Manager's View

Oil & Gas: Weighing the carbon costs

30/06/2016

Solange Le Jeune

ESG Analyst

As part of a project to assess mounting carbon risks in the energy sector, we reviewed the direct impact of potential carbon costs on oil and gas upstream activities.

Global pricing mechanism?

The most obvious and efficient climate change regulation should be the introduction of carbon pricing. Ecofys estimates that 12% of global emissions are covered by carbon pricing mechanisms – this represents a threefold increase over the past decade. We think the trend will continue, and we should therefore factor this risk into valuations for companies with long-life-cycle business models.

Our analysis

Our latest analysis focuses on the direct impact of a potential carbon cost on oil and gas upstream (exploration and production, or E&P) activities. While the energy used during extraction is minor compared to the scale of carbon embedded in fossil products, E&P remains an energy-intensive process.

We see greenhouse-gas-emission intensity in E&P activities as both a proxy for operational efficiency (as it reflects the energy cost of operations) and a risk of additional costs to operations (as carbon becomes regulated). Analysing emissions per barrel produced gives an indication of the carbon efficiency of extracting fossil fuels.

Is producing oil more carbon intensive than producing gas?

We compared our investee companies’ carbon operating efficiencies (E&P activities only) and attempted to differentiate between the types of fossil fuels they extract. We found that beyond the required upgrading process, it is not clear that production mix impacts emissions. Some companies are particularly carbon efficient despite being oil-focused and vice versa. Therefore, the carbon efficiency ratio is more likely to reflect operational efficiency.

Sensitivity to a carbon tax?

We analysed the carbon intensity of production (GHG emissions per barrel of oil produced) of our investee companies, looking at the cost of a carbon tax on their upstream businesses (based on 2014 emissions). We ran the analysis against a range of carbon tax levels. The higher the carbon intensity (per barrel of oil or per operating income) the more vulnerable to carbon taxes a company will be. Before drawing radical conclusions about individual companies, we would point out that:

•The carbon cost impact is a function of profitability (the stronger the financial performance, the better the resilience to more costs);

•Efficiency gains should be factored into longer-term analysis so that the ramping up of a carbon tax is offset – to some extent – by a reduction in energy use and carbon emissions in operations over time;

•Downstream activities may compensate for lower upstream profits (although one should bear in mind that a carbon tax would impact refining activities as well);

•Oil sands companies are impacted by some level of carbon price already (Alberta carbon tax on efficiency) hence we should see faster energy and carbon efficiency improvements in this local industry over the coming years.

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