Rapid Energy Transition Could Doom Oil Exporting Countries

It’s a tough time being in the oil and gas business. Big Oil has lately come under a plethora of attacks from all directions, ranging from uncooperative financiers and investors amidst a global shift to renewable energy to hostile governments and hardline climate activists.

And although the major oil-exporting economies of the world weren’t necessarily in the environmental crosshairs like Big Oil was, the shift could have a devastating effect on those oil-dependent economies. 

In a virtual climate summit with 41 world leaders last month, President Joe Biden unveiled an ambitious ten-year Climate Plan that has proposed cutting U.S. greenhouse gas emissions by 50-52% by 2030. That represents a near-doubling of the U.S. commitment of a 26-28% cut under the Obama administration following the Paris Agreement of 2015.

Just last week, some of the biggest names in the business suffered a trifecta of blows after Chevron (NYSE:CVX) shareholders voted to further cut emissions; Exxon Mobil (NYSE:XOM) lost at least two board seats to an activist hedge fund while a Dutch court ordered Royal Dutch Shell (NYSE:RDS.A) to cut its greenhouse gas emissions harder and faster than it had previously planned. Never mind the fact that Shell already had pledged to cut GHG emissions by 20% by 2030 and to net-zero by 2050. The court in The Hague determined that wasn’t good enough and demanded a 45% cut by 2030 compared to 2019 levels.

Things are looking decidedly murky at a granular level, with environmental activists taking advantage of the clean energy momentum and major policy changes by the world’s governments to turn the screw on Big Oil.

But what happens when you zoom out and look at the bigger picture—Entire nations that depend on oil to power their economies. How will economies that are heavily dependent on oil exports cope with the shift to low-carbon fuels?

In 2019, 40 countries across the globe exported crude worth $1 billion or more, with some like Iraq depending on oil sales to finance upwards of 90% of their budgets. Fossil fuel-dependent economies represent almost one-third of the world’s population and are responsible for a fifth of global greenhouse gas emissions. 

And now the International Energy Agency (IEA) has warned that pursuing net-zero emissions target is likely to be catastrophic for many oil exporters.

Source: The Financial Times

A Looming Catastrophe

Pursuing a net-zero emissions target by 2050 would see OPEC become even more dominant and end up accounting for more than 50% of world production as supplies become concentrated among a smaller number of countries. Unfortunately, it would also mean there’s a lot less pie to go around, with annual per capita income from these commodities predicted to fall by as much as 75% in little more than a decade.

According to the IEA, countries where hydrocarbon exports make up a large part of GDP are likely to be the hardest hit. 

However, countries that are the least resilient—where the revenues from the sale of fossil fuels have not been adequately managed by means such as using the cash to diversify into other domestic industries or create sovereign wealth funds that invest abroad to secure long-term revenues—will also bear the full brunt of the energy transition.

One such country is Iraq.

Despite harboring ~145bn barrels of proven crude reserves, Iraq’s finance minister Ali Allawi recently warned that pursuing a net-zero target by 2050 could be catastrophic for the country. Allawi has been desperately trying to push sweeping state and economic reforms in a bid to avert this eventuality, but has seen his efforts thwarted by a government more concerned with more prosaic matters.

The World Bank has named Iraq, Libya, Venezuela, Equatorial Guinea, Nigeria, Iran, Guyana, Algeria, Azerbaijan, and Kazakhstan as the most vulnerable oil-producing countries due to their high exposure to the oil and gas sector and relative lack of diversification.

On the other hand, some oil giants such as Saudi Arabia and Russia are seen as being less vulnerable thanks to their more complex economies and bigger financial buffers. 

A good case in point: When it comes to embracing the energy transition, Saudi Arabia appears to be ahead of most of its OPEC peers.

The Saudi government is building a $5 billion green hydrogen plant that will power the planned megacity of Neom when it opens in 2025. Dubbed Helios Green Fuels, the hydrogen plant will use solar and wind energy to generate 4GW of clean energy that will be used to produce hydrogen.

But here’s the main kicker: Helios could soon produce clean hydrogen that’s cheaper than oil.

Bloomberg New Energy Finance (BNEF) estimates that Helios’ costs could reach $1.50 per kilogram by 2030, way cheaper than the average cost of green hydrogen at $5 per kilogram and even cheaper than gray hydrogen made from cracking natural gas. Saudi Arabia enjoys a serious competitive advantage in the green hydrogen business thanks to its perpetual sunshine, wind, and vast tracts of unused land.

During the company’s latest earnings call, Saudi Aramco CEO told investors that Aramco had abandoned immediate plans to develop its LNG sector in favor of hydrogen. Nasser said that the kingdom’s immediate plan is to produce enough natural gas for domestic use to stop burning oil in its power plants and convert the remainder into hydrogen. Blue hydrogen is made from natural gas either by Steam Methane Reforming (SMR) or Auto Thermal Reforming (ATR) with the CO2 generated captured and then stored. As the greenhouse gasses are captured, this mitigates the environmental impacts on the planet.

Last year, Aramco made the world’s first blue ammonia shipment—from Saudi Arabia to Japan. Japan—a country whose mountainous terrain and extreme seismic activity render it unsuitable for the development of sustainable renewable energy—is looking for dependable suppliers of hydrogen fuel with Saudi Arabia and Australia on its shortlist.

Dwindling reserves

Big Oil, however, faces a bigger existential crisis that could hit home even sooner: Rapidly dwindling reserves.

Massive impairment charges saw Big Oil’s proven reserves drop by 13 billion boe, good for ~15% of its stock levels in the ground, last year. Rystad now says that the remaining reserves are set to run out in less than 15 years, unless Big Oil makes more commercial discoveries quickly.

The main culprit: Rapidly shrinking exploration investments.

Global oil and gas companies cut their capex by a staggering 34% in 2020 in response to shrinking demand and investors growing wary of persistently poor returns by the sector.

The trend shows no signs of moderating: First quarter discoveries totaled 1.2 billion boe, the lowest in 7 years with successful wildcats only yielding modest-sized finds as per Rystad.

ExxonMobil, whose proven reserves shrank by 7 billion boe in 2020, or 30%, from 2019 levels, was the worst hit after major reductions in Canadian oil sands and US shale gas properties. 

Shell, meanwhile, saw its proven reserves fall by 20% to 9 billion boe last year; Chevron lost 2 billion boe of proven reserves due to impairment charges while BP lost 1 boe. Only Total (NYSE:TOT) and Eni have avoided reductions in proven reserves over the past decade.