Action to achieve Paris climate goals will upend oil and gas markets
If the world acts decisively to limit global warming to 2°C by 2050, the scale of change will revolutionise the energy industry. Progressive electrification will squeeze the most polluting hydrocarbons out of the energy mix, nearly eliminating their markets. Oil demand will shrink, and with it, so will the power of major oil producers. Gas demand will remain resilient, but business models will need to evolve.
Ann-Louise Hittle, vice president, Macro Oils, at global natural resources consultancy Wood Mackenzie, said: “Our Accelerated Energy Transition Scenario – AET-2 – gives an indication of how energy demand, supply and pricing will change if policy and technology are rapidly deployed to cut greenhouse gas emissions in line with the Paris Agreement.
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“If we move to keep global warming to the 2°C limit set by the Paris Agreement, the energy matrix will change – and change profoundly.”
She added: “Our AET-2 scenario is a scenario, not our base-case forecast. It is one interpretation of how the Paris Agreement could be achieved, based on our fundamental analysis across the natural resource sectors.
“Even so, the oil and gas industry cannot afford to be complacent. The risks associated with robust climate-change policy and rapidly changing technology are too great.”
Under WoodMac’s AET-2 scenario, oil demand will drop significantly, and with it, oil prices. OPEC has an oil-market share of more than 50% by 2050, but less control. The steep fall in demand prevents those key oil producers from managing the market and supporting prices in the way it does today. Despite losing their price-setting ability, however, low-cost Middle East OPEC producers remain core providers of oil.
Oil demand begins to drop in 2023. Soon after, the decline accelerates to year-on-year falls of 2mn barrels/day, reducing demand to about 35mn b/d by 2050.
Consequently, oil prices begin to slip later this decade. By 2030, under AET-2, we would expect Brent to average $40/b, down from $60 to $70/b currently. By 2050, Brent may slide to $10 to $18/b.
Gas demand, however, remains resilient.
Massimo Di-Odoardo, vice president, Global Gas & LNG, said: “Replacing coal with gas for power generation in Asia’s developing markets contributes to 8% of global emission reductions under our AET-2 scenario. Large-scale development of CCS/CCUS in the industrial and power sector supports gas, while the deployment of blue hydrogen is a gas growth segment.”
Di-Odoardo said the resilience of gas demand will continue to require investments in gas and LNG supply which will support prices. As oil prices decline, gas will eventually trade at a premium to oil under Wood Mackenzie’s AET-2 scenario, accelerating the shift of capital investment towards the sector.
The price outlook for gas under AET-2 remains firm. In North America, low oil prices lead to reduced tight oil production, cutting into the availability of cheap associated gas. Greater volumes of expensive dry gas are needed to meet gas demand. Our analysis shows Henry Hub prices trading at $3-$4/'ooo ft3, similar to our base-case view.
In the global LNG market, resilient Asian gas demand leads to reliance on 290mn metric tons/year of pre-final investment decision LNG supply, including higher-cost US LNG. As a result, LNG prices jump to $8-9/mn Btu by 2040. It is not until after 2040, when global gas demand begins to ease, that Henry Hub and LNG prices start softening due to increased competition of supply.
Di-Odoardo said: “We estimate that an AET-2 world would require $330bn to support LNG growth globally and $700bn to support dry gas development in North America.
“However, business models under AET-2 will need to evolve to maintain margins and the ability to raise capital in a low-carbon world. Gas and LNG sellers will need to focus on low-cost, low-carbon supply and Scope 1 and 2 CO2 emission reductions as carbon prices increase. The management of Scope 3 carbon emissions through CCS will need to become a part of integrated gas and LNG sales strategies.”
AET-2 would see gas pricing paradigms evolve too. LNG is increasingly commoditised as oil indexation becomes irrelevant, requiring a dramatic overhaul of existing oil-indexed contracts. Carbon prices will define netback values for producers as natural gas competes with hydrogen and gas-plus-CCS in the industrial and power sectors. Trading of carbon emissions, offsets and credits are key to ensuring value creation across the gas and LNG value chain.
Gas is not the only sector to see a change in fortune in a 2C world. The downstream sector faces continued rationalisation as oil demand collapses.
The AET-2 scenario is grim for the downstream sector. The scenario modelling shows that by 2050, our global composite gross refining margin is negative. Alan Gelder, vice president, Refining & Chemicals, said the scenario indicates only the most competitive assets remain viable, earning margins perhaps $5/b below 2019 levels. The refining sector has withered to one-third of its current capacity. Each site finds itself in fierce competition for transport fuels in a declining global market. The survivors are coastal integrated refinery/petrochemical facilities located in industrial clusters, processing a wide range of feedstocks (crude, biomass and waste) and with low-carbon operations (electrified processes, low-carbon hydrogen and CCS).
IOCs and NOCs will be severely challenged under AET-2 - no oil company is prepared for the scale of change envisioned. In the scenario, all companies face a decline, and the sector sees asset impairments and bankruptcy or restructuring on a scale far greater than that of 2020.
Our scenario would see the end of Big Oil and the rise of Big Energy. Financially strong integrated companies step up their investment plans to supplement dwindling upstream revenue with new cash flow from renewables, hydrogen and CCS.
Our benchmarking of the majors’ new energy strategies shows that, on the three technological pillars of AET-2, they are latecomers to renewables, are leaders in CCS and, as large consumers, enjoy a potential early-mover advantage in integrating hydrogen.
The tantalising hope of a few more years of windfall cash flows may lead some IOCs and NOCs to defer action, but delay will not be a sustainable corporate strategy under the AET-2 scenario.