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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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How Viable Are Net Zero Strategies For Energy Companies?

  • The goal to decarbonize by 2050 was agreed to in the UN’s climate conferences by governments around the world.
  • Energy investors have become increasingly skittish about the role of the fossil fuel industry in a low CO2 emissions climate future.
  • Fossil fuel producers and users need to show that they are aware of the risk and sustainability issues and are doing something about them.

This sounds like the old motto of the 1859 Colorado gold rush, “Pike’s Peak or Bust!” But regardless of potential riches, “Net Zero by 2050” has become the unofficial environmental motto of much of the utility and fossil fuel industry. The list of corporations aiming for net zero carbon emissions in thirty years includes BP, Royal Dutch Shell, Total, and Repsol, as well as US and foreign electricity producers CMS Energy, DTE, Dominion Resources, Duke, Enel, Iberdrola, National Grid, Pinnacle West, Public Service Energy Group, Southern Co. and XCEL. A few companies are aiming to reach this environmental target sooner while two major holdouts, ExxonMobil and Chevron, have yet to commit.

Keep in mind that these senior managers who today commit their organizations to this path do not say that they will stop producing or using carbon emitting fuels. No oil wells are being prematurely abandoned or power plants shuttered. The key term for us today in the net zero phrase is the “net” part. This implies that the carbon polluters or emitters will not cease their activity by 2050. Instead they promise to fully offset the greenhouse gases they produce in some manner.

There is a certain magical thinking characteristic to the notion of environmental offsets. Emitted CO2 remains in the atmosphere cumulatively for perhaps thousands of years. Today’s carbon emissions may still be influencing the climate 500 or 1,000 years from now. While methane as a greenhouse gas is pernicious albeit for briefer periods. But what does an offset really mean when these pollutants once emitted can’t easily be removed?

Let’s use an analogy. Imagine a corporate polluter instead as a sinner with a guilty conscience in church. But facing a priest with a certain flair for negotiation. Our executive confesses to “business crimes” and asks forgiveness. The priest suggests a rather large charitable donation to the children’s hospital and orphanage in the amount of the ill gotten gain. Is this a true offset? We are not metaphysical accountants but the environmental movement has the same problem with the fossil industry. Are good deeds like saving a portion of the rain forest an adequate or even appropriate carbon offset? Up until now our policy makers have been rather generous with their dispensation of offsets. Related: Oil May Never Hit $100 Again

Let’s go back to “church”. CO2 emitters are like the executive in confession expressing a desire to keep sinning albeit with appropriate charitable recompense or offsets. But at some point the ethically problematic activity in question, CO2 emissions in this case, typically comes up for closer scrutiny. In other words conceptually offsets at best are a crude stop gap. Governments permit ongoing environmental degradation while forcing polluters to pay or otherwise perform charitable acts. At some point however the policy focus becomes the pollution itself and the activity (oil drilling, power production from fossil fuels) begins to cease although this process can occur rapidly or over decades.

Why the recent interest in declaring a net zero goal? The goal to decarbonize by 2050 was agreed to in the UN’s climate conferences by governments around the world. Second, energy investors have become increasingly skittish about the role of the fossil fuel industry in a low CO2 emissions climate future. And finally environmentally oriented investors have decided to opt out of companies and industries not perceived to be “sustainable”.

The fossil fuel producers and users need to show that they are aware of the risk and sustainability issues and are doing something about them. Thus the need to make a declaration and set a date in order to assuage this growing group of investors. Without a date, they would not seem serious.

Why 2050? The obvious answer is that 2050 is the year targeted by many countries to reach zero carbon emissions. Much of the fossil fuel and energy industry have implicitly agreed to comply by then. Corporate managements may favor a 2050 carbon compliance date for other more practical reasons. First is what was cynically referred to as the IBGYBG rule —I’ll be gone, you’ll be gone. That is present senior managers are making promises that their successors decades in the future will have to make good on.

The second appeal of the faraway 2050 date is from an asset and accounting perspective. Stated broadly most business assets are fully depreciated within thirty or forty years. A 2050 target date suggests no need for any accounting unpleasantness in the form of asset write downs. We would not underestimate the power of asset impairment and its avoidance. Related: Iraq Considers A String Of Massive Oil Deals With China

Let’s stay with the notion of depreciation. Depreciation of assets, like many accounting principles, although stated with mathematical precision is at its core simply an estimate, and our estimation of the useful lives of certain assets in the energy industry are now changing and shortening. These shorter asset lives means faster depreciation which in turn implies greater near term corporate cash flows. And here we come to a managerial crossroads. Managers who only sees a dead end for the business might repurchase stock, pay exorbitant dividends but in general not invest in what they perceive as a business with very limited prospects. An optimistic manager, with a long term perspective might take the opposite action: end stock buybacks, severely curtail or eliminate stock dividends and aggressively redeploy cash into new, profitable businesses.

To sum up, “net zero emissions by 2050” might really mean “business as usual now and for the foreseeable future”. But as we’ve pointed out there may be lots of optionality in the deployment of cash flows. We would look closely at proximate corporate capital spending forecasts for hints of a shift away from emissions heavy activities.

Now for the real question. Will the world wait as fossil fuel companies transition to greener activities on their own leisurely schedule or will substantial action, less clement from an accounting perspective, be required? None of us knows and this uncertainty embodies the risks facing the fossil fuel industry. Maybe an energy transition occurs within a far bumpier fifteen year horizon rather than the leisurely thirty years currently wished for.

Managements and investors cannot know how fast climate change will occur or whether new technology offers CO2 mitigation that rescues the fossil fuel industry. Present behavior suggests considerable comfort with the status quo and a long thirty year environmental compliance “runway.” This is also the time for certain managers to attempt to exploit first mover advantages. Energy investors face a period of elevated risk. The difference is that now we could begin to see them offered different paths to the zero carbon promised land.

By Leonard Hyman and William Tilles for Oilprice.com

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  • Mamdouh Salameh on June 25 2020 said:
    As long as the global economy continues to run on oil and gas, the notion of zero emissions by 2050 will be no more than a mirage.

    The global oil industry will never veer away from the business that has made it the most profitable in the world and which will continue to sustain it well into the future unless they are forced to do so by mandatory legislation thus risking the collapse of the global economy and civilization as we know and enjoy.

    Any talk about the global oil industry turning green is based on illusions such as a post-oil era, peak oil demand, imminent global energy transition from oil and gas to renewables and achieving zero emissions by 2050.

    It is possible that the global oil industry may be using the notion of zero emissions to burnish its environmental credentials and also to justify the drastic dividend cuts and the thousands of redundancies they are implementing currently.

    Neither the notion of zero emissions by 2050 nor the strategies suggested to achieve it are viable.

    For now, we’re in an era of “energy diversification” where alternative sources to fossil fuels, notably renewables, are growing alongside—not at the expense of—the incumbents.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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