But this approach could also damage the oil majors which pursue it. That's according to a new report from the Carbon Tracker Initiative (CTI), which argues that the long-term portfolios of the super majors will only work if oil prices consistently exceed $120 a barrel.
Only by reducing their reliance on high cost, high volume projects can the largest oil companies maximise shareholder value, say CTI's analysts. What's more, the combined upstream assets of the seven largest listed oil and gas companies - ExxonMobil (US:XOM), Royal Dutch Shell (RDSB), BP (BP.), Chevron (US:CVX), ConocoPhillips (US: COP), Eni (Ita:ENI) and Total (Fr:FP) - would be worth $100bn more if they reduced the carbon intensity of their portfolios.
Crude numbers
Arriving at that figure requires some legwork, and a number of assumptions.
According to the report's authors, Andrew Grant and James Leaton (who recently spoke to us about the risks facing Shell), oil investors should be asking themselves a variation of the following question: "under what parameters is the net present value of a 'business as usual' portfolio higher than a low production portfolio future-proofed for a '2°C warming demand scenario?"
Firstly, some definitions. 'Two degrees of warming' refers to the highest global temperature rise, above pre-industrial levels, that the climate can sustain before runaway warming kicks in. A portfolio that meets this demand is therefore smaller and less productive, in line with the International Energy Agency's 450 scenario, which envisages demand declining to just 74m barrels of oil a day (2016 demand is expected to eventually hit 97m barrels a day).
To answer the above question, the CTI report also uses Rystad Energy's supply cost curve to arrive at the 'business as usual' breakeven cost, and the oil industry's standard 10 per cent discount rate to determine likely future cash flows and net present value. The chart below shows the results of this calculation for a 'business as usual' portfolio, and a low-carbon subset of that portfolio which focuses on smaller, low-cost projects.
Easy switch?
Of course, the argument for managed decline is inimical to the strategies of most oil companies, jostling for market share through high-volume production. The more critical point is that new low-cost, low-hanging fruit isn't easily available or abundant. If it were, it's unlikely we would have seen attempts to drill the Arctic, or the proliferation of the high-cost tar sands industry. What's more, the drop in the oil price has fully exposed the industry's over-reach in expensive fields.
What the CTI report underlines, however, are the flaws in a pure reserves-based valuation model for oil companies. The industry will obviously counter that, contrary to the research group's assertions, global demand for oil is increasing and that the transition to renewable energy sources is anything but a straight-forward path.
But the concept of a fossil fuel risk premium - for companies alive to the hazards of continuing the approach of the past decade - is welcome. It's something we attempted to analyse, in a different sense, in last year's feature 'Don’t Get Burned'.
