ExxonMobil’s Energy and Carbon Summary is a step in the right direction, but lacks clarity across a number of areas
ExxonMobil, the largest US energy group, has published its Outlook for Energy, which provides the company’s view of future energy supply and demand. It is the bedrock for its financial reporting and investment decisions. Simultaneously, Exxon also quietly produced its 2018 Energy and Carbon Summary report, in response to last year’s shareholder resolution asking for better disclosure of the company’s approach to climate risks.
Taken together, they demonstrate the difference between Exxon’s “business-as-usual” planning case for continued growth in oil and gas use and a much weaker demand scenario that is aligned with keeping global temperatures to 2˚C of warming since pre-industrial times. Companies are entitled to their own views on future demand for their products, but investors want to be reassured that boards are taking transition risks seriously, and to better understand resilience to possible downside turns that management might not expect .
Compared to Exxon’s 2014 analysis, “Managing the Risks”, this report is a marked improvement.
However, the new report lacks clarity across a number of areas, including the impact on the value of Exxon’s existing and potential assets thereby minimizing the “decision-usefulness” to investors. We look forward to future iterations, and hope that Exxon will continue to add further detail on the challenges ahead.
Better, but still lacking
Interestingly, Exxon acknowledges several key points that highlight transition risks for fossil fuel producers.
Exxon admits that lower expected demand = lower expected prices, but doesn’t assess value impact. Exxon implicitly acknowledges that a 2°C compliant pathway would mean the world has more hydrocarbon supply than it needs. Lower demand — all other things being equal — would imply lower prices, making low supply costs the key to competing successfully.
The importance of this is not about having a public debate on who has forecast the long-term oil price correctly (probably no-one) but rather who is giving adequate consideration to the impact that reduced demand might have on their finances. A sensitivity analysis of valuation to a range of prices would be welcome – or at least, disclosure of their long-term price assumptions along with comparison to modelled 2°C prices and the valuation results. This would give a better understanding both of the company’s conservativeness and whether their 2°C analysis represents a meaningful test or a mere tick-box exercise.
Focus should be on value, not volume
Many oil and gas companies have restricted their climate analyses to proven reserves – volumes of oil and gas that are currently economically recoverable with a high degree of confidence.
These are typically associated with near-term or already producing projects. Exxon concludes that there is little risk to these reserves being burnt – given the longer-term nature of demand threats and that production from operating fields will likely naturally fall at a faster rate than demand does, we would generally agree. The risk to proven reserves is largely not whether they will be produced or not, but the oil and gas price that they will receive.
Exxon goes beyond a discussion of just proven reserves, but offers scant details
The more significant risks lie with future projects (resources), and Exxon acknowledges that some of its options will be uneconomic in a world that is successful in its climate aims.
It assumes that these higher risk resources wouldn’t be sanctioned. However, given that Exxon’s Outlook assumes oil and gas use will continue to grow through to 2040 (and that the world will miss it’s climate commitments by some margin), we would argue that the question investors are more interested in is “if the company makes investments in projects based on assumptions that subsequently turn out to be over-optimistic, what is the financial risk?”
Exxon provides nothing by way of detail on these assets and although it does provide a financial measure, this is solely based on expenditures to date – given that these are future projects, this is likely to be a small fraction of the capital that might be overinvested if they were developed.
Exxon’s climate test is improved
Exxon models a 2°C scenario by identifying commensurate demand trajectories for oil and gas. The actual pathway that future demand will take is unknown, but such potential pathways provide a sensible starting point.
In 2014, Exxon cherry-picked the friendliest model they could find – an outlier on the high end of cost estimates for a low carbon transition. Moreover, its application of that model to suggest that a low carbon transition was impossible was criticized by the researchers who did the original modelling some years before.
This time they have shifted focus to the potential outcomes if such a transition did take place. Further, the benchmark they have used is an average of a range of 2°C pathways, resulting in a scenario that appears only slightly more generous than the frequently used International Energy Agency’s 2°C scenario. Exxon’s scenario sees oil demand fall at -0.9% p.a. over the period 2016-2040 compared to the IEA’s -1.0%; gas demand grows at +0.8% compared to the IEA’s +0.6%. Small differences in compound growth rates do add up over time, but they are clearly along the same lines. Both scenarios require significant advances in carbon capture and storage technologies.
The IEA’s scenario assumes a 50% chance of limiting global warming to 2°C, and could be considered at the upper limit for compliance with the Paris Agreement which pledged to hold global warming to “well below” 2°C and aim for 1.5°C. Exxon is far from an outlier in using a benchmark of this order, but there is increasing interest in seeing the results of scenarios that would result in a higher probability of a better climate outcome.
We would agree that, at least for the larger oil and gas companies, there is only a small risk that they won’t be able to monetise at least the majority of their proven reserves.
The primary risks relate to spending on future projects. These may represent a minority of value at present — but given that Exxon’s planning is based on its forecasts rather than a climate-safe outcome, investors are right to ask what portion of their capital might be deployed on the hazy assumption that global climate targets will fail.
Andrew Grant – Senior Analyst
Robert Schuwerk – Executive-Director (North America)