Mark Lewis of Kepler Cheuvreux (e-mail circular, no url): “Exxon downplays climate-policy risk to its portfolio saying all its hydro-carbon reserves will be needed.”
“In a press release issued yesterday afternoon Texas time, ExxonMobil announced the publication of two reports it had agreed to prepare in response to external pressure from shareholders and not-for-profit organizations. Both reports are available on Exxon’s website here. The first is entitled Energy and Carbon –Managing the Risks, and was written in response to pressure from Arjuna Capital and As You Sow. ….The second is entitled Energy and Climate, and was written in response to pressure from The Christopher Reynolds Foundation. The press release quotes Exxon’s Vice President of Corporate Strategic Planning, William Colton, who summarizes the findings of both reports thus: “All of ExxonMobil’s current hydrocarbon reserves will be needed, along with substantial future industry investments, to address global energy needs”.
Exxon explicitly rules out any risk of stranded assets in its current portfolio. In its report Energy and Carbon – Managing the Risks, Exxon explains that it makes its investment decisions on the basis of a “rigorous, comprehensive annual analysis of the global outlook for energy”, and emphasizes that its modelling of future energy trends has repeatedly been in line with the modelling of the IEA, the US Energy Information Administration (EIA), “and other reputable, independent sources”. It then goes on to make the following very clear statement (page 1): “Based on this analysis, we are confident that none of our hydrocarbon reserves are now or will become ‘stranded’. We believe producing these assets is essential to meeting growing energy demand worldwide, and in preventing consumers – especially those in the least developed and most vulnerable economies – from themselves becoming stranded in the global pursuit of higher living standards and greater economic opportunity.” (Our emphasis). In Section 5 of the report (pages 12-16) Exxon states that it is taking steps to address the risk of climate change in its own operations in “concrete and meaningful ways”, and it does acknowledge that policymakers will continue to pass legislation in the areas of energy efficiency and carbon pricing that will have an impact. In the end, though, the report is essentially arguing that business-as-usual will prevail in global energy markets for decades to come, owing to growing energy demand and the political need to keep costs affordable.
Exxon is making a political bet that affordable energy will trump climate-change as a policy concern: Exxon’s core thesis in Energy and Carbon – Managing the Risks is that population and GDP growth will continue to drive growth in energy demand, and that a continuing rise in global living standards—especially in developing countries — is contingent on affordable energy (page 2) : “Assuming sufficient, reliable and affordable energy is available, we see world GDP growing at a rate that exceeds population growth through the Outlook period, almost tripling in size from what it was globally in 2000”. This leads Exxon to conclude that “all economic energy sources are needed to meet growing global demand”. Exxon’s own base-case forecasts for energy trends over 2010-40 see oil demand growing by c.20%, gas by c.60%, coal flat, and renewables growing very quickly (especially wind and solar) but from a much lower base. Ultimately, then, its argument boils down to one of cost: oil and other fossil-fuels will be needed long into the future, and governments will balk at the cost of the kind of dramatic emissions reductions required by a carbon budget consistent with stabilizing GHG-concentration levels at 450ppm (page 11): “While the risk of regulation where GHG emissions are capped to the extent contemplated in the ‘low-carbon scenario’ during the Outlook period is always possible, it is difficult to envision governments choosing this path in light of the negative implications for economic growth and prosperity that such a course poses, especially when other avenues may be available, as discussed further below.” And just in case that sentence is not clear enough for some readers, the same point is made again (page 16): “In assessing the economic viability of proved reserves, we do not believe a scenario consistent with reducing GHG emissions by 80 percent by 2050, as suggested by the low-carbon scenario’, lies within the reasonably-likely-to-occur range of planning assumptions, since we consider the scenario highly unlikely.”
Our take: Exxon’s view of climate risk appears naively binary: the reality is much more nuanced. On our reading, Exxon is essentially arguing that only if governments institute climate policies consistent with a 450-scenario globally would there be a risk of stranded assets, and that (i) it thinks such a scenario is highly unlikely, and (ii) even then it implies that there would be no risk to its existing portfolio of assets, rather only to future planned investments (see page 8, and especially footnote 8). Without getting into the ins and outs of the undoubted challenges that exist in reaching a global climate agreement, we think this is a very binary approach on Exxon’s part to what is actually a much more nuanced issue. We also think there are other risks from climate and environment-related policy and market issues that could in the end have a significant impact on the value of Exxon’s assets.
Three risks to Exxon beyond a global climate framework The first risk we see is tighter national or regional climate policy. In other words, whether a global policy framework consistent with a 450-Scenario is ultimately put in place or not, there is always also the risk of tighter legislation that could lead to stranded assets in certain markets. A good example of such a risk at the moment relates to the ongoing debate over the Keystone XL (KXL) pipeline between Canada and the US. If President Obama ultimately decides to veto KXL, this could create stranded assets in the Alberta oil-sands plays both for Exxon and other oil companies. Second, there is the risk that certain kinds of investments – notably high-cost, high carbon assets such as Canadian oil sands – could become socially unacceptable as investments for growing numbers of institutional investors over time. Indeed, this was one of the assets explicitly cited by As You Sow in its shareholder resolution that ultimately forced Exxon to write the report it published yesterday. Third, we can also envisage a risk of stranded assets arising for oil companies under a scenario of rising demand and rising oil prices. Specifically, if oil prices rise faster in future than currently assumed by the IEA in its base-case projections, we think this could lead to an acceleration of the policy incentives for, and deployment of, renewable-energy technologies and energy-efficiency measures, and hence a faster shift away from oil in the global energy mix over the next three decades than Exxon assumes.
And recent capex cuts by Exxon and other majors point to future upside price risk Over the last two months, most of the world’s major international oil companies have announced cutbacks to their capex plans as costs have begun to outstrip prices, with Exxon itself reducing annual spend by $5.5bn over 2015-17 versus 2013 levels. This is despite the fact that oil prices have been stable at record-high real levels for the last three years. With capex plans recently having been scaled back by many of the world’s largest oil companies, there is a risk that supply will be lower than projected in future years. After all, as the IEA says (2013 World Energy Outlook: p. 459), “the main threat to future oil supply security is insufficient investment”. In short, we think these cuts to industry capex are bullish for future oil prices for two main reasons: (i) lower capex today implies a slower rate of future replacement for current production lost to ongoing decline, and hence greater difficulty in meeting future demand-growth forecasts; and (ii) if so many of the world’s major oil companies do not feel confident to maintain their capex levels with prices still at all-time record highs, this suggests that prices will have to rise further still in future for investment to revert to a track consistent with meeting the base-case demand forecasts of bodies such as the IEA, the US EIA, and indeed Exxon itself.”
Future Today
