The Geopolitics and Opportunities of Decarbonization

Article courtesy the Carbon Herald

The war in Ukraine has created a new demand for oil and gas, but the energy transition to low-carbon energy sources and renewables remains one of the megatrends of the coming decades. How are energy companies responding to the call for decarbonization and what impact is the war having?

The geopolitics of decarbonization

The ongoing conflict in Ukraine has rearranged relationships between most, if not all, of the global economies. Russia is a key part of the energy landscape and its aggression has led to major shifts in policy.

The US and UK have banned its oil. Companies like Halliburton, BP and Shell have divested or exited the country. The EU has refocused towards LNG from the US, Qatar and Algeria.  

All these actions have caused gas prices to surge across the globe, as markets absorb the impact of the conflict. Demand for coal has increased amidst these high oil and gas prices.

Source: Wikimedia

With climate change a growing concern, there are many that feel uncomfortable with increasing our reliance on fossil fuels. UN Chief Antonio Guetteres recently said that pursuing dirty fuels to replace Russian hydrocarbons comes at too high a cost.

“Countries could become so consumed by the immediate fossil fuel supply gap that they neglect or knee-cap policies to cut fossil fuel use. And this is madness: addiction to fossil fuels is mutually assured destruction,” he said, quoted by CNBC.

To policymakers, having your own source of energy is not only a way to reduce climate change, but also a better alternative to relying on external players.

To that end, leaders of the European Commission, faced with high energy prices and exposure to Russia, have announced that the bloc will improve energy efficiency and increase the production of biomethane and green hydrogen.

Legislation and subsidies

The main factor driving the politics around this issue is the perception of climate change. With the effects of extreme weather events becoming more tangible, public perception of the threat from a warming climate has changed.

A slow but gradual shift is starting to take place across the political spectrum.

In the United States, for instance, Republicans and Democrats worked together to pass the Bipartisan Infrastructure Bill which includes initiatives for clean energy and electric vehicles (EVs) among others.

EVs have had government support on both sides of the Atlantic and this has supercharged their adoption in the last five years.

In Europe tax incentives and support for charging networks have been in place in Norway, the Netherlands and the UK. In the US, Tesla’s success story has much to do with the $4.5 billion in credits provided by the government throughout the years.

Carbon credit markets

Underpinning these efforts are carbon credit markets. Also referred to as compliance markets, their framework comes from state or regional laws.

Their aim is to compel large emitters to reach greenhouse gas emission targets. There is usually a quota involved, a limited and predetermined amount of carbon credits that can go around. This implied scarcity and the ability to trade the credits on an open market makes them like a commodity.

Now there are six carbon credit markets in different countries. The largest are in the EU and China, with the rest formed in Australia, New Zealand, South Korea, and the state of California.

With this market mechanism a price for emissions has been created and emitters can make an informed decision about how to behave - either pay a certain price for their emissions or reduce them.  

The US is considering plans for a similar mechanism and oil companies are monitoring that development. 

Exxon’s CEO Daren Woods has voiced his support for a carbon price by saying: “Putting a price on carbon will allow policymakers to eliminate the inefficient patchwork of regulations that is broadly recognized to be more expensive. Through the current approach, policymakers are putting a very high, but hidden, price on carbon that people can’t see and are unaware they are paying.” 

“An explicit price on carbon would be transparent, incentivize behavior to reduce emissions, allow the market to function efficiently, and stimulate the cross-sector opportunities needed to uncover the largest emission reduction opportunities at the lowest cost,” he adds. 

Renewable energy prices falling

Another source of “motivation” to decarbonize is the continued drop in prices for renewable energy.

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Clear cut energy producers of solar, wind and nuclear energy have not yet risen to compete with oil and gas multinationals. Many projects are public-private partnerships or utility companies shifting towards green energy.

An  example of such a shift is utility company Duke Energy. The North Carolina headquartered energy company recently announced plans to phase out coal plants and double their investments in renewables. 

Oil producing countries are also aware of the falling prices for renewable energy production and have been making progress on their own diversification.

Saudi Arabia announced plans to become a global producer of green hydrogen, with the United Arab Emirates also sharing a similar initiative.

Although hydrogen still has a lot of challenges ahead of it, Exxon has been keeping close tabs on its potential and is exploring opportunities for developing future hubs. 

Should renewable prices continue to fall and if they can  scale to meet rising demand, this could be an existential risk for oil and gas companies. This is part of the reason many energy corporations have started focusing on low carbon businesses and getting more exposure to end users.

Carbon management and acquisitions

Decarbonization itself can be a big business. According to Exxon, carbon capture will be a $2 trillion market by 2040 and energy companies are already jostling for a share.

At least four of them have already established business units that are focused on CO2 services and products, while Total have been busy with acquisitions that will allow them to develop low-carbon energy sources.

Exxon perhaps has the most ambitious set of projects when it comes to carbon capture and its utilization. The company has just appointed a new CEO of its Low Carbon Solutions and recently restructured its entire business to put renewables on the same footing as oil and gas production. 

Its carbon capture initiative has a reported budget of $3 billion, but the most ambitious idea they are working on is a $100 billion carbon capture hub in Texas.

Chevron has also been busy on this front with its own investment initiative. It has its own $300 million fund which has already made several strategic investments. One of those is in Carbon Clean, a producer of modular carbon capture systems that can be installed on a wide variety of plants at reduced costs.

Occidental is the oil company with a focus on what they call “carbon management.” Its CEO Vicky Hollub announced in October 2021 that the company will reinvent itself and focus on net zero projects. 

Its 1PointFive subsidiary is up and running and it recently announced its first sale of carbon credits to Airbus and that it will be investing $1 billion for the development of several hubs and up to 70 direct air capture (of CO2) facilities. These are landmark developments that demonstrate how such a business will work in the future and hint at its capacity for growth.

TotalEnergies has a slightly different approach to the challenge of renewables. The French oil giant has decided to expand downstream and gain exposure indirectly to renewables and the promise they bring through acquisitions. The company recently acquired a stake in Direct Energie, a French utility provider with over 2.6 million clients. 

TotalEnergies chairman and CEO Patrick Pouyanné commented on the €1.4 billion deal by saying: “This operation allows us to accelerate our integration downstream …[and] is part of the group’s strategy to expand along the entire gas-electricity value chain and to develop low-carbon energies, in line with our ambition to become the responsible energy major.”

Decarbonization or diversification?

Is all this just diversification? Hedging your bets against a risk that might develop into something more, without it being a certainty. After all, projected global demand for energy is set to outpace the growth in renewables.

But even though there is renewed demand for coal and oil, the factors driving the energy transition have not stopped because of the war in Ukraine. Some of them are even likely to accelerate.

Peter Drucker - credited as the father of modern management - once said: “We need to encourage habits of flexibility, of continuous learning, and of acceptance of change as normal and as opportunity - for institutions, as well as for individuals.” 

We are on the cusp of change for the oil and gas industry and its role in the world. And one thing is for sure - the energy transition will be impossible without a transformation of today’s largest energy companies.