Our stakeholders have expressed an interest in understanding the potential impact that future climate change regulation may have on Hess’ market valuation.
Through our enterprise risk management process we have developed risk profiles for each of our assets to identify key risks – including carbon – and estimate the likelihood and potential impact that these risks could have on our business. We compile all risks we identify as critical on an integrated risk register that catalogs actions for managing or mitigating each risk. All new significant projects are rigorously screened to verify they meet or exceed established threshold return-on-investment criteria to balance risk and return and meet Hess’ capital discipline philosophy.
In addition, we actively evaluate viability for significant projects based on potential future carbon constraints. In 2016 we updated the theoretical carbon price we use in economic evaluations for significant new projects to $40 per tonne of carbon dioxide – equivalent to the current estimate by the U.S. Environmental Protection Agency of the social cost of carbon. Factoring carbon dioxide prices into our valuation process enables us to evaluate project viability based on differing ranges of potential future carbon constraints.
A select group of stakeholders and investors has raised concerns that energy companies may be overvalued in a future carbon-constrained world because these companies may not be able to produce a portion of their reserves and, hence, these reserves will be “stranded.” As discussed in the Global Energy Outlook section in our 2016 Sustainability Report, the International Energy Agency (IEA) has stated that even in their 450 Scenario (2 degree case), failing to invest in upstream assets through 2040 could lead to major supply problems because the decline in oil production from currently producing fields far exceeds the decline in demand for oil. In addition, according to IHS Energy’s September 2014 report Deflating the Carbon Bubble, the intrinsic value of an oil and gas company is based primarily on its proved reserves, 90 percent of which are expected to be monetized during the next 10 to 15 years. Based on the IHS study and the IEA positions cited above, Hess believes there is a high likelihood our reserves will be monetized and that markets are currently valuing our carbon assets rationally.
According to IHS Energy, the stranded asset theory underestimates the realities of the projected growing demand for hydrocarbon resources through 2040 as well as how the categorization and timing of reserve development contribute to the market valuation of a company.
By using an extremely broad definition of proved reserves, stranded asset proponents misstate how reserves contribute to market valuation. The Securities and Exchange Commission defines “proved reserves” as those quantities of oil and natural gas that, by analysis of geoscience and engineering data, can within reasonable certainty be estimated to be economically producible – from a given date forward, from known reservoirs and under existing economic conditions, operating methods and government regulations.
Stranded asset advocates argue that extractive companies will be left with stranded reserves over the next 30 to 40 years, thus undercutting current valuations. According to IHS Energy, while proved reserves on average account for only 24 percent of the resource base by volume, they account for 84 percent of the 2014 resource base that drives a company’s total valuation. Therefore, reserves that are expected to be produced beyond a 15-year time horizon appear to have limited impact on a company’s valuation.
The stranded asset theory also assumes that coal, oil and natural gas are equally vulnerable to climate policies restricting energy sources, without considering the differences in carbon intensities. Coal is the most carbon-intensive energy source, with a significantly larger carbon footprint than natural gas. As a result, coal is most likely to experience demand degradation in a carbon-constrained economy. The production of natural gas will likely be promoted as part of the transition to a lower-carbon environment.
We will continue to do our part to help provide reliable, affordable energy to meet growing demand, while endeavoring to take actions to reduce our carbon footprint through investments in energy efficiency, flaring reductions, fuel switching and new and emerging technologies.