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Greening the barrel

Translating net-zero ambitions into action in the oil and gas industry

Viewpoint

Executive summary

National oil companies (NOCs) and international oil companies (IOCs) are aiming to reduce greenhouse gas (GHG) emissions from their operations. Regulators, investors, customers, and other stakeholders are pressuring the industry to decarbonize. Although the long-term aim is net-zero emissions, it is vital to translate these targets into action in the near term and manage perceptional and commercial risks. Companies that reduce their emissions will acquire a differentiated value proposition. Going forward, each barrel of oil with the lowest possible emissions intensity—that is, the greenest barrel—will become a source of competitive advantage. Companies need to rapidly translate their net-zero targets into actionable plans.

To do this, it is essential for oil and gas companies to start by understanding and resolving three specific complexity challenges. The first challenge is establishing a clear emissions baseline across vast value chains to recognize the sources, concentration, and magnitude of emissions. The second challenge is to determine the actual emissions intensity across assets in the portfolio, which can vary greatly due to technical and operational characteristics. The third challenge is to develop a clear understanding of the range of decarbonization solutions, and their maturity and economics, to assess feasibility across the asset portfolio.

Thereafter, to drive tangible action toward net-zero emissions, oil and gas companies have five imperatives:

  1. Approach decarbonization with a focus on long-term shareholder value.
  2. Identify portfolio decarbonization priorities and make clear choices.
  3. Take a systems approach to decarbonization solutions.
  4. Capitalize on new partnership models.
  5. Build integrated pathways for implementation.

Additionally, NOCs in the Gulf Cooperation Council (GCC) should become national decarbonization catalysts. Beyond decarbonizing their own operations, they should build partnerships, lead development of capabilities, and work closely with their governments to promote wider decarbonization efforts.

Growing pressure to decarbonize

Transforming the hydrocarbons-based energy system will be one of the most significant corporate actions of this decade. The oil and gas industry plays an outsized role, accounting for 45 percent of global anthropogenic GHG emissions, according to the International Energy Agency. Of that total, 10 percent comes directly from within oil and gas companies—known as Scope 1 (from internal operations) and Scope 2 (for the energy purchased to run those operations). The remaining 35 percent of the industry’s emissions occur when customers combust oil and gas products and their derivatives, which is defined as Scope 3.

Main sources of oil and gas industry greenhouse gas emissions

Main sources of oil and gas industry greenhouse gas emissions

Governments, investors, customers, and other stakeholders have all declared their intent to reduce GHG emissions, and the race for decarbonization in the oil and gas industry has begun. At the national level, all 192 signatories of the Paris Agreement have set decarbonization targets for 2030. Currently, about 22 percent of global GHG emissions are covered under carbon-pricing schemes, a fourfold increase since 2010. Several countries are establishing or expanding national emissions trading schemes, taking advantage of market forces to determine a fair cost of hydrocarbons.

Shareholders are taking similar steps. In the first half of 2021 alone, nearly as many shareholder resolutions related to climate change and the environment were filed as in all of 2020. According to a 2020 study by Schroders, 67 percent of the world’s 650 biggest institutional investors cite full environmental, social, and governance (ESG) integration as their favored investment approach, which makes reducing emissions critical for companies looking to raise debt or equity capital from international markets. At the same time, public activism has focused pressure on certain types of oil and gas operations, particularly assets that have a larger environmental impact, such as oil sands and shale.

In most other sectors, companies that use oil are seeking to shift to non-hydrocarbon-based alternatives and renewables to meet their energy needs. More than 25 percent of companies listed on the S&P 500, and more than 20 percent of the Forbes Global 2000, have announced net-zero pledges, which they intend to meet mainly by reducing their reliance on hydrocarbons.

All of these measures have considerable implications for the oil and gas industry. Although a significant need for oil and gas will remain for the foreseeable future, companies will no longer be assessed solely by the price and quality of their products. Instead, customers will factor in the emissions intensity behind every barrel produced and sold, creating new challenges and opportunities for the industry.

In response, many oil and gas companies have set targets for decarbonizing their operations. IOCs began announcing such targets in 2019, focusing primarily on achieving net-zero emissions from their operations (Scope 1 and 2). A subset of IOCs also announced their intention to reduce emissions from the use of oil and gas products among customers (Scope 3). Recognizing the importance of decarbonization, many NOCs have also announced GHG emissions reduction targets.

Oil and gas emissions in the GCC

In line with the global momentum on climate change, GCC countries are also developing plans to decarbonize their economies. Leading economies in the GCC region have announced ambitious plans to reduce direct GHG emissions, increase renewable energy production, get the most out of carbon sequestration by expanding mangroves and green areas, and develop hydrogen and carbon capture, utilization, and storage (CCUS) capabilities. National net-zero targets are imminent. NOCs in the GCC will need to play an outsized role to achieve these ambitions, as oil and gas production is a critical factor in national economies as a source of revenue and energy, and as the main contributor to emissions.

Main sources of global and GCC greenhouse gas emissions

Main sources of global and GCC greenhouse gas emissions

At the same time, developments in international markets and regulations give an added impetus for NOCs to demonstrate a clear commitment to decarbonization. Transparency and tangible action on emissions are already becoming important in certain export markets. For example, some governments are considering measures such as carbon border adjustment taxes for imported products based on the emissions intensity at the source of production. Also under consideration are market-based mechanisms such as introducing production emissions intensity as a quality indicator impacting crude oil pricing in a manner similar to sulfur content and American Petroleum Institute (API) gravity (a measure of how heavy or light a petroleum liquid is compared with water). Moreover, the increased focus of global investors on ESG means that emissions disclosures and action will be critical for continued access to international capital markets.

To play a leading role in national decarbonization plans and to maintain their position as reliable energy suppliers to the world, NOCs in the GCC need to continue to outline clear ambitions on decarbonization and translate these into visible action.

Five imperatives for translating ambition into action

There are five imperatives that oil and gas companies should follow to generate tangible action from their decarbonization strategies and targets.

Five imperatives for oil and gas players

Five imperatives for oil and gas players

1. Approach decarbonization with a focus on long-term shareholder value
Companies need to ensure that they can provide their investors with positive returns along with tangible progress toward emissions reduction targets. Some decarbonization investments will generate a near-term positive impact, due to potential savings and efficiencies. Others may take longer to result in a return on investment, factoring in expanding carbon price regimes, the incorporation of emissions intensity benchmarking in product pricing, future access to capital markets, and maintenance of the social license10 to operate in global markets. Management teams must weigh these considerations carefully. They will need to prioritize capital expenditures and other initiatives with an eye to ensuring positive shareholder returns while maximizing progress in reduction of emissions.

2. Identify portfolio decarbonization priorities and make clear choices
Companies need to identify and focus on the largest opportunities to ensure that decarbonization efforts are effective. These opportunities are presented by the small number of assets in the portfolio (typically 20 to 40 percent) that contribute a disproportionate share of emissions (typically 60 to 80 percent). To find these priorities, it is essential to create a baseline of total emissions for the full value chain of operations, along with the emissions intensity of individual assets, and then benchmark them against those of industry peers in order to identify priority areas for decarbonization.

3. Take a systems approach to decarbonization solutions
Companies need to use integrated systems to address the most urgent decarbonization priorities, rather than implementing discrete solutions at specific points of emission across their operations. Doing the latter risks resulting in unfavorable returns on capital and poor levels of reduction in emissions intensity. To succeed, companies must first develop a clear understanding of solution economics, categorizing the sources and magnitude of specific emissions (energy versus process versus waste) addressed by potential solutions. For broader systems solutions, companies should determine their technology maturity, required investment, time to realize benefits, and cost per unit of emissions avoided.

4. Capitalize on new partnership models
Companies will require a new approach to partnerships because of the magnitude of emissions reductions required and the need to achieve climate targets in a timely manner. To become contenders in the race for the greenest barrel, companies must reflect on their specific contexts and develop a new partnership approach; they must take advantage of capabilities, pool investments, and maximize lessons learned from the ecosystem.

5. Build integrated pathways for implementation
Companies can begin implementation by building integrated decarbonization pathways with the components below once they have clarity about priority assets and solutions.

Critically, all of these components need to be flexible and updated regularly, given that technology is developing and regulations are changing, along with other factors that will be in flux during decarbonization. Companies must make plans but be prepared to adapt their planning in response to changing circumstances. The components of an integrated pathway are:

  • A technology road map that prioritizes mature solutions with the largest near-term impact on decarbonizing operations, along with emerging technologies that can generate greater progress across the entire portfolio over the long term.
  • Integrated business cases that consider cumulative investment requirements, sources of financing, and forecasted cash flows, factoring in potential savings created through efficiencies and carbon cost avoidance.
  • A blueprint for activation that covers making changes to governance and operating models, building the necessary capabilities, developing partnerships, and implementing time lines for all decarbonization initiatives.

Conclusion

The oil and gas industry’s recently announced decarbonization agendas and initiatives are significant. They require effective implementation and tangible results in the near future. Translating net-zero ambition to action requires that leadership teams think beyond their traditional focus on the cost and quality of their oil and gas. That will be difficult. However, the fate of individual companies and the environment depends upon how they rise to this challenge.

Contact us

James Thomas

James Thomas

Partner, Strategy& Middle East

Aditya Harneja

Aditya Harneja

Manager, Strategy& Middle East

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