Pump it while you can: stranded asset risk and the race to produce
'Pump it while you can' may be the new modus operandi for the oil and gas industry. The acceleration in the deployment of renewable energy technologies, coupled with the emergence of unconventional oil production in the United States, fundamentally shifts the outlook for the future of oil and gas. As evidenced in BP’s recently published Energy Outlook, the abundance of oil supply, alongside the prospect of slowing demand, has created a strategic incentive for producers to sell their oil now to ensure these reserves do not end up 'stranded' – or unprofitable to produce – in the future.
In a recent quote in the Financial Times, BP’s chief economist Spencer Dale sounded the warning on this stranded asset risk, stating: “I think it is increasingly likely that there will be technically recoverable oil reserves which will never be extracted and if I was the owner of one of those companies which owned that oil I would have every incentive to make sure it wasn’t mine [left in the ground].”
BP’s view of stranded asset risk resonates strongly with the concept of a global 'carbon budget' established by the International Panel on Climate Change. This 'carbon budget' quantifies the amount of carbon dioxide that can be emitted while limiting the global average temperature rise to no more than 1.5C, 2C, or 3C above pre-industrial levels. The recent Paris Agreement represents a cooperative framework through which participating countries have expressed their commitments to adhere to the carbon budget by implementing policies to limit greenhouse gas emissions. With a finite carbon budget established, fossil fuel producers must now fight for their share of the remaining natural gas, barrels of oil, or tons of coal that can be burned. Any producer that does not sell a barrel of oil now may not have the opportunity to sell that barrel of oil later.
Of equal concern for the fossil fuel industry is the rapidly declining costs, and subsequent increasing market share, of renewable energy generation capacity. As recently reported by the International Energy Agency, 2015 marked the first time in history that renewable energy surpassed coal to become the largest source of installed power capacity in the world. Although BP and other large producers predict oil demand to continue growing through 2035, the pace of this growth will be largely impacted by renewable energy deployment, energy/fuel efficiency improvements, and the electrification of the transportation fleet. These uncertainties further incentivize fossil fuel producers to monetize their assets now, while renewable energy’s share of the market remains low and costs remain relatively high.
In this new competitive landscape for fossil fuel producers, who will be the winners and losers? In its Energy Outlook, BP suggests that low-cost producers, such as the Middle East OPEC nations, will increasingly dominate market share, growing from 56 percent in 2015 to 63 percent by 2035. In contrast, other OPEC members will see their share dwindle from 15 percent in 2015 to less than 10 percent in 2035, largely due to the higher cost of production for these market participants. The increasing dominance of low-cost producers incentivized to maximize market share and mitigate stranded asset risk, combined with technology development leading to slowing demand, will likely exert sustained downward pressure on crude oil prices. BP predicts that natural gas consumption will grow rapidly, with a significant amount of growth in supply coming from unconventional production in the United States. Per the data presented in the Outlook, natural gas will largely supplant coal for power generation, and due its relatively low volume of carbon emissions compared to coal and crude oil, will continue to remain a large portion of the energy supply mix beyond 2035.
With the strategic landscape shifting in such profound ways, how can investors manage their exposure to these emerging risks? The Sustainability Accounting Standards Board (SASB) has established a reporting framework for companies to disclose material sustainability risks to investors – and for the oil and gas Industry, SASB’s standard includes metrics to quantify company exposure to stranded asset risk. Specifically, the standard recommends that oil and gas companies disclose the sensitivity of their reserve levels to future price projection scenarios that account for a price on carbon emissions, as well as the estimated carbon dioxide emissions embedded in proven hydrocarbon reserves. With these indicators, investors will be better equipped to evaluate and manage climate-related risks. According to SASB’s Annual State of Disclosure report, only approximately 30 percent of companies are currently using metrics to disclose information on this topic, and no companies are disclosing the full framework specified in SASB’s standard.
As oil and gas companies compete within a rapidly changing ruleset, investors need the decision-useful, standardized, and material disclosure now more than ever.
David Parham is the Non-Renewable Resources sector analyst at the Sustainability Accounting Standards Board (SASB)
Read the January 2017 issue of Energy Digital magazine
Ofwat allows retailers to raise prices from April
Retailers can recover a portion of excess bad debt by temporarily increasing prices from April 2022, according to an Ofwat statement.
The regulator confirmed its view that levels of bad debt costs across the business retail market are exceeding 2% of non-household revenue, thereby allowing "a temporary increase" in the maximum prices. Adjustments to price caps will apply for a minimum of two years to reduce the step changes in price that customers might experience.
Measures introduced since March 2020 to contain the spread of Covid-19 could lead to retailers facing higher levels of customer bad debt. Retailers’ abilities to respond to this are expected to be constrained by Ofwat strengthening protections for non-household customers during Covid-19 and the presence of price caps.
In April last year, Ofwat committed to provide additional regulatory protection if bad debt costs across the market exceeded 2% of non-household revenue.
Georgina Mills, Business Retail Market Director at Ofwat said: “These decisions aim to protect the interests of non-household customers in the short and longer term, including from the risk of systemic Retailer failure as the business retail market continues to feel the impacts of COVID-19. By implementing market-wide adjustments to price caps, we aim to minimise any additional costs for customers in the shorter term by promoting efficiency and supporting competition.”
There are also three areas where Ofwat has not reached definitive conclusions and is seeking further evidence and views from stakeholders:
- Pooling excess bad debt costs – Ofwat proposes that the recovery of excess bad debt costs is pooled across all non-household customers, via a uniform uplift to price caps.
- Keeping open the option of not pursuing a true up – For example if outturn bad debt costs are not materially higher than the 2% threshold.
- Undertaking the true up – If a 'true up' is required, Ofwat has set out how it expects this to work in practice.
Further consultation on the proposed adjustments to REC price caps can be expected by December.
"While it’s great that regulators are helping the industry deal with bad debt in the wake of the pandemic, raising prices only treats the symptoms. Instead, water companies should head upstream, using customer data to identify and rectify the causes of bad debt, stop it at source and help prevent it from occurring in the first place," she said.
"While recouping costs is a must, water companies shouldn’t just rely on the regulator. Data can help companies segment customers, identify and assist customers that are struggling financially, avoiding penalising the entire customer in tackling the cause of the issue."
United Utilities picks up pipeline award
A race-against-time plumbing job to connect four huge water pipes into the large Haweswater Aqueduct in Cumbria saw United Utilities awarded Utility Project of the Year by Pipeline Industries Guild.
The Hallbank project, near Kendal, was completed within a tight eight-day deadline, in a storm and during the second COVID lockdown last November – and with three hours to spare. Principal construction manager John Dawson said the project helped boost the resilience of water supplies across the North West.
“I think what made us stand out was the scale, the use of future technology and the fact that we were really just one team, working collaboratively for a common goal," he said.
Camus Energy secures $16m funding
Camus Energy, which provides advanced grid management technology, has secured $16 million in a Series A round, led by Park West Asset Management and joined by Congruent Ventures, Wave Capital and other investors, including an investor-owned utility. Camus will leverage the operating capital to expand its grid management software platform to meet growing demand from utilities across North America.
As local utilities look to save money and increase their use of clean energy by tapping into low-cost and low-carbon local resources, Camus' grid management platform provides connectivity between the utility's operations team, its grid-connected equipment and customer devices.