Oil and gas companies in energy transition - Part 1: An introduction
Believe it or not, as recently as 10 years ago there were serious concerns about a shortage of oil and gas (termed “peak oil”, see here, here, here, and here). The peak oil concern was driven by a steep rise in prices between 2003 and 2008, but was quickly put to rest by the advent of horizontal drilling and hydraulic fracturing. It is worth noting, however, that much of the 20th century was spent revisiting whether or not we would run out of the vital fuel. These concerns were not taken lightly, as during this time the world became deeply dependent on fossil fuels. As I inspected in detail in my review of Smil’s “Energy and Civilization”, the explosion of useful energy made available by fossil resources resulted in critical societal advances. To name a couple, the enabling of concentrated power transformed manufacturing and transport, and fertilizer (manufactured using natural gas) has catalyzed the enormous growth in food production.
Today, concern has shifted from oil’s scarcity to its abundance. Scientists are threatening extreme disruption if we don’t make serious changes to get off fossil fuels in the next decade. Public attitudes are also beginning to shift. In September, a massive coordinated strike by teenagers demanded that global leaders “end the era of fossil fuels”. But despite these encouraging signs of change, over 80% of our primary energy (depending on whose numbers you count) is still produced by massive, integrated oil and gas (O&G) companies. The scale of the industry is so massive, it is difficult for anyone to fathom it going anywhere any time soon.
In order to explore the current status and future of our energy providers, I will be dedicating a three part Stanford Energy Journal series to this topic. For this first installment I will briefly introduce the O&G industry through a (very) abridged historical discussion. As Einstein said, “If you want to know the future, look at the past”.
The first petroleum era – The golden age of gasoline
The first petroleum era begins in 1919, following World War I. Beginning with Winston Churchill, the global powers started to appreciate the importance of oil as a strategic resource. By the end of the war, the American automobile industry was in full swing. The post-WWII surge in oil production and competition for reserves led to two key agreements being signed (see the Red Line Agreement (1928) and the Achnacarry Agreement (1928)). The Red Line Agreement, in particular, allowed the western powers to exploit newly discovered Middle Eastern reserves for years to come. During the first petroleum era, due to these agreements the western-owned international O&G companies controlled nearly all of the oil trade. These oil companies included Exxon, Mobil, Gulf Oil (now Chevron), Texaco, BP, and Shell (or the so-called “seven sisters”, as coined by businessman Enrico Mattei).
America has a strong sense of nostalgia for the 1950s and the later years of the first petroleum era. We had just won the war, the economy was growing, and technology was rapidly improving. People look back on a middle class that could afford a house and a car in the suburbs, television, rock and roll, drive ins, and a general sense of optimism. The post WWII economic boom was partly a result of low oil prices driven by a surge in production (8.7 million barrels per day in 1948 to 42 million barrels per day in 1972) due largely to increases in the Middle East. However, while production was surging, demand was also catching up fast. The 20 years of price stability ended in a dramatic fashion in 1971, marking the end of the first petroleum era.
Motels, drive ins, and fast food restaurants boomed in popularity after Americans took to the highways (image by Jan Messersmith)
The second petroleum era – The countries take over
While a boon to consumers, the end of the first petroleum era and the beginning of the second petroleum era was a difficult time for producers. In the latter half of the 60s, production was unable to keep pace with consumption. Further, beginning in 1967, concession agreements were beginning to be renegotiated between Middle Eastern governments and oil companies. In the first petroleum era, producer governments who lacked sufficient expertise would sign concession agreements with oil companies to drill and produce their local reserves. However, driven by a rising nationalism against colonial exploitation, a belief (largely justified) that insufficient benefits were reaching the local people, and a growing shared consciousness, these producing governments began to kick out the western oil companies and nationalize their respective oil industries. Today these producing governments operate so-called National Oil Companies (NOCs) (e.g, Iranian National Oil Company, Saudi Aramco, Pemex).
The end of the first petroleum era could be set at 1971, when instigated by threats made by Libya’s Qaddafi, an “Organization of Petroleum Producing Countries” (OPEC) was called upon to negotiate terms between oil companies and the producing governments. The members of OPEC (which include Saudi Arabia, Iran, Libya, Venezuela and others) in 1971 controlled nearly 50% of the global oil production. The Arab nations, with their new-found supply dominance, imposed an export embargo on the US and other nations supporting Israel in the Yom Kippur wars. This embargo resulted in a price spike and gasoline shortages in the US. A second price spike was experienced in 1979 during the Iranian Revolution, when Iran’s supply was disrupted due to the overthrow of Shah Pahlavi.
Revenue (billions of US dollars per year), production (millions of barrels per day), and proved reserves (billions of barrels) for a select group of NOCs and IOCs in 2018 (Source: Rystad UCube).
Challenges to the oil companies
Several challenges were faced by the major oil companies in the second petroleum era. First, resource nationalization shifted the balance of power to the NOCs (see Figure above). Second, though the majors weren’t culpable, anger due to gasoline shortages and investigations of government and corporate collusion abroad led to a growing public distrust of the industry. This distrust was also reflected in a growing environmental movement, driven by rising air pollution in major cities, the 1969 offshore oil spill in the Santa Barbara channel, and culminating in the first Earth Day in New York (1970) when over 100,000 people marched down Fifth Avenue. This is referred to as “second wave environmentalism” and is reflected in books like Silent Spring, Limits to Growth, and Population Bomb. The environmental movement lost steam in the 1970s, but gained global momentum in the late 1980s primarily as a result of the Chernobyl meltdown. The “third wave environmentalism” also marked a recognition of global warming, sparked by James Hansen’s famous speech to congress (1988) and the first assessment of the Intergovernmental Panel on Climate Change (1992).
These two trends combined to put the oil companies in a tough position. As a result of the resource nationalization and the formation of OPEC, the majors lost access to much of the world’s easily accessible reserves. Further, with the addition of crude oil to the commodity exchange in the late 80s, the majors lost much of their influence over oil markets (In the early days of the oil industry, the trading was done entirely between producers and refiners. Today, oil trading happens on financial markets, like NYMEX, and investors are also involved in speculating on the price of oil (similar to stocks) to try to make money). The rules of the game had shifted, and the oil majors were left vying for increasingly expensive and technologically challenging projects.
The oil industry, according to millennials (image by Jonathan McIntosh)
So, what’s next?
Despite a volatile market, the business model of the IOC has been one of the most successful over the past decades. However, storm clouds loom over the horizon. First, evidence suggests, relative to the past the oil and gas majors are witnessing financial stress. As reported by CNBC, at the end of the month in August ExxonMobil dropped out of the S&P500 top 10 for the first time in nine decades, and the energy sector hit a low of about 4%, its lowest in four decades. These events help confirm a trend, which we will later explore in greater detail, that fossil energy is becoming less favorable for investors. However, the recent admonition from investors is nothing compared to the treatment given to oil and gas by the younger generation. September’s protests, led by teenage activist Greta Thunberg, have mobilized millions of people in an estimated 185 countries, all in support of a transition away from fossil fuels. This degree of public sentiment cannot be ignored.
These headwinds suggest that we may be heading for a third era of petroleum. One purpose of this article was to highlight how the oil and gas majors have faced significant disruption in the past, but evidence suggests that coming changes will be more jarring than price swings. This will be the focus of the next two articles in this series: in article 2, we will further elaborate on these threats, and in article 3, we will summarize plans that oil and gas companies have in place to address these threats.