Our stakeholders have expressed an interest in understanding how Hess’ oil and gas portfolio might be impacted by a transition to a lower-carbon economy. In particular, 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.”
Since 2013, in our annual sustainability report, Hess has been providing an assessment of our company’s view on climate change-related risks and opportunities that might result from a potential transition to a lower-carbon economy. In order to evaluate any potential exposure to our portfolio in a lower-carbon environment, we first consider the long-range outlook for energy supply and demand. Hess uses the International Energy Agency (IEA) World Energy Outlook 2017 to examine various supply and demand scenarios through 2040 (see www. iea.org/weo2017/). The World Energy Outlook 2017 contains three main scenarios, as follows:
- Current Policies – the business-as-usual case
- New Policies – incorporates existing energy policy as well as an assessment of the results likely to stem from the implementation of announced policy intentions (chiefly the Nationally Determined Contributions — i.e., the emission reductions agreed to by individual countries under the Paris Accord)
- Sustainable Development – reflects a pathway to achieving key energy-related components of the United Nations Sustainable Development Agenda, including universal access to modern energy by 2030, urgent action to tackle climate change and measures to improve poor air quality
The charts below show world energy demand and carbon dioxide emissions under the IEA’s three main scenarios.
Hess’ focus is on the New Policies scenario, which we, along with the IEA, view as the most likely environment in which we will operate. While the Sustainable Development scenario would be extremely challenging to achieve, as discussed in more detail below, we also consider that scenario in examining potential risks and opportunities associated with our oil and gas portfolio in a low-carbon environment.
In the New Policies scenario, worldwide energy use will grow approximately 28 percent between 2016 and 2040. In this scenario, energy demand for oil and gas is projected to grow by 24 percent during the same period and account for 52 percent of the energy mix in 2040, down slightly from 54 percent today.
According to the IEA, in this New Policies scenario, the oil and gas sector requires cumulative investment of some $21 trillion between 2017 and 2040, three-quarters of which is in the upstream sector. Upstream capital spending needs to average around $640 billion every year to avoid potential mismatches between supply and demand. This figure takes into account the need to meet growing oil and gas demand while compensating for underlying declines in existing sources of production. Annual investment in the upstream sector alone under this scenario needs to increase from $435 billion in 2016 to about $535 billion per year through 2025 and then to $710 billion per year through 2040 to balance oil and gas supply and demand. This would represent a 25 percent per year increase from current investment levels through 2025 and a 60 percent increase from current investment levels from 2025 through 2040.
The IEA states that “the impact of the near-record lows of new conventional oil projects receiving approval in recent years has yet to be fully seen” and stresses the dangers of a possible shortage of supply in the future (World Energy Outlook 2017, p. 155).
Even in the Sustainable Development scenario (which is consistent with a 50 percent chance of limiting the concentration of carbon dioxide in the atmosphere to around 450 parts per million), worldwide energy use is projected to grow by 2 percent through 2040 and oil and gas is expected to account for 48 percent of the energy mix in 2040, down slightly from 54 percent today.
The IEA has indicated that the challenges of achieving the Sustainable Development scenario are substantial, requiring a major reallocation of energy-sector investment capital. The IEA states that “even in the carbon-constrained world of the Sustainable Development scenario, upstream oil and gas investment remains a major component of a secure energy system” (World Energy Outlook 2017, pp. 27–30). Therefore, Hess has no reason to assume widespread stranding of upstream assets.
Furthermore, 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. 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 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, while the production of less carbon intensive natural gas is being promoted as part of the transition to a lower-carbon environment.
Based on the IHS study and the IEA positions cited in this section, Hess believes there is a high likelihood our reserves will be monetized and that markets are currently valuing our carbon assets rationally. However, in order to further evaluate any potential climate change-related risks and opportunities associated with Hess’ portfolio, senior management has approved a carbon asset risk scenario planning exercise to test the resilience of our portfolio against the IEA’s main scenarios. This exercise will establish a range of energy supply, demand, oil price and emissions estimates that are projected to prevail under different publicly available, long-term scenarios for environmental policy and market conditions. We anticipate this exercise will allow us to qualitatively assess any areas of potential stress on Hess’ portfolio in a lower-carbon environment. We expect to conduct this scenario planning exercise in 2018 and publish the results in 2019.