Can Big Oil Adapt to Climate Change? Industry Analyst Views

Interviews with Industry Analysts

Editor’s note: There is no longer any serious dispute about the reality of climate change, or the need for political measures to address them. There remain, of course, very serious disputes about what measures are appropriate. Can the big oil companies adapt to a world that is undertaking policy measures to mitigate global warming?

To get a glimpse into industry views on this question, Multinational Monitor interviewed the following analysts: Sarah Emerson, director, Energy Security Analysis Inc.; Phil Flynn, senior oil market analyst, Alaron Trading; Linda Rafield, senior oil analyst, Platts; Jeff Rubin, chief economist and chief strategist, CIBC World Markets; Adam Sieminski, chief energy economist, Deutsche Bank; Bob Tippee, editor, Oil and Gas Journal; Philip Verleger, president, PKVerleger LLC; Phil Weiss, senior analyst, Argus Research Group.

Multinational Monitor: How will efforts to address global warming affect the future profitability of the oil majors?

Phil Weiss, senior analyst, Argus Research Group: There’s no doubt in my mind that global warming is something to be concerned with. The different oil companies have different views in terms of how they approach that concept. Traditionally, in any industry, as it makes major changes, the leaders today aren’t the leaders of tomorrow. There’s certainly a danger to any one of these companies that, as we develop alternative fuels, the business of these companies could suffer. They’re all taking different steps to try and plan for that future.
           
I actually think if you put too much of the burden on the oil companies, that could have a negative impact because they still need to explore, they still need to look for new things, they still need to develop new technologies. If you take away their profitability by putting various taxes and tariffs on those companies, that could limit exploration and limit their availability to look at new things.

Adam Sieminski, chief energy economist, Deutsche Bank: I don’t think that there are big issues in terms of the profitability of oil majors coming from climate legislation or regulation. From a climate perspective, the biggest problem in terms of fuels is coal. The real pressure is going to be on coal companies and electric utilities that rely on coal as the major source of their power.
           
Then you could look at it as many businesses are starting to do: What are the positive aspects of climate [change]? What are the needs that the economy will have because of climate legislation? You can argue, for example, that we need electricity; we can’t just shut the coal plants down. So we’re going to have to learn how to capture and sequester carbon dioxide. And sequestering it means largely pumping it underground. And guess who knows how to do that? The oil majors. They have the gas reservoirs that could be depleted or oil reservoirs that could hold the carbon dioxide, and they have the skills — they have already, on occasion, used carbon dioxide in tertiary recovery, which means they pump carbon dioxide into oil reservoirs to try and force more oil out. For all I know, climate change is going to have a positive impact on the oil industry rather than a negative one.

Philip Verleger, president, PKVerleger LLC: Some companies will respond, taking it very seriously — BP and Shell. Chevron actually looks like it’s doing a pretty good job. Some companies will resist. The companies that try to ignore it are going to really suffer.

Bob Tippee, editor, Oil and Gas Journal: Mostly what governments do in terms of taxation — that will be the main affect on oil companies’ profitability. No matter what happens with global warming politics, demand for oil will remain substantial. Demand for natural gas could be even more substantial, because natural gas [is] a preferable fuel in terms of the mitigation of global warming. Oil and gas companies produce a lot of natural gas, so if global warming politics attaches a premium to natural gas because of its lower carbon emissions, then whatever oil companies might suffer from in the way of oil can be compensated for in the way of natural gas. But that depends on the politics.
           
If politics treats all hydrocarbons alike and taxes them not on the basis of carbon, but taxes them because they are hydrocarbons, then both fuels stand to be more heavily burdened by taxation. Global warming mitigation would suffer accordingly, but oil companies will still be able to make money because the demand for those fuels is not going to go away.

Sarah Emerson, director, Energy Security Analysis Inc.: I don’t think it’s going to be a huge burden on oil. It certainly will affect demand growth, but we’ve already done that with the fuel economy changes and the alternative fuel changes.
           
If you then were to tax or put in a [carbon] cap-and-trade system, then you’re going to increase the cost to the oil company to make its products, but it’s pretty easy for the oil company to pass that on to the consumer. The numbers aren’t going to be huge. They might increase gasoline prices 30, 40, 50 cents a gallon.

Jeff Rubin, chief economist and chief strategist, CIBC World Markets: It will affect the future price of oil. Take for example, the Canadian oil sands: to go from roughly 1 million barrels of production to 3 million barrels of production in the next 10 years — that’s not going to happen at today’s oil prices. It’s going to take steadily higher oil prices to make that profitable, or to make it profitable enough that people are going to commit billions and billions of dollars to the development of that resource.
           
I would argue the peak in profitability in the industry probably was the last couple of years. Because what you’re seeing all across the world is that governments are now demanding a larger royalty share, or tax share, of the oil that’s coming out of their ground. I guess the most radical version of that would be Hugo Chavez basically expropriating Conoco-Phillips and Exxon in Venezuela. But even in Canada — even in Alberta — there’s been a royalty increase. And I think all around the world you’re seeing governments wanting a larger share of the huge economic rents created by today’s oil prices.

MM: How would a mandatory carbon emissions reduction affect the future of the oil industry?

Rubin: That would have a huge impact. If we’re really going to put a cap on demand growth, we’ve got to realize that unlike natural gas, which is used for heating and electricity generation, oil is basically a transport fuel. Seventy percent of oil is used in motor fuels, gasoline and, to a lesser extent, jet fuels. When you look at where the future growth of oil and demand is going to be, it’s going to be in countries that have exploding rates of car ownership. Those countries aren’t Canada, the U.S., Japan, Western Europe. Those countries are China or Mexico. Oil demand outside of the OECD [Organization for Economic Cooperation and Development], i.e. in the developing world, is growing about six to seven times the rate it is in the developed world. And prices have something to do with that.
           
All I can say is, if we are going to limit the consumption of oil globally, we have to move the focus outside just the OECD and onto the developing world. That’s where most of the growth is going to occur going forward, and has already occurred over the last four to five years.

Tippee: A shift to natural gas should be a natural outcome of an effort to reduce emissions of carbon dioxide. But that depends on adequacy of supply of natural gas, and it depends on the structure of the regulation that aims to bring this about — as to whether it allows that to happen. Some global warming remedies are to blindly [cut] off hydrocarbons — let’s do away with hydrocarbons. That won’t happen because those efforts don’t count toward the scale of the problem. Hydrocarbon energy is two thirds of total energy. The most you can hope for in any sort of economic or politically reasonable scenario is to hold that proportion even, or diminish it slightly, and let other forms of energy that make economic sense gain market share. But those other energy forms are very, very costly. The scale of the challenge to move away from hydrocarbons is daunting. We’re going to continue to use hydrocarbons no matter what, it’s just a matter of how much.

Verleger: I actually believe if we’re going to address it, we have to do a tax — a global tax — and it has to be integrated with the WTO [World Trade Organization]. With countries that don’t do something about this, we’ll put tariffs on their exports.
           
It’s actually going to help oil. The worst actor in global warming is coal. There’s not even a close second. The best is natural gas. And oil comes in three or four times worse than natural gas, but still much, much better than coal. If you do the rational policy, which is impose a tax on carbon, that makes coal much more expensive relative to oil and natural gas. It makes nuclear much more favorable, but we can’t do nuclear because we just don’t have the human beings who are trained.

Weiss: It depends on what they do along with it. If they were to just put in some type of emissions guideline like you’re speaking of, I think that would be less damaging. I’m talking more about different types of taxes, or limiting exploration. From a U.S. perspective, I think we need to have a diversified policy that lets us explore what we have here — I like to believe that there are [environmentally] safe ways that we can get at some of the things that we haven’t been able to get to. So I’d like to see a policy that’s more balanced.

Phil Flynn, senior oil market analyst, Alaron Trading: I think we’re moving that way, whether we like it or not. I think Kyoto obviously was a disaster that wouldn’t have worked anyway. I think the market forces are starting to move in that direction anyways because petroleum is getting scarcer. I think the market is going to encourage that more than these international agreements.
           
Carbon credits, I think, are going to be the best way. If there’s financial incentive to do this, or if you have a market that’s going to make it more efficient [to invest in and develop renewable energy sources], that’s going to encourage everyone to do it. If we can create a free marketplace with speculators and with market participants, I think a market-based solution is going to be, ultimately, what we come down to when you talk about emissions. And I think that’s going to be a great thing.

MM: Is it realistic to imagine that the oil majors might transition to a new business model where they provide more alternative energy or a variety of energies rather than just oil?

Weiss: I certainly think it’s possible, and some companies are taking steps. If I look at the range, Exxon is probably the most conservative in terms of its forays into alternative energy. Companies like Conoco-Phillips, Chevron and Shell are all looking at other things. But the costs of all those things are high and it’s really hard to tell at this point what the likelihood is that any one of them is going to be the solution.
           
I know that they’re expanding their business [in alternative energy], but if I were to make a bet, it would be that somebody different will be the leader. I’m not saying that these companies are going away. I’m not saying that they can’t have a role in a world that’s more carbon-friendly to the environment. But I wouldn’t necessarily expect them to be the leader, based on how it normally goes.

Flynn: Yes. Some of them will, some of them won’t. That’s why the free markets are good. We have seen a massive shift in the psychology from the old school to the new school with the big oil companies. Remember British Petroleum is now “Beyond Petroleum.”
           
Back in the old days, the oil companies were looking at alternative fuels as competition, and they were against it. I think now we’re getting to a point where they’re going to embrace it because, guess what? Global warming is great business. It’s a great gig for these companies. They should embrace this stuff because look at how much money these companies can make. I think if the oil companies don’t get in on alternative fuels, they’re missing the boat.

Rubin: That is happening in the U.S. right now, although under certain perverse circumstances. By that I mean that ethanol is being pushed in the U.S., particularly in the Midwest.
           
I don’t want to paint all ethanol with this brush, but when it comes to corn-based ethanol — that is, the ethanol produced in the United States through growing corn — I think it is a very serious head-fake and a dead-end. It’s a dead-end because the amount of dead energy contribution coming out of that is pretty marginal, maybe 20, 25 percent. Huge amounts of hydrocarbons are burnt in the process of creating ethanol from corn, and the inflation impact, particularly on food prices, is absolutely huge. If we can develop ethanol from fiber, from wood chips for example — something that has been done in the laboratory but is not yet commercially viable — that’s an entirely different story. Brazil is a different story because Brazil can produce ethanol efficiently from sugar cane. But don’t forget that Brazil is on the equator and can get multiple crops in one year. But what does the United States do? They slap a 56 percent tariff on Brazilian ethanol, which is produced efficiently, so they can protect inefficiently produced ethanol made by U.S. corn producers.
           
We’ve got to learn to grow the economy by not using any more fuel, as opposed to becoming more efficient [but overriding efficiency gains by] using even more fuel than we did before.

Emerson: They already have. I think most of the major oil companies are going into this transition where you could argue they’re going from oil companies to energy companies. Some people say they’re going from oil companies to energy technology companies. Some people say they’re going from oil companies to energy technology and delivery companies. I absolutely think that’s a trend that’s underway.
           
If you look at a major oil company and you look at the ratio of their downstream business to their upstream business — in other words, refining and retail and distribution versus how much crude oil they produce — they have much more downstream business. They are definitely very oriented to the end of the supply chain. So it’s very natural for them to get into alternative fuels, because their business is really providing a fuel to the customer.
           
That’s a very different situation than the national companies, like Aramco and NIOC and Pedevesa and Pemex and Petrobras — the big national companies that produce oil. All of their business is very clustered at the front end of the supply chain. They know their business is basically pumping the stuff out of the ground and putting it in a tanker and sending it to consumer countries. It’s not a natural for them to reach out and become alternative fuel producers, where it is a natural for a private multinational to do that. I think the private multinationals have woken up to this; I think they’re all examining sequestration technologies, they’re looking at alternative fuels technologies, they’re looking at alternative engine technologies with the auto makers, they’re looking at other ways to make diesel and gasoline themselves cleaner. Because diesel and gasoline are great products except for the pollution and the energy security questions.

Verleger: That model hasn’t worked. The oil industry tried it in the 1970s, it didn’t work. Other industries have tried it in the past. The renewables, I think, will be produced by a new set of companies.
           
The other thing is it’s going to be a long time before the renewables come forward. The scale of building a big industry and overcoming the different hurdles you run into just takes a lot of time. If we really want to do something, what we’re going to have to do is conserve — use a lot less energy. That’s the only thing we can do quickly.

Tippee: All the oil companies are looking at it and a number are investing in it, but there are some political problems. An example is when Conoco-Philips formed a joint venture with Tyson foods to make renewable diesel from waste animal fat. The biodiesel makers screamed bloody-murder and said, “We don’t want to let the oil companies into our space.” And some of the politicians are saying, “We’re not going to give a major oil company the same tax incentive that we give other producers of renewable diesel or biodiesel because they’re oil companies.”
           
In the case of fuels like ethanol and biodiesel, the plants that make those fuels are very small. And a plant that size is absolutely not material to the business of a major oil company. It’s too small to be considered much of a business at all, other than showing support for renewable energy.
           
If an oil company is going to get into, say, ethanol, it’s got to find a way to build a big plant. That means it’s got to gobble up all the corn or switchgrass or whatever it’s using, from all around. Other makers of ethanol aren’t going to like that very much. Or, the company has to buy a lot of those plants, which by oil company standards are quite small, and the ethanol industry, or the biodiesel industry, isn’t going to like that much either. So there’s some real political resistance.
           
The fact of the matter is there is real political resistance to allowing major oil companies into these markets on a scale that the companies really need. That’s not something that gets any attention at all in politics. But it’s a reality. And the experience of Conoco-Philips with renewable diesel shows the kind of resistance I’m talking about.

MM: Does oil company investment in renewable energy affect how Wall Street values them?

Rubin: I think how Wall Street values them is going to depend on how high oil prices go. And don’t forget technology just doesn’t occur in a vacuum. It’s inspired or influenced by market forces. The more that people come to realize that $100 barrel oil isn’t some temporary aberration, but the new point of equilibrium between the global demand and global supply curve, the more people are going to be willing to fund technology and alternative fuels, and the more Wall Street is going to be willing to underwrite securities of firms in alternative fuels.

Emerson: I think it will. I don’t think it does right this minute. There are two ways in which oil companies benefit, let’s say in the stock market, from looking at alternatives. One, they’re perceived as being more green. Everyone likes green companies, and so I think that’s an important PR development. Two, you see a lot of investment in biofuels right now by entrepreneurial companies. So some start-up that’s got a technology finds some venture capital angel to give him some money, and he builds this thing and it’s great and it’s new and it’s wonderful, but it’s on a pretty small scale. If you really want to develop a big alternative fuels component of our energy use, you’re going to have to get the deep-pocketed oil companies involved. And so the big action is going to be when they start producing the stuff.

Tippee: I think there are some investor groups that are really interested in green investment, but does that really alter the valuation of oil company stock? My suspicion is no. Renewable energy projects are not new for oil companies. Oil companies have been in and out of solar many times over the years.

Sieminski: Sure. I worked on the National Petroleum Council (NPC) — [a federally chartered industry advisory committee to the Secretary of Energy] — study that came out in July. What the National Petroleum Council said was that, first of all, we need demand management programs. This is kind of interesting if you think about it — that their leading point was we need to moderate demand growth for energy.
           
The second thing they said was we need to expand and diversify production from every energy source, including biomass and renewables and unconventionals. We need it all and we need it yesterday. That’s what $90 oil is telling you. The oil industry was not standing in the way of that. In fact, some of the oil companies have been very active in looking at solar energy and biomass activities because they’re big companies, they understand how to do these things.
           
The third major recommendation to the Secretary of Energy from the NPC was that we need to think about this on a global basis and integrate these policies into trade.
           
And fourth, they said we need to get some science and engineering capabilities going. It’s almost like what we did for the space program back in the 1960s. We just said look, we have an enormous problem ahead of us and in order to solve this we need lots of scientists and engineers. Let’s get going on that at the university level.
           
Finally, they said, we need a regulatory framework for carbon capture. If we’re going to capture and sequester carbon from coal plants and other fossil energy sources, we need the legal and regulatory framework that will make that doable. I suspect that we’re going to need something like a federal insurance policy for people who sequester the carbon dioxide, in the same way that we have an overriding federal insurance program for the nuclear power industry, the Price-Anderson Act. Somebody is going to have to put their names on one that has to do with carbon.
           
So sure, the oil majors are investing. BP has been very active in solar and a lot of the other companies have been looking at this. They’re going to do that because it’s in their own self-interest to make sure they have a product to sell in 25 years where maybe there’s going to be less carbon-based fuels being sold.

MM: BP is investing non-trivial resources in alternative energy, but a company like Exxon is not. Who is making the smarter move? If there were an emissions mandate adopted, would BP have a leg-up or would Exxon be able to catch up quickly?

Linda Rafield, senior oil analyst, Platts: I don’t think Exxon-Mobil is going out of business within the next 10 years because they don’t want to devote more resources to develop more alternative fuels. But I certainly think that very high oil prices and the rate of demand growth that we’ve seen in the last three or four years will keep prices high enough for companies to want to develop alternative fuel sources.
           
But they will do so as a result of pressure by the consumer. You reach a point in a mature economy like the United States where either disposable income is growing at such a rapid pace that can keep up with these types of price increases, or consumption is curtailed.

Weiss: Again, it’s probably too soon to tell only because an investment doesn’t mean anything. Look at the pharmaceutical industry right now. You’ve got companies spending billions of dollars in R&D [research and development] and they’re all facing issues because they have a dearth of new products that can replace what’s going off patent. So it sounds good, but we don’t know yet.