2022 was one of the most successful years for the oil and gas industry; the industry is estimated to have made income of USD 4trn vs an average of USD 1.4-1.5trn in previous years. The six largest western oil companies made more money than in any year in the history of the industry: over USD 200bn.
The dynamics behind this bumper year are pretty well understood – the Ukraine invasion layered on the supply disruptions from the global pandemic along with low levels of investment, but it is important to also acknowledge the role of government subsidies. While at COP26 in Glasgow in 2021, the states agreed to reduce fossil fuel subsidies, they doubled in 2022 to a record USD 1 trillion (twice the amount spent on renewables in 2022), according to the International Energy Agency report last month, not including the USD 500bn that was spent to reduce energy bills. These subsidies essentially protected consumers from the real market price of fossil fuels, therefore protecting demand and allowing for record-breaking profits.
Source: IEA, 2023
Why were these profits not taxed, considering they were due to a combination of exogenous events combined with government subsidies? For a successful transition to net zero, not only do fossil fuel subsidies need to be phased out, but the money needs to go into investment in transitional capacity and technology. Most governments have initiated windfall taxes on the supernormal profits, but these have been applied to only local extraction, not to international profits. We can imagine the extensive behind-the-scenes negotiations; while governments sought to reduce the profits made, many were also encouraging these companies to invest in new oil and gas projects locally to secure domestic supply. Various oil major CEOs publicly stated this wouldn’t be possible if their profits were going to be taxed away.
BP’s announcement that their carbon emission reduction targets would be significantly reduced due to increased investment in oil production was a further blow for climate change campaigners, although the headline was more damaging than the details. The company now plans to increase their investment in renewable energies and emission reduction efforts alongside increased capex on fossil fuel development, a theme we saw at other oil and gas majors. Bioenergy, hydrogen and EV charging are areas of focus for BP, whilst others, especially those in the US are focused only on reducing the emissions of their fossil fuel production (these efforts are long overdue and could have a meaningful impact on methane emissions). However, this conflicting message, of increasing fossil fuel investment while also investing in decarbonization, demonstrates the growing challenge for the transition, already immense in complexity we now have the additional factor of energy security and independence dominating conversations. Managing supply to match reducing demand will be volatile; especially when it matters where that supply is coming from.
BP forecasts their oil and gas production to stay relatively flat to 2025. Nonetheless, many of the oil majors are expecting their supply to grow annually; Chevron and Exxon are forecasting 3% production growth per year until 2027. This brings us to the final and most important point, which is whether there is a need for this new supply?
Whatever the scenario, there is a significant need for oil supply, however the pace of change for oil demand varies enormously depending on the assumptions for the transition. According to the International Energy Agency (IEA), their Net Zero Emissions (NZE) scenario shows that to achieve net zero by 2050 and to limit warming to 1.5°C we don’t need any more exploration, just development of current oil and gas fields. In the Announced Pledges Scenario (APS) which assumes all country targets and pledges are met on time and in full, demand peaks in the next few years before declining. Finally in the Stated Policies Scenario (STEPS) which incorporates only policies that are backed by existing legislation, demand won’t peak for more than 10 years.
Source: World Energy Outlook from the IEA, 2022
Looking at the scenarios in detail, the biggest potential driver of oil use reduction will likely be from the road transportation segment, the industry which accounts for nearly 50% of global oil demand. The big country level commitments to phase out internal combustion engines (ICEs) are included in the APS scenario. This scenario assumes that one in every two new cars sold across the US, EU and China are electric vehicles (EVs) by 2030. Is this a reasonable assumption? Will the industry pass a tipping point after which the infrastructure for ICEs starts to fall away and demand accelerates? Buses are already far ahead of passenger cars, and trucks are not far behind. To put this into perspective, in 2022 China reported a 28% EV penetration of passenger cars, while Europe reported a 20% penetration of pure EVs and the US lags behind at 5.8%. Of course, the fleet will move more slowly than the new sales, but this will also start to impact developing markets that often important older vehicles from western markets.
The key question is whether this much anticipated shift from ICEs to EVs will follow a steady pace or whether uptake accelerates as the market passes a tipping point. Many automakers are expecting a more rapid shift to EVs, especially those in high-end cars, and much depends on the continued cost reduction in the technology used in electric vehicles for a more rapid uptake in the mass market segment of the industry. Should there be technological advancements, a 50% penetration forecast may well underestimate the pace of this future change.
The recent good fortune for the oil and gas industry does not, in our opinion, affect these scenarios and what we consider the inevitable ramp up in policy response. The industry will need to decarbonise; the question will be how they manage the decline.