In this latest in our series on ESG investing, Mike Scott assesses the global energy outlook ahead for 2022. Although oil and gas prices are healthy, energy firms will need to stay focused on net zero and emissions targets, and keep an eye on growth areas like hydrogen and other renewable energy sources.
On the face of it, life is good for energy companies – crude oil prices are predicted to be heading towards $100 per barrel and gas prices are equally robust. North Sea oil and gas producers are set to see ‘near-record’ cash margins in 2022.
Their growth prospects are so good that the UK government is considering a windfall tax to help alleviate the pressure on consumers’ expected increase in household energy bills.
In the short term, drivers such as geopolitical upheavals – from Kazakhstan to the Russia and Ukraine conflict, and Libya to the Gulf – plus Germany’s closure of its nuclear capacity point, to ongoing energy price strength all and give energy firms good reason to be bullish about 2022.
Global Energy Outlook for 2022
Underlying trends suggest the future is going to be more challenging for the energy sector as companies and governments aim for net zero emission goals.
A character in Ernest Hemingway’s The Sun Also Rises is asked how he went bankrupt and replies: “Two ways. Gradually, and then suddenly.”
There is a clear danger of something similar happening to the decline in fossil fuel demand, as highlighted by two recent announcements.
Maersk pushes towards decarbonisation
One of the world’s biggest shipping groups, Maersk, is bringing forward its decarbonisation target by an entire decade to 2040.
CEO Soren Skou said that when it set its 2050 target, it was a “moonshot” and it didn’t know how it would get there, but a combination of the ambitions of companies like Maersk and the innovation those ambitions fostered has made the new target possible.
Electric vehicle growth in Europe
Similarly, electric vehicle sales have progressed faster than expected in Europe, and they are now predicted to overtake gasoline car sales by 2025.
As sales move beyond eco-enthusiasts into the mainstream car industry, and more models and charging infrastructure comes on stream, the switch from internal combustion to green and hybrid alternatives will only accelerate – and that trend is only exacerbated by every $1 increase in oil prices.
Such moves will be reinforced by the continuing strength of carbon prices, in Europe but also, increasingly, in China.
Acting on Net Zero Targets
Governments, investors and the companies that buy energy have embraced net zero targets over the past two years, and this is the year that they start to digest what those pledges towards net zero by 2050 mean and turn them into meaningful action.
Following a year of unprecedented extreme weather events, most recently wildfires in the depths of a Colorado winter, the World Economic Forum’s Global Risk Report says that the three biggest global risks are climate-related, and these risks highlight some of the key drivers for the energy industry this year.
Global Risks to achieving net zero targets
The top risks are climate action failure; extreme weather; and biodiversity loss.
These factors highlight that companies will have to deal with increasing, and increasingly chaotic, regulation of carbon emissions, that they will have to ensure that their own assets are robust and resilient enough to deal with extreme weather events such as floods, wildfires; and there will be an increasing focus on nature-based solutions and efforts to protect forests and other biodiversity.
The Regulators Are Coming – And So Are Standards
In the US, the Securities and Exchange Commission is set to release its requirements for companies to disclose climate risks, joining the UK and the EU in demanding more information from businesses about their exposure to the impacts of climate change.
The growing number of net zero targets means that companies and investors will be paying increasing attention to emissions, not just within their own operations but within their value chains as well. Investors are becoming accountable for the emissions within their portfolios, and companies for those within their supply chains and beyond.
The $10.4 trillion Net Zero Asset Owner Alliance has just announced that its 69 members must cut the emissions of their portfolios by at least half from 2020 levels by 2030, for example. It has also expanded the asset classes it covers to include infrastructure, which will have implications for energy companies’ access to finance to develop new projects.
With the introduction of “green taxonomies” in the EU and the UK, which will likely be copied elsewhere, it will become easier for investors to know what constitutes a green investment and harder to justify directing capital towards “brown” companies, especially if they are not clearly demonstrating how they intend to become greener.
This will include scrutiny of executive incentive structures – those that encourage increased production of fossil fuels will attract increasing opposition and investors will want to see more sustainability targets as a component of bonus schemes.
This trend will be helped by the increasing standardisation of sustainability accounting, through the creation of the International Sustainability Standards Board and the EU’s Corporate Sustainability Reporting Directive.
Reduction of Scope 3 Emissions
Fossil fuel companies will come under increasing pressure to account for and reduce their Scope 3 emissions, those that derive from the use of their products by their customers.
This is something they have long resisted, but they will struggle to hold that line in 2022.
One of the arguments energy providers use to resist this trend is that it is very difficult to track these emissions, let alone control them, but this year will see that argument diminish in force as a range of new digital tools come online, such as Climate TRACE, the Al Gore-backed platform that is promising to bring “radical transparency” to the sources of global emissions using satellite data and AI.
New Climate Resolutions
After a record-breaking year for climate resolutions in 2021, both in the number that were filed and the number that were approved, 2022 will see more of the same.
One of the key architects of this wave, activist group Follow This, has said it will file at least 10 resolutions with companies this year, including Shell, BP, Chevron, ConocoPhillips, Phillips 66, and Occidental Petroleum, and for the first time at ExxonMobil and Marathon Petroleum.
This year’s AGM will be the first at ExxonMobil with the three board members appointed in the wake of start-up activist investor Engine No 1’s resolution win last year, so that meeting will be watched with close interest by the wider energy industry to see how Exxon’s stance has changed, if at all.
“Half a year after shareholder rebellions during their AGMs, the boards of oil majors are still determined to increase absolute emissions, while claiming to have support from their shareholders for their own ‘Paris-consistent’ strategies,” said CEO Mark van Baal.
Divesting Fossil Fuel assets and going private
In the face of this increased scrutiny and engagement, more companies will consider going private or divesting fossil fuel assets, as BHP Billiton did last year. But even these options are coming under increased scrutiny.
The SEC has already indicated that it is considering the role of private companies, and unlisted groups still have customers, investors and bankers, all of whom are increasingly concerned about climate issues and demanding more transparency from their suppliers. Consumers, too, are increasingly aware and vocal about climate change issues.
There is also a growing realisation that while selling off carbon-intensive assets is good for a particular company’s carbon footprint, it does nothing to cut overall emissions.
With the need for a Just Transition also in the spotlight, companies are set to come under pressure not to wash their hands of troublesome assets but to manage their decline, setting out a clear timetable for their eventual (but earlier than otherwise) shutdown and plans for retraining and redeploying workers.
Hydrogen and renewable energy growth
In the face of all these drivers, the rapid roll out of renewables and battery storage will continue, while the first meaningful volumes of clean hydrogen energy will come online.
It remains to be seen whether blue hydrogen will be the transition to green that many companies think. Given the surge in electrolyser capacity, blue hydrogen facilities may find themselves stranded within the energy transition industry before they get off the start line.
Road to sustainable energy and climate action
While the direction of travel towards a decarbonised energy system is clear, the road will not be smooth.
Governments are wary of job losses in the energy sector and shortages of some of the key long-term commodities that the global energy transition revolution requires, from copper to cobalt and lithium.
Meanwhile, elections in key countries including France, Brazil and Australia, along with the US midterms, have the potential to make a huge difference to the pace of climate action in years to come. It’s going to be an interesting year.