which suddenly decided to phase out nuclear power. And what happened? Coal filled the gap. There is not enough wind power to do it. Paradoxically, replacing nuclear with coal is counterproductive for CO2 emissions and the environment.

A more positive example is the UK, which has completely phased out coal power and replaced it with gas and renewables. It is of course commendable when advanced countries try to set an example of pursuing a critical environmental agenda, but initiatives from individual countries typically end up being symbolic as they will not make a big enough difference globally. 

The environment is a global issue, which requires global solutions. Reducing our problem to climate change, then to CO2 and finally to measuring emissions only at the point of energy production is a significant misrepresentation of our challenge. There is much that can be done within fossil fuels which could make a critical difference globally, such as replacing coal with gas, and focusing on the most efficient oil producers. Financial institutions, investors and banks have a role to play. They can direct their investments and their funding to the industry players that are the best, most efficient and doing the right things. There are tough challenges ahead that society will need to address because the transition will require enormous amounts of investment and profound changes in consumer behaviour.

For a small independent oil company, dividends can fluctuate, varying with the development of its portfolio and the oil price. For a super major like ExxonMobil, its size and balance sheet has allowed it consistently to pay a dividend for 30+ years. But our argument has been that we have significant growth to offer. In Lundin Energy, from 2010 to 2023, we will have grown from 20,000 to about 200,000 barrels of oil equivalent per day. 

Now some of the majors are letting the dividend vary according to market conditions. Some are resisting, but several have announced dividend cuts. Some have also started making major investments in renewables. The reality today is that returns on these investments are not as high as the returns on investments in oil & gas projects. This is provided that the oil price will recover. If you tell me it will stay at USD 10 or USD 20 per barrel, I don't think we will have an oil industry. It will not work. If you want to transition today from an oil company into a renewables company you will have to accept considerably lower returns, at least in the short term.

Lundin Energy is in oil & gas, and we are striving to be best in class. We are going into renewables, but we will do it step by step and link it to our oil & gas operations. If we go too fast, we will end up investing in projects which don't have the same returns. And then we could not pretend to be able to pay the same dividends to our shareholders. It is a balancing act. Yet commodities have cycles. I don't think this will change. I see the possibility of another upcycle for oil & gas in 2022 and beyond. We are in exceptional times. Longer term, I think the models of oil majors like Shell, BP and ExxonMobil will continue to work but they will go through a significant energy transition phase. 

The model in the future will only work if you continue to invest in very efficient oil & gas projects which have a low breakeven level and are resilient to oil price movements, and if you carefully manage the speed and execution of the energy transition phase to meet society’s need for more, cleaner and affordable energy.