Navigating The Energy Transition: A Tale Of Two Hemispheres

Between Covid-19 and the imperative to decarbonize, there’s a sense of urgency for the oil and gas industry to reshape that has never been seen before. The contrast between European and American oil majors’ approach to the energy transition couldn’t be clearer. On the surface, it appears they have very different views of what the future energy system will look like.

Based on stated intentions, European majors are all in on alternative energy and reducing their carbon footprint. They’ve made big promises, going so far as to take responsibility for eliminating or offsetting carbon emissions created when their customers burn oil and gas to net-zero. They’ve taken bold steps to reorganize their companies to succeed in alternative energy markets and are looking to make big investments in low-carbon energy. If they remain focused on these commitments, it’s hard to see them looking anything like what they do today.

For the most part, the U.S. majors are doubling down on their core businesses. They’ve promised and taken action to reduce the carbon-intensity of their operations but avoided commitment to reallocate capital or reorganize in a way that leads them toward being something other than oil and gas companies. Their investments in new energy technologies tend to focus on efficiency, decarbonization solutions and biofuels. Bold steps to move into more emerging and economically challenged energy solutions, like green hydrogen, are not a central focus. Company executives continue to question whether real disruption will occur soon in end-user behavior or energy infrastructure.

What explains how these companies got to these very different places? Do they really see the world differently? Are their skills and competencies that much different?

While the majors are multinational companies, there are biases in the asset bases and the environment in which companies operate that contribute to explaining differences in strategy. Oil and gas demand have been falling in Europe over the last 10 years, while oil demand in the U.S. has grown modestly and natural gas demand has grown more rapidly than it has in the rest of the world. Moreover, the political and regulatory environments in which they operate couldn’t be more different — at least in the here and now. The current U.S. administration is committed to light-touch regulation of production and use of fossil fuels. It has announced its intention to withdraw from the Paris Agreement, and if that decision holds up, the urgency to decarbonize in the native market will be muted and competition from renewables and electric vehicles won’t be as intense as it is in the European markets.

Even without pressure coming from governments, customer attitudes, brand perception and investor pressure continue to matter. European oil companies have been long aware of how their commitment to low-carbon energy affects the way they are seen. A stated commitment to low-carbon energy may help them gain market share, sell more fuel and improve returns now. In U.S. markets, where U.S.-based companies have disproportionate investments and market share, customers won’t be swayed as much by a climate-friendly brand. The EY Fuels of the future survey of 1,500 American consumers found that despite significant concern over the environment and climate change, Americans overwhelmingly prioritize price and affordability with regard to energy decisions. The current economic downturn driven by Covid-19 will crimp household budgets further, making even a small increase in fuel or power costs less palatable.

Another dimension to the different paths by U.S. and European oil majors has nothing to do with where they are based. According to the BP Statistical Review, 78% of the growth in global oil demand came from developing countries in Asia, Africa and Latin America. It’s inevitable that whatever happens in those regions will dominate how the world’s energy landscape will evolve.

So, who’s going down the right path?

At Ernst & Young LLP (EY), we’ve analyzed the paths to energy transition in our Countdown Clock (power and utilities) and Fueling the Future (oil and gas) projects and believe there are a wide range of outcomes in both magnitude and timing of the energy transition from hydrocarbons to green energy. With that said, we can identify some key signposts that may require a quick pivot on strategy.    

The U.S. election is an obvious one. Depending on who is elected President and which party controls the Senate, the incentives for companies that do business in the U.S. could be very different than they are today. There could be considerable risk of new regulatory and tax burdens on fossil fuels and new incentives and subsidies for renewable energy. The Paris Agreement — which the U.S. formally pulls out of the day before the election — could be the driving force in U.S. energy policy again. In that scenario, the European majors’ strategy could be the way forward and U.S. oil companies may need to pivot quickly.

Regardless of which way the election goes, the fallout from economic collapse and government deficit spending during the Covid-19 crisis looms large. The overhang of Covid-19 spending and the ongoing health crisis may hamper even the most ambitious climate policy as other immediate priorities and the economic reality take center stage. Either party will be keen to stimulate the economy after the crisis. Infrastructure spending — including renewable energy projects and research and development — could be at the top of the agenda. What remains to be seen is how much pressure there will be to resist new spending and move the government toward a more sustainable fiscal balance.

Another signpost is the rate at which fossil fuel alternatives gain market share. There’s conventional wisdom that the CO2 reductions during the Covid-19 shutdowns will create new momentum toward longer-term decarbonization. It’s not clear why, other than a potentially long road back to economic recovery.

Before Covid-19, it was axiomatic that the energy transition depended on how quickly fossil fuel alternatives became cost-competitive. That equation hasn’t changed or been influenced by Covid-19. If the cost-competitiveness of alternative energies struggles to advance or if consumers are slow to make the necessary investments, it’s not hard to imagine the alternative energy businesses of European oil majors struggling. In that case, they and their investors might have second thoughts.

Arresting climate change will require substantial innovation, and innovation doesn’t just happen. Hydrogen is an excellent example. The potential is limitless: it can be carbon-free if produced from renewable electricity, it could be delivered using existing infrastructure, it works in transportation and industrial applications, and it can be used as a way of storing green power. But it will take time for breakthroughs in technology to scale and bring costs in line with current fuel sources. The International Energy Agency estimates that it will take until at least 2030 (70 years after the first prototypes were built) for hydrogen fuel cell vehicles to reach 1% market share in its most aggressive transition scenario.

An oil company hoping to become a low-carbon energy company will need a lot of patience and some tolerance for wrong turns and dead ends. 

Strategies are always shades of gray. Every oil and gas major has made some commitments to decarbonization and plans to invest in low-carbon businesses. The differences in approach will almost certainly make the majors look completely different in a matter of one or two decades.

It was once said that all politics is local. Now it appears that aspects of oil company strategy are local, and the geography and existing resource base of the oil business will depend critically on how the transition to low-carbon energy unfolds.

The views reflected in this article are the views of the author and do not necessarily reflect the views of Ernst & Young LLP and other members of the global EY organization.