As pressure grows on the world’s largest extractive companies to cut down on emissions, the question has turned to how much they are actually responsible for.
The oil and gas supermajors are working hard on cutting their own carbon intensity, but that’s not enough to stop their outsized contribution to global warming, as the use of their products contributes far more than their own operations. This is where ‘Scope 3’ emissions come in. Royal Dutch Shell (RDSB) says its direct greenhouse gas emissions in 2018 were 95m tonnes of carbon dioxide equivalent (CO2e). Its indirect, or Scope 3 emissions, were 599m tonnes of CO2e. That compares with 449m tonnes for the UK’s 2018 provisional carbon-equivalent emissions.
For investors, the focus on emissions might seem irrelevant – no one buys oil and gas or mining stocks to show off their environmental credentials. But shareholder pressure and the potential for carbon pricing schemes means that high emissions have become a risk factor for earnings. Nick Stansbury, head of commodity research at Legal & General Investment Management (LGIM), told us that he was looking carefully at Scope 3 emissions. “[They] are important primarily because they’re a useful proxy for us for substitution risk,” he said. “In other words, what we as investors are interested in is the fact that at some point down the line, there’s going to be a cost of carbon, and people are going to have to pay the cost for the environmental externalities that they’ve never had to pay for before.” Broker Berenberg said carbon pricing could knock 5-10 per cent from free cash flow at the “most exposed” oil and gas companies.
On the mining side, BHP (BHP.) leapt to the front of the pack in July 2019 when chief executive Andrew Mackenzie announced that Scope 3 emissions would be a focus of the company’s new sustainability plan. “Next year we will set a medium-term, science-based target for the decarbonisation of BHP operations, which will reflect the goals of the Paris agreement,” he said. “And we won’t stop at the mine gate. We will also increase our focus on Scope 3 emissions. These emissions are generated as customers transport, transform and use our products to serve the needs of billions of people and they are almost 40 times higher than the emissions from our own operations.” BHP’s Scope 3 emissions come largely from the iron ore it sends to China’s steelmaking industry. The group has set aside $400m over five years to get emissions down.
But the extractive industry is not settled on this as a major goal. Fellow major diversified miner Rio Tinto (RIO) had earlier in 2019 refused to commit to targets when prompted by a shareholder resolution including Scope 1, 2 and 3 targets and alignment with the more ambitious Paris goal of limiting warming to 1.5 degrees. Environmental advocacy organisation Market Forces (see ‘expert view’, right) put the resolution up for a vote, and it garnered only 6 per cent of shareholder support. The Friends of the Earth subsidiary estimates that Rio Tinto’s Scope 3 emissions are the same as the whole of Australia’s annual CO2e emissions. When telling shareholders to reject the call, Rio chairman Simon Thompson said it was the Scope 3 targets that made the idea impossible. “Scope 3 are primarily the emissions of our customers – mainly steelmakers in China, Japan and Korea – over which we have very limited control,” he said. This month, Market Forces said it would keep trying to get Rio Tinto to set Paris targets.
There are also different approaches from oil and gas companies. Shell, as above, has published its Scope 3 emissions, along with Total. BP (BP.) has set a narrower internal target of keeping operational emissions flat to 2025. Berenberg depicted the choice faced by the oil and gas supermajors as a stark one in a June note. “If companies focus purely on their operational carbon emissions (Scopes 1 and 2), improved efficiency, reducing routine flaring, and investing in carbon capture or sequestration will be the main areas of focus,” its analysts said. “Meeting Scope 3 targets will require significant remodelling of the business: to meaningfully reduce Scope 3 emissions in absolute terms requires switching oil production into gas, and refined products into petrochemicals – or alternatively reducing the production of refined products or gas.”
Smaller companies
The pressure is certainly there for major miners and oil and gas companies. But how should smaller companies react? Looking only slightly further down the tree from Rio Tinto and BHP, coal miner South32 (S32) – which has a market capitalisation of £8bn – has already started publishing its Scope 3 emissions. Its Scope 3 emissions of 116m tonnes of CO2e dwarfed its Scope 1 (10.5m tonnes) and Scope 2 (13m tonnes) output. It has also raised substitution risk in its annual climate change report. Meanwhile, Ferrexpo (FXPO) – a Ukrainian miner that produces friendlier-to-the-environment iron ore pellets and is valued at £1.2bn – defined its Scope 3 emissions as those from energy generated from living matter such as biofuels. The company indicated that in due course it hoped to add more into that calculation. Diversified Gas & Oil (DGOC), worth around £700m and about to move to London’s main market, is a shale oil and gas producer. A spokesperson said the company was working on an emissions target as part of a “best in class ESG [environmental, social and governance] programme”.
Mr Stansbury from LGIM said that mid-cap companies might not need to get on the Scope 3 bandwagon. “If you’re a large oil and gas company that has clearly articulated a strategy to increase your exposure to natural gas, for example, as a percentage of your revenue measured in energy equivalent, then setting Scope 3 targets is entirely consistent with that strategy,” he said. “[If] you’re managing your exploration programme in a way that is consistent with a 2 degree or a Paris-type outcome, it may not necessarily make sense for you to set Scope 3 targets.”
The context to all of this emissions talk is keeping global warming to between 1.5 and 2 degrees, as per the Paris agreement. Carbon Tracker analyst Mike Coffin said that reporting of Scope 3 emissions was just one part of heavy polluters’ responsibilities. “To reach the goals of the Paris agreement, emissions from the production and utilisation of oil and gas must reduce rapidly, and there is only a limited number of new projects that can be sanctioned,” he said. “By reducing investment in new projects, Paris-compliant Scope 3 emissions will reduce on an absolute rather than intensity basis, and company investment practice should reflect that.” This month, Carbon Tracker put out a report on recently greenlit oil and gas projects that would be stranded under a 1.7-1.8 degree warming scenario. The research organisation said that Shell, BP and Total continuing to build projects like the $13bn liquefied natural gas (LNG) Canada project and the $1.3bn Zinia 2 deepwater project showed that they were not taking the Paris goals seriously. Shell chief executive Ben van Beurden said in July that his company wanted to be part of a “global climate coalition of business” working to meet the Paris goals.
Source: Julien Vincent, executive director, Market Forces
