Greener, Faster, Stronger – The Future Of The Downstream Is Taking Shape

We have been talking about the ups and downs of oil and gas industry for a while now, especially after last year’s crisis and ongoing recovery phase, but the process that took over the whole world now – not only the hydrocarbons production and processing – is sustainability. ESG can officially be called a global trend now – but is actually new?

Volatility of commodity prices, uncertainty about the future of fossil fuels and increasing tensions around trade negotiations around the world over the last 5 to 10 years have changed the fundamentals of the supply-demand and economics, and it is fair to say that oil and gas executives have predicted and adapted to surfing the quicksand for a while now. Although social and governance policies are already quite developed in most of companies we deal with, and annual corporate sustainability reports are a routine practice, it is still the ‘E’ part of ESG strategies that are yet to fight their way in.

The movement toward sustainability has become more and more significant and widespread in recent years. Last year, it reached a new level: according to BNEF, the value of global ESG assets reached over $137 trillion, showing 24% growth, setting the record. So what is it in ESG, that helps set the scene for the whole energy-related business? According to UN reports regarding the 17 SDGs, around 800 mln. people (or 10% of global population) have no access to electricity, let alone ‘clean and available’ energy.

Top 10 key reasons we think are driving the development of Sustainable agenda are the following:

1. potential growth of the company's capitalization (for public companies)
2. support from customers and society due to reliable brand
3. favorable conditions for obtaining finance
4. compliance with the requirements of the State and foreign partners
5. saving the cost of penalties, extra duties, etc.
6. growth of attractiveness as an employer
7. competitiveness on the market
8. opportunities for expansion and diversification of business
9. strengthening of long-term relations with suppliers and other partners
10. synergy from 3 areas (E+S+G)

When we analyzed strategies of the leading companies, we came to a conclusion that vital elements to them are still the same as before: technologies, economics (return on investment, cost optimization, margin improvement), people (culture and interconnections), and the right support/regulations.

Companies – as with anything new on global scale - face many challenges on the road to implementing sustainability goals: an ambiguous understanding of the value of sustainability to the business; lack of certain competencies; and lack of data and uniform approaches to collecting it to assess their sustainability and track progress. To overcome these and other challenges, most companies have taken a systematic approach and created a separate organizational unit to implement and manage sustainability.

Companies that progressed on this journey identify several major visible effects:

• employee motivation increases;
• shareholders and stakeholders begin to rate business performance higher;
• and the company becomes more attractive to customers and partners – all of these can then be measured finally in monetary terms.

Indeed, some companies are already noticing the impact of sustainability on profitability, but are having difficulty measuring it. On the other hand, the issue that is still keeping some people on both corporate and customer side – will the cost of developing clean energy become a burden for investors or end-users, increasing the final product costs or taxes? We discussed a similar uncertainty as one of IMO 2020 implications as well. We hope that this will not be a bad apple spoiling the whole barrel (literally).

According to Accenture’s survey, some industries are more focused on the sustainability agenda: over 80% of respondents in the machine building and manufacturing sector, 70% of respondents in wholesale and retail trade and in the financial sector agreed with this approach as their major driver going forward. Surprisingly, consulting services as well as transportation and logistics companies (about 30% each) prioritize sustainable agendas less than other sectors. Wholesale and retail companies had to rapidly adapt to consumer demands for environmentally friendly products, recyclable packaging and build an open dialogue with consumers, create partnerships to develop a circular economy (closed-loop economy). The financial sector plays a crucial role in sustainable development because, as a vital engine of economic growth: creating ratings that affect companies’ value on market, financing green projects in accordance with the goals of sustainable development, developing green financial products, investing and owning assets, reducing its own negative footprint on the environment.

Trying to understand the differences, it is important to understand that all companies start working on sustainability goals with different starting conditions. Some are just looking for an answer to the question of why sustainability is necessary for business, while others have long prioritized their ESG agenda and have begun to integrate it into all business processes. This is why an open discussion sharing success stories and challenges and helping others with an advice is so important in building a conscious and proactive business environment.

We discussed with our partners what areas they prioritize currently to achieve net-zero goals by 2050 or earlier, and most of them said, respectively: reduction of CO2 emissions, employee development and social welfare, safety and reliability, reduction of waste and recycling, improvement of energy efficiency / use of renewables, reduction of negative impact on water and land resources, creating a sustainable supply chain, gender equality, switching to a circular economy, migration of climate risks. Another trend worth mentioning here is use of digital tools and technologies to promote faster and more efficient path towards sustainability. So-called ‘hybrid’ (process + digital technology) projects are expected to prevail in the portfolio in the next 10 years or so.

A local industry case is Saudi Aramco (according to their recent public announcement):

• They do not expect oil shortages that other oil companies may face. According to an audit by the independent company, oil reserves are sufficient for the next 50 years of production.
• The company plans to actively develop the petrochemical segment. In particular, in the first half of 2020 the purchase of 70% of SABIC will be completed which will allow Aramco to become the leading player in the petrochemical market.
• Saudi Aramco intends to increase the transparency of the environmental side of the business. In 2019, for example, the production segment's carbon footprint was 10.1 kg CO2-equivalent per barrel.
• Greenhouse gas emissions in 2019 were down 6% from 2018, from 61.3 to 57.9 million tonnes CO2-equivalent.
• The proportion of women in the company increased by 4% compared to 2018.
• Lost-time injury rate was 0.016 per 200,000 man-hours.

It comes as no surprise that petrochemical and chemical industries are considered as an opportunity to improve the monetization of O&G resources. However, against the background of increasing environmental and political agenda that changes the principles of taxation of companies and access to finance, oil and gas companies can view their chemical business segment as an option for improving the sustainability of activities. Diversifying the businesses in favor of petro- and chemicals allows companies to expand their product pool with the introduction of products with a smaller carbon footprint. Petchem is also one of the tools for solving the problem of associated petroleum gas utilization, leads to the emergence of new materials that are used in other industries and allow to reduce greenhouse gas emissions throughout the entire life cycle of products.

The EU Strategy for Energy System Integration sets the scene for the framework of the green energy transition – it implies that new links between sectors must be created and technological progress exploited with three main pillars to this strategy. First, ‘circular' energy system, with energy efficiency as the core (the ‘energy efficiency first' principle shall come to practice and to use local energy sources more effectively). Second, a greater direct electrification of end-use sectors. And then, clean fuels, including renewable hydrogen and sustainable biofuels and biogas.

In determining the best path to success over the long term, smaller independent oil and gas companies have less margin safety buffer to put on stake. In the short term, they are better off focusing on their traditional strengths and managing the cost curve more carefully and disciplined to free up cash to diversify their portfolio. Smaller companies that don't like to take high investment risks may also consider strategic alliances to share costs (and profits) with a larger oil company and save money that can be used to invest in unconventional energy sources.

What is being done and has been developed by companies so far: valuation and disclosure of data regarding the carbon footprint - updating the methodology for calculating direct (scope 1) and indirect (scope 2 and 3) GHG emissions of the company, the development of methods for projecting GHG emissions, reporting on GHG emissions from the main production activities of the oil and gas sector. Еhe issue is to achieve balance with sharing their data with 3rd parties and providing clear and stable information on projects and activities in the pipeline. Some companies progressed with the Development of the company's climate strategy, setting medium- and long-term climate targets in terms of GHG emissions in accordance with the Science Based Targets Initiative (SBTI), and started changing the corporate management system – i.e., introducing decarbonization key performance indicators into the management system. Key players now moved on to investing directly in decarbonization technologies and partnering not only in a traditional client-contractor way, but also with former engineering competitors and also with companies across the supply chain and related sectors.