It has always been clear that fixing climate change would require a massive industrial and technological transformation, with widespread social and economic consequences.
The recent UN Intergovernmental Panel on Climate Change (IPCC) Special Report on 1.5 degrees, however, deeply challenges dominant assumptions about the speed and scale involved.
This has profound implications for many industries and policy makers, but perhaps most dramatically for the future of the multi-trillion-dollar fossil fuel industry, particularly the oil and gas majors (the coal industry now being in terminal decline regardless).
For the last few years, I have been examining what to expect in such major economic transformations – from both large incumbents and disruptive new players.
The evidence suggests that when business models are overturned, the dominant tendency of large incumbent companies is to fail. That led me to question the assumption that these giant oil and gas companies would transition to become the giant energy companies of the future.
Central to any such analysis is the science, as this will ultimately drive how society acts and in particular at what speed. The IPCC recently told us that to achieve a safe climate we must reduce CO2 emissions by nearly half by 2030 (vs 2010) and to net zero by 2050 (1).
The science is very straightforward. We either achieve that outcome or face the existential risk of runaway climate change and economic collapse. Doing the latter would be madness. So despite today’s lack of political attention, it is reasonable to assume we will act – dramatically and soon – in the face of such an urgent existential risk.
For the oil and gas industry that has very clear implications. The market for their product (for use as energy) could halve within 10 years and then decline to zero thereafter. If you find this hard to imagine, you must assume we will knowingly choose collapse instead. I would argue humanity may be slow, but we are not stupid.
It is therefore important to think realistically about how such transitions occur and how society and the market will manage this one. Separately – and it is a quite separate issue – we also need to ask if there is a realistic likelihood of today’s oil and gas companies transitioning as corporate entities. Do they have a future? Or will they just fail – as incumbents most often do when faced with such dramatic market change?
We must first acknowledge that the business challenge facing oil and gas majors is mind boggling in speed, complexity and scale.
As I argued in some detail in this article this is not only a change in technology. It is total business system change – different technologies, price and cost cycles, valuations, supply chains and business cultures. It is effectively a transition from a centralised long-life resource business to a distributed consumer technology business. It simply couldn’t be more different.
So the transformation is inherently very difficult anyway, even without the issue of speed.
Also, let me be crystal clear on something I think most people get wrong – and as I did before this research. The question is not could they change, or should they change. Nor is it would it be better for society if they change. Those questions really don’t matter. This is a market question not a social or moral one.
Only one question actually matters: “On the balance of probabilities, given the way markets work and based on real evidence, what is the likelihood they will change.”
Timing is a really critical issue. If they act too late, they will fail. As one of Britain’s most influential energy experts Professor Paul Stephens said, the choice for oil and gas companies is stark. It is between an urgent and radical change in business model – with a strategy of managed decline but ultimate survival on a much smaller scale – or, “what remains of their existence will be nasty, brutish and short.”
In my work, I have considered five key factors, drawing conclusions on each and then overall. (This blog post is a summary of my full analysis which can be found here.)
- 1.The speed of transition now required – 12 years to have cut CO2 emissions by around 50% with continued rapid decline thereafter;
Conclusion: Nothing short of dramatic and rapid transformation by the International Oil Companies (IOCs) will see them survive, given how markets value them.
- 2.The economic viability of Carbon Capture and Storage (CCS) technology for energy production vs the dramatically falling costs for renewables and storage;
Conclusion: CCS may well be useful for society, but it will do little to support the use of oil (not relevant to how it’s used) and gas (not price competitive) for energy. It will at best be a marginal issue for IOCs.
- 3.The viability of a transition strategy – does it actually make business sense for IOCs to become energy companies (thus would the market support IOCs doing so)?
Conclusion: In many ways, becoming energy companies would be the mostdifficult transition strategy for oil and gas companies. Even more so when the required speed is taken into account. There are different, more logical transition strategies, but they all imply smaller, leaner companies.
- 4.The evidence of the real business behaviour of large listed IOCs over the 30 years since the existential threat to the industry’s future became clear.
Conclusion: The industry has already lost the race to become energy companies. They are now up against “built for purpose” companies that are large, well-financed and have the right culture. These new companies are way ahead and the oil and gas majors will not catch up.
- 5.The behaviour of financial markets with respect to incumbents and disruptors during major economic transitions.
Conclusion: The attitude of the financial markets to incumbents vs disruptors makes profound transitions by incumbents very hard. Consider the gap between how markets value GM vs Tesla despite stock pricing fundamentals. And that is not a profound business model change.
Given this context, I have concluded that dominant assumptions regarding the transition of the oil and gas companies are wrong. The evidence suggests it is far more likely they will fail. The recent IPCC report makes this even more likely because of the speed of change.
The market will soon come to the same conclusion and price in this risk accordingly. Considering the way markets work and capital flows – and observing the history of other incumbents that have failed – this will then trigger a market spiral of irreversible decline.
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