Integrated oil companies are increasingly coming under pressure from investors and regulators to reduce emissions. Although their continued investment in oil and gas resources is being criticized, we find they are taking steps, to varying degrees, to address the emissions intensity of their portfolios because investors increasingly request they do so. Repsol REP, Shell RDS.A/RDS.B, and Total TOT lead on this front. The issue is increasingly one of competitiveness as well. As the global community reaches agreement that reducing emissions should be a common goal, so the probability of carbon taxes rises.
In this case, reducing emissions is equivalent to reducing costs, and those with the lowest emissions will therefore be the lowest-cost operators, a coveted position for a commodity producer. We have examined integrated oils' main efforts to reduce the intensity of emissions and how effective they might be. Our analysis suggests that investments in renewable power generation are most impactful for reducing full-cycle emissions, followed by increasing natural gas production. Reducing flaring and methane emissions is important for reducing operated emissions intensity and typically makes economic sense. Investments in electric vehicle charging and biofuels are unlikely to have a material impact financially or on emissions intensity.
Integrated oils largely recognize the need to reduce emissions and have adopted targets to do so. However, on average 90% of integrated oil greenhouse gas emissions are Scope 3--those that occur during the combustion of oil products and natural gas--and as a result are beyond the companies' control. Shell, Repsol, and Total have the most comprehensive plans for greenhouse gas reduction, including Scope 3.
All barrels are not created equal, and there is a wide range of emissions intensity for oil and gas companies. Moving from the upper to the lower end of the carbon-cost curve could reduce upstream-operated emissions by 85% or more. Other options such as improving energy efficiency by electrifying offshore fields or investing in or purchasing renewable energy for onshore fields can further reduce emissions for an oil and gas portfolio.
Increasing natural gas production can help improve total emissions intensity for those seeking to do so, such as Shell and Total. However, it's unlikely to reduce operated emissions for those companies just focused on reducing Scope 1 and 2 emissions, because on average, upstream-operated emissions are higher for natural gas. Even for those focused on total emissions intensity, increasing natural gas alone is unlikely to result in long-term targets being met.
Flaring, which is responsible for 23% of greenhouse gas industry emissions, is a key opportunity to make reductions while increasing revenue. For integrated oils, flaring is largely an issue in the United States (ExxonMobil XOM), and Africa and Asia (Chevron CVX, Eni E). Efforts to reduce routine flaring by building out gas infrastructure are paying dividends and we expect flaring levels to continue falling, given the commitments by management teams and favorable economic incentives.
Methane constitutes only about 5% of integrated oils' operated emissions on average, but given its greater global warming potential and opportunity for economic recovery, it's a key opportunity. Additionally, reducing methane leakage will improve the environmental credentials of natural gas and support future demand.
Integrated oils' move toward renewable power generation could be the most effective way to reduce emissions intensity. Ambitions vary widely, with Shell, Total, Repsol, and Equinor EQNR leading the way. While participation along the power distribution value chain is likely to lead to lower returns than oil and gas historically have delivered, it provides a way to generate cash flow to support shareholder returns and reduce the emissions intensity of the portfolio.
Electric vehicle charging provides a growth opportunity for integrated oils and a way to leverage existing retail locations to capture future demand. However, the economics of charging remain challenging, given low utilization rates and the preference for home charging. The adoption of ultrafast Level 4 chargers should improve utilization rate and returns. The amount of energy supplied will still remain relatively low, given the size of the integrated oils' portfolio, limiting the effect on emissions intensity as well.
Biofuels can reduce emissions intensity because their emissions are much lower than those from gasoline or diesel. However, investments are relatively small at this point relative to oil and gas production. Even assuming the most ambitious potential targets, such as Shell's, biofuels will remain a relatively small part of an integrated oil's portfolio outside technological disruption.
Integrated oils have multiple opportunities to deploy carbon capture to reduce emissions intensity, but cost remains prohibitive. Gorgon's liquefied natural gas carbon capture project is a good example, as are Equinor's offshore Norway projects. However, without a carbon tax, even at relatively reasonable levels of $20 per ton, many projects are unlikely to be funded.
Understanding Integrated Oils' Challenge
Key to understanding the sustainability of integrated oils is determining their ability to reduce emissions to satisfy regulators and investors as well as manage the transition to a lower-carbon world. Both goals go hand in hand because efforts to reduce emissions will involve adjusting the mix of energy provided to lower-carbon sources, which will ultimately ensure future viability. While the energy mix is part of the equation, there are several actions companies can take to improve emissions in their current portfolio. Based on the various metrics we examine, only Equinor scores in the top third in each, leaving ample room for improvement for the sector.
Despite popular perception about their indifference, there is consensus among integrated oils that there is risk surrounding greenhouse gas emissions, and as such, they should be reduced. The regulatory risk around not doing so remains uncertain, however, even with the Paris Agreement on climate change. While carbon taxes currently exist in some countries, they cover very little of global oil production or consumption. That said, the bigger risk is likely to be investors voting with their feet well before there is global governmental consensus on regulation, which is probably what integrated oil management teams believe is the more immediate threat.
Companies have found near-universal agreement on efforts and targets to reduce flaring and methane emissions thanks to industry agreements including the Oil and Gas Climate Initiative and World Bank, which have initiatives to achieve reductions in methane emissions and routine flaring, respectively. Ambitions to reduce carbon emissions, which represent the bulk of greenhouse gas emissions, are less uniform. Agreement on what constitutes the company's responsibility is even less clear.
Management teams, investors, and advocates often disagree on what emissions companies are responsible for, which is typically defined as scope. The nomenclature of Scope 1, 2, or 3 indicates when emissions are incurred. According to the Greenhouse Gas Protocol, Scope 1 is direct emissions from owned or controlled sources, Scope 2 is indirect emissions from the generation of purchased energy, and Scope 3 is all indirect emissions that occur in the value chain of the reporting company, including upstream and downstream operations.
The key issue facing any integrated oil company is that on average, 90% of its emissions are Scope 3, or those that occur during the combustion of oil products and natural gas. As such, the bulk of emissions from oil and natural gas are beyond the company's control.
Few companies are incorporating Scope 3 into their reduction targets or ambitions, and understandably so. While management teams can implement actions to reduce emissions during extraction or processing, such as reducing methane leakage, there is little they can do during combustion to address emissions, apart from changing the products they sell. Only three companies--Shell, Total, and Repsol--have incorporated Scope 3 emissions into their reduction targets or ambitions. The remainder of companies are focused solely on their own operations, which is positive, but any reduction will have little effect on global emissions, and thus their actions do little to stem the threat of declines in future demand related to emissions avoidance. However, in some cases the methods they are pursuing as part of their overall energy transition, such as producing more natural gas, will actually work toward reducing Scope 3 emissions.
Despite the challenges of controlling full-cycle emissions, it's likely that companies will face increasing pressure to take account of them. And investors are likely to increasingly measure companies on their total emissions as well as efforts to reduce them as part of efforts to ensure sustainability. As such, we include Scope 3 emissions in our evaluation of each company's carbon footprint and efforts to reduce its emissions profile.
As part of that analysis, we first standardize then measure emissions by company. This is more complicated than it might appear at first glance. While each company discloses a variety of emissions measurements, they often lack standardization, making comparability a challenge. Additionally, total emissions reveal little as they must be adjusted to each company's size. Perhaps the most complete metric, encompassing total emissions related to total energy delivered (including end use or combustion), is Shell's net carbon footprint metric. However, the calculation of this efficiency metric is not entirely clear, and few others produce similar metrics.
To capture this holistic measurement of emissions intensity, we have replicated work done by the Transition Pathway Initiative, which is composed of investors evaluating how companies are preparing for the transition to a low-carbon economy in terms of management quality and carbon performance. By replicating the initiative's methodology to measure emissions intensity, we can gauge where companies currently stand and ultimately how their strategic efforts might affect their emissions footprint. The result is an emissions intensity metric that combines emissions from production and combustion and divides that by the amount of energy produced (gCO2/MJ).
While we find this methodology useful, we caution against interpreting it as a precise metric of emissions intensity. Differences in disclosures, or the lack thereof, present problems when trying to precisely measure total energy output. However, we'd note two things:
First, there has been little change in the last five years. This is unsurprising, considering that the energy-supplied profile of each company has remained largely constant during that time. Second, there is differentiation among companies due largely to the structure of each company. For example, Eni scores well because of its large natural gas distribution business, which skews its energy supply toward lower-emitting natural gas. In contrast, Petrobras PBR scores poorly because of its relatively low natural gas output and high operated emissions. Equinor scores well based on high natural gas output and low operated emissions.
Our figures also might not be directly comparable with what the companies report themselves. For example, we calculate Shell's emissions intensity at 74 gCO2/MJ, while the company reports its net carbon footprint at 79 gCO2/MJ. However, we do think the metric is accurate enough to estimate the challenge that integrated oils will face when trying to reduce emissions and identify important differences between the intensity of companies. We think this metric is most useful in establishing a baseline for tracking future improvements.
Placing the integrated oils into context of the global energy supply shows their carbon emissions intensity is relatively high at an average of about 74 gCO2/MJ compared with 60 for the global energy supply. Furthermore, we can see that while ambitious, the targets laid out by Total (15% reduction by 2030), Repsol (40% by 2040), and Shell (20% by 2035, 50% by 2050) will not bring them in line with the International Energy Agency's 2-degree scenario, much less the beyond-2-degree scenario. Only Repsol's net zero emissions target by 2050 will do that. Still, the other targets will lead to an improvement beyond the Reference Technology Scenario, a baseline that incorporates existing energy and climate-related commitments by countries, including those pledged under the Paris Agreement. While the RTS does not incorporate achievement of global climate mitigation objectives, it does mark a break with the business-as-usual approach. As such, the targets set by those companies do mean a positive contribution to reducing global emissions.
In attempting to reduce emissions, integrated oils are typically using the same playbook by doing one or more of the following:
Reforming the oil and natural gas portfolio by jettisoning higher-emitting assets or improving energy efficiency.
Increasing the volume of natural gas produced or sold.
Reducing the amount of flaring and methane emissions.
Investing in the electricity value chain, particularly renewable power generation.
Investing in electric vehicles' mobility through charging infrastructure.
Increasing output of biofuels.
Exploring opportunities for carbon capture and storage.
Acquiring natural carbon sinks to offset oil and gas emissions.
Most areas of focus actually go toward improving full-cycle emissions (Scope 1, 2, and 3), but not all companies are pursuing the full range. Instead, nearly all are pursuing reduction of operated emissions, such as methane/flaring reduction, which aligns with most targets that are focused only on Scope 1 or 2 emissions. Although operated emissions play a relatively small role, at about 10% in our total emissions intensity calculation, our analysis suggest there is a relationship between the two. As such, while the effect of reducing operated emissions on total full-cycle emissions might be limited, it does behoove companies to focus on reducing operated emissions in a bid to reduce their total emissions intensity. In other words, reducing the emissions from extracting and producing the energy sold should contribute to reducing total portfolio energy intensity.
Therefore, companies can differentiate themselves by reducing operated emissions. If carbon taxes ever come to fruition, it will be important to have lower operated emissions as the associated costs will be difficult to pass along compared with those levied on consumption, which will be evenly distributed based on volume.