Uncertainty for O&G sector’s profits as world aims for net-zero: Sustainable Fitch
Yong Hui Ting
PROFITS in the oil and gas (O&G) sector in the next 10-15 years will be volatile, as companies have not been able to come up with a business strategy to shift away from fossil fuel production, Sustainable Fitch analysts said in a report published Thursday (Jul 21).
While the price shock caused by the ongoing Russia-Ukraine has provided a large windfall for some companies, the analysts were unsure this would continue to uplift the sector, noting that over 90 per cent of the world’s gross domestic product (GDP) was now covered by some sort of net-zero policy or target.
The analysts warned that lower demand for O&G products in key consumer markets in the medium to long term, combined with lower return on investment in alternative business models such as renewables – could have significant impact on O&G companies’ long-term profitability.
The effect will be felt unevenly throughout the sector, as the analysts believe that companies with an overall low cost base, low-intensity production, and assets in more benign environmental regulatory environments are better placed to ensure profitability in the long term.
O&G majors are also generally in a stronger position to successfully manage the energy transition due to their size, asset mix and business diversification.
Examples of such large-cap companies include BP, which received an “A/Stable” rating from Sustainable Fitch, Shell Group and TotalEnergies, who both were awarded “AA-/Stable” rating.
A NEWSLETTER FOR YOU
Friday, 12.30 pm
ESG Insights
An exclusive weekly report on the latest environmental, social and governance issues.
Mid-cap and junior players however, will have a much harder time.
“They generally do not have the cash and/or scale and in-house expertise and capacity to develop robust climate strategies, finance decarbonisation effects and shift their business model while ensuring ongoing profitability,” the analysts said.
Most of these smaller O&G companies hence received “BBB/Stable” ratings, though the research house was more upbeat on European companies than US ones as they noted that all European O&G companies have announced “significant changes to their business strategies in response to transition risks”.
As compared to the European mid-caps and juniors, US majors appear to be investing at a much lower level in renewable energy, said Sustainable Fitch in its report.
More will need to be done, however, to ensure the future of the O&G sector.
This is particularly as key markets such as the EU and US are upping their regulatory demands for climate-related disclosure, said the research house, adding that this is likely to put further pressure on companies to decarbonise. The tighter regulatory policies will also create additional operating costs for companies to collect and manage the necessary data, analysts added.
At present, O&G companies still generate the bulk of their revenues from producing and selling fossil fuels. Coupled with the fact that investments in upstream production and exploration also remain significantly larger than capex in low-carbon business models, this places much uncertainty on the future of O&G players.
To tackle this, Sustainable Fitch recommended several approaches, including better disclosure, setting short, medium and long-term goals and keeping offsetting to a minimum.
“Emissions reduction targets should cover the entirety of a company’s operations, which includes not only assets where the company has operational control but also where the company has an equity share,” wrote analysts in the report.
“Even if the company does not operate an asset, through its equity stake it is still exposed to carbon-related risks and therefore needs to manage this risk and include it in its emissions reduction strategy.”
Companies can also tie its green targets to executive remuneration — therefore making its current senior managers responsible for achieving emissions reduction targets.
At the same time, companies should not have any KPIs for its senior management team to increase production or exploration activity, which would contradict its goals to switch to the greener side.
Copyright SPH Media. All rights reserved.
