Oil and gas companies should be making hay while the sun shines and use their current record cash flow windfalls to speed up their decarbonisation plans, according to new analysis by Wood Mackenzie.

In the CO2mmit and CO2llaborate: Squaring the carbon circle for oil and gas report, Edinburgh-based WoodMac claims the oil and gas industry is currently on notice, with increased demand for accountability over carbon emissions.

“It is incredibly rare for an industry to get a decades-long notice that its business is under threat,” said Wood Mackenzie senior vice president, corporate research, Tom Ellacott.

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“Not only does the oil and gas industry have the luxury of clear warning, it has significant cash flow coming its way from higher prices. The commodity price upcycle provides a golden opportunity to accelerate emissions reduction, with a clear financial framework.”

$1 trillion windfall

Looking at a grouping of 45 international oil companies, WoodMac believes they will generate a $1 trillion cash windfall if current prices are sustained within a range of $50 to $70 per barrel to 2030.

“Allocating 30% of operating cash flow to shareholders would boost collective distributions by more than 80% versus 2020. That still leaves room to expand capital budgets by one-third relative to current planning and our base case,” said Ellacott.

If the windfall capital expenditure was channelled — at a ratio of 2:1, respectively — into low-carbon spending versus oil and gas, those 45 companies would have $660 billion of investment firepower to put towards decarbonisation, which WoodMac said represented a near threefold increase.

“This level of investment from the sector would fund more than 10% of global low-carbon energy investment by 2030, compared with less than 2% today. A commitment of this magnitude could be transformative,” according to Ellacott.

Hedging long-term carbon risk

David Clark, vice president of corporate research at WoodMac, said the cash windfall would allow energy companies “to do it all” and return money to shareholders, fortify balance sheets and accelerate corporate transformation.

“Many oil and gas companies willingly accept hedging costs in order to de-risk near-term cash flows. It’s time to hedge longer-term carbon risk with rising low-carbon investment,” he said.

“To build credibility, companies should lay out a clear financial framework for their energy transition. It should cover capital allocation between dividends, financing and investment in the legacy oil and gas businesses and low-carbon businesses.”

Clark added those frameworks would vary by company, but stressed all should have one thing in common: a quantified, credible, material and rising capital allocation to decarbonisation and low-carbon solutions.

Call for collaboration

WoodMac’s research found that, in addition to increasing investment, there was also a need to increase collaboration across industry, as well as with government and customers.

Its report identified four near-term imperatives that would require collaboration — the standardisation of emissions measurement and reporting; partnering with other companies and industries to support the development of emissions-reducing technology; engagement with governments to create supportive regulatory and policy frameworks; and developing a credible, liquid, global offset market that accurately reflects the cost of carbon abatement.

Scope 3 emissions

While many companies have already committed to reducing their Scope 1 and 2 emissions, increased pressure is being placed on curbing Scope 3 emissions, with WoodMac highlighting the recent court verdict in the Netherlands for Shell to reduce its absolute Scope 3 emissions by 45% from 2019 levels by the end of the decade.

WoodMac noted the only way to plausibly achieve that target by 2030 would be through massive divestments. However, it also points out that will only result in a reshuffling of asset ownership while having little impact on overall emissions reductions.

“Stakeholders need to recognise the dilemma facing oil and gas companies. Rapid and large-scale divestment to reduce Scope 3 emissions is counterproductive folly,” said Ellacott.

“Scope 3 reductions are fundamentally a shared responsibility between suppliers, governments and consumers. For the industry to defend that position, however, it needs to produce a credible alternative.

“A disunited, dismissive industry runs the risk of an accelerated wind-down and de-rating long before oil and gas demand disappears. A committed and collaborative response, in contrast, could transform (international oil companies) into a credible part of the solution.”

While noting that carbon capture, utilisation and storage and blue hydrogen offered enormous long-term low-carbon potential, it would take time to build the necessary scale and reduce costs and would not materially reduce Scope 3 emissions by 2030.

However, investment in building a renewables portfolio will help reduce emissions intensity, while upstream electrification is another entry point into renewables, reducing Scope 1 and 2 emissions while creating long-term optionality.

While many companies have set net zero goals for Scope 1 and 2 emissions by 2050, WoodMac also suggested companies should look to accelerate those plans.

It estimates the 45 companies in its international oil company peer group have $465 billion of value at risk from Scope 1 and 2 emissions, alone, under a $150 per tonne carbon price scenario — equivalent to 27% of their current value.