Investors Open Path to More Upstream Growth

Investor tolerance for upstream growth this decade has improved significantly over the past year in response to mounting energy security concerns. While climate considerations have not disappeared, they are not the force they were before the outbreak of the Ukraine war for many investors — at least not when it comes to oil and gas projects with timelines before 2030. This sentiment shift may be most evident in waning pressure on oil companies to reduce Scope 3 (end-user) emissions, a movement that had been driving some firms — mostly in Europe — to plan for lower oil and gas production down the road. BP’s recent strategy shift is a prime example. The UK major’s 2020 strategic plan saw upstream production falling 40% by 2030, but energy security and valuation concerns forced a rethink. Under a new plan announced Feb. 7, it projected a more modest 25% decline in oil and gas production by 2030 and said it would invest an extra $1 billion annually in oil and gas. The moves forced it to relax its Scope 3 emissions targets, but BP shares have surged about 15% since the plan was unveiled. Bob Maguire, a managing director at Carlyle Group, told the recent CERAWeek by S&P Global conference that this share rally suggested “the marginal investor in BP is interested in hydrocarbons.” Under new CEO Wael Sawan, Shell is now reviewing its plan to reduce oil production by up to 2% each year this decade.

Oil majors emphasize that 2050 net-zero targets remain intact, even if they see room for more oil and gas production in the near term. However, for those committed to Scope 3, such as the European majors, an easing of this pressure could be an important test. Adding more production now could spell faster decay later, since cutting Scope 3 has effectively become code for reducing output volumes. Navigating the Scope 3 debate has been tricky for oil companies, since end-use of their products accounts for the vast majority of their overall emissions. Scope 3 pressure was never as intense in the US, where firms have argued that these targets disconnect supply from demand and, more recently, that they can be counterproductive. "If I have a Scope 3 target and try to limit my Scope 3 emissions, that means I make less gas. That means somebody else supplies coal out there and emissions for the world go up," Exxon CEO Darren Woods said at CERAWeek. US firms also argue that the work they are planning in carbon capture, which will help others reduce their emissions, would not be recognized by Scope 3 measures, which "disincentivizes me doing that," Woods said.

As more investors fret about energy price shocks, climate goals for the industry are increasingly being narrowed to the decarbonization of oil and gas operations. This emphasis on Scope 1 and 2 (operational) emissions has been at the center of decarbonization plans at top US oil companies and Mideast national oil companies in recent years. But the industry still has much work to do here. At CERAWeek, Sultan al-Jaber, CEO of Abu Dhabi National Oil Co. and president of this year's COP28 climate conference in Dubai, noted that only half of the industry has set a 2050 net-zero goal for Scope 1 and 2 emissions. He said the oil and gas sector must “up its game” and urged it to achieve net zero "even earlier" than 2050, hit net-zero methane emissions by 2030, electrify operations, roll out carbon capture and storage, improve its efficiency and help others address Scope 3 emissions.

While there is more freedom for companies to grow short-term oil and gas production, investor demands for strict capital discipline and robust cash returns remain. Moreover, finding upstream projects that can withstand price volatility while also enabling emissions reductions will be an enormous challenge. There is no guarantee climate demands on the industry won’t expand again in the future as the transition accelerates, just as they did during the pandemic when investors got a preview of what faltering demand could mean for oil companies. Despite the ongoing energy crisis, banks in Europe continue to target ambitious cuts in financed emissions and oil and gas commitments. And more production for oil companies means more emissions to abate. “As much as we think we have the ability to invest, we also increasingly are finding it difficult to find good quality projects to invest in,” Petronas upstream CEO Adif Zulkifli told CERAWeek. Projects "not only have to be low-breakeven, you also have to factor in carbon cost, and that makes things even more challenging," he added.