COVID-19 has shown that decarbonization goals are achievable

Uncertainty around the outcome of the 26th annual United Nations Climate Change Conference of the Parties has been holding back the launch of new carbon projects, with a potentially harmful impact on the development of voluntary carbon markets, several stakeholders told S&P Global Platts.

Concerns are emerging around the implementation of Article 6 of the Paris Agreement on climate change in particular, which will be one of the key points on the agenda for the conference in Glasgow, due to take place in November.

Article 6 will determine whether countries can use voluntary carbon markets to reach their net-zero emissions goals. It will also allow participating countries to set additional goals such as mitigating climate change and promoting sustainable development.

“The uncertainty around the Article 6 of the Paris Agreement is responsible for the current slowdown in supply,” a European carbon trader said. “We would have more projects implemented if there wasn’t a lack of clarity and understanding of what Article 6 will mean for countries and players.”

“The lack of internationally agreed rules as a basis increases the risk to investment in carbon markets generally,” said Hugh Salway, Head of Environmental Markets at The Gold Standard Foundation, in an emailed statement. “It prolongs uncertainty about the future of the Clean Development Mechanism and its projects.”

Three primary issues

There are three main unresolved issues that the Parties will be discussing at the 26th annual Conference of Parties.

The first is the future of the United Nations Clean Development Mechanism (CDM) and its projects, mentioned by Salway. The Parties will have to decide whether to allow carbon credits issued under the CDM as part of the Kyoto Protocol to be recognized also by the Paris Agreement.

Credits issued under the CDM are known as Certified Emission Reduction (CER) credits and currently represent some of the most competitive credits available on the market. Their competitive price is due to the old vintages held by these credits and the low-quality reputation deriving from this. The CDM scheme is the first scheme of its kind and CERs were issued as far back as 2006.

For some, the continuity of previous mechanism should be guaranteed to create a stable and inviting regulatory environment. According to others, many of the projects issuing CERs no longer comply with one of the core principles of voluntary markets, which is additionality, and should therefore be excluded from the current carbon finance space. Under the principle of additionality, to be eligible for credits issuance, a carbon project needs to prove that it would not be able to operate without the additional revenue generated from the sale of carbon credits.

A second unresolved issue is represented by the Share of Proceeds (SOP). Article 6 is expected to rule whether a portion of the proceeds coming from the trade of voluntary carbon credits should be destined to developing countries to help their mitigation and adaptation efforts. This portion of proceeds, which some opponents call tax, would go into a separate fund that will be used by developing countries to finance their mitigation efforts. Negotiations are underway to decide not only if a SOP should be set, but how large the percentage should be and how it will be managed.

The third and last issue is about deciding whether a percentage of carbon credits should be canceled any time a bundle of credits is purchased.

In other words, when a buyer purchases a bundle of carbon credits, a set percentage of those credits, for example 20%, is immediately canceled and no longer available to the buyer for its offsetting needs. This share of canceled credits could either be treated as a “climate bonus” to help reach even higher climate targets or, according to others, should be offered to host countries as a way to meet their mitigation obligation under the Paris Agreement.

According to Jeff Holmstead, a partner at the Bracewell legal firm and head of Bracewell’s Environmental Strategies Group, the second and third issues stem from the same question: “Should carbon credits be used simply to reach emission reduction targets at the lowest cost, or should it be used for other purposes — such as redistributing wealth across countries or attempting to go beyond the actual targets?”

“If we allow developing countries to benefit from a share of the proceeds coming from trading activities, or to keep some of the emission reduction credits purchased by buyers, we would help developing countries to reduce the cost of their mitigation efforts,” Holmstead said in an emailed statement. “But this would have an impact on voluntary carbon markets and on the environment because carbon finance will become less efficient and more expensive.”

Things will move on

While carbon markets are on the edge of their seat and are keen to get more clarity on the topic at hand, the general sentiment in the industry is that carbon credits will still play an important role on the journey to net-zero. The question just remains of what capacity.

“Regardless of the outcome of COP26, voluntary carbon markets will continue to grow,” said Robin Rix, Chief Policy and Markets Officer at Verra, in an emailed statement. “The world is witnessing an inexorable trend toward net-zero by 2050, and voluntary carbon markets are leading the way.”

Even if governments are not able to reach an agreement in Glasgow this November, negotiations will continue, according to Salway.

“Bilateral trading arrangements between a select number of countries will also likely move forward, shown by the agreements Switzerland has already struck with Peru, Ghana and Thailand,” Salway said.

The transition to a low-carbon energy future raises tough questions for the US upstream natural gas industry over its environmental impacts and what measures should be taken to mitigate them. It also threatens to end nearly 20 years of growth in gas production.

In earnings calls, investor presentations and at conferences, the low-carbon narrative has become a recurring theme among upstream companies and their investors as the energy transition grows in prominence. In the 2020s and beyond, that narrative promises to dramatically alter the shale gas producer business model.

ADDITIONAL COVERAGE: Natural Gas in Transition

Throughout the early 2000s, the stunning success of shale drilling was determined largely by institutional investors and politicians directing capital and tax incentives to the upstream sector. Those investments allowed US producers to nearly triple domestic output since the early 2000s to more than 90 Bcf/d currently.

As boardrooms and legislatures scrutinize the carbon costs of drilling, their mandate for the 2020s is one of discipline and stewardship. First and foremost, low-cost, maintenance-level production will remain critical to the survival of individual producers. Beyond that, though, intensive carbon-tracking and emissions reductions will also become vital in the years ahead.

Low prices, narrow margins

Over the past decade, the price of benchmark Henry Hub gas has averaged just $3.01/MMBtu, according to S&P Global Platts data. Consistently low prices have long been the hallmark of shale drilling and will remain a major selling point for gas as a residential-commercial and industrial fuel.

Through 2030, the real, inflation-adjusted, price of benchmark Henry Hub gas will average just $2.85/MMBtu, according to a forecast from S&P Global Platts Analytics. Through the decade that follows, prices will likely rise by less than 45 cents.

In the US, low prices – and the high cost to overhaul or repurpose midstream and downstream infrastructure – will make gas a fierce competitor to alternative fuels, even in a low-carbon world. While the push toward renewable power will erode market share for gas in the generation sector, the fuel is forecast to remain critical to both the residential-commercial and industrial markets over the next 30 years.

For the upstream industry, low prices will require further improvements in efficiency and cost-control.

Over the past 10 years, low gas prices have rendered obsolete some of the most prolific early-era shale basins, such as the Fayetteville in Arkansas and the Barnett in Texas. In the decades to come, that trend will only accelerate as producers focus on a narrowing pool of profitable resources in a handful of plays. These are likely to include the Delaware and Midland sub-basins of the Permian in Texas and New Mexico; the Bakken, largely in North Dakota; the Marcellus in Appalachia; and the Haynesville in Texas and Louisiana.

As of first-quarter 2021, an average shale producer in the Delaware Basin – currently the most profitable in North America – sees an internal rate of return close to 34%, based on a half-cycle, post-tax analysis. Across Appalachia, the average producer sees closer to 14% to 19% – just enough to remain profitable.

In recent years, average IRRs in even the most prolific basins have at times dipped lower – into the single digits, sometime for months. Generally, producers require a return of at least 10% to achieve breakeven, making margins below that level unsustainable longer term, according to Platts Analytics.

Consolidation

Over the next decade, thin margins and a growing focus of investors on profitability will likely narrow the field by way of bankruptcies, mergers and acquisitions, leaving only the most efficient standing.

In Q1 2021, bankruptcies among US exploration and production companies totaled eight, according to recent data published by Haynes and Boone. It was the most for any first-quarter period since 2016, but still down from peak levels in Q2 2020 when 18 E&Ps filed, and Q3 when 17 bankruptcies were filed. Even for producers that have weathered the recent storms, consolidation pressures in the 2020s are only likely to grow. During a recent earnings call, EQT President and CEO Toby Rice told analysts that scale will become increasingly critical to producers’ survival in a low-price commodity environment.

“In Appalachia, we’ve got 30 teams running around 30 rigs; you may have very efficient companies, but when you look at that, it could be more efficient than that,” he said. “You’ve got a lot of service providers that are running at, call it 50% utilization. And you’ve got multiple gathering infrastructures.”

Carbon costs

Cost, efficiency and consolidation pressures are just half of the equation for E&Ps, though. In the 2020s and beyond, discerning investors and tighter regulations will demand environmental stewardship, too.

For natural gas producers, emissions detection, tracking and certification at the wellhead and on gathering lines will become an indispensable, routine component of environmental stewardship. Beyond that, investors will look to E&Ps for leadership in the adoption of low- or zero-carbon business models and emissions-cutting technologies.

This spring, the US’ largest gas producer, EQT, already took its first step in that direction, saying its Marcellus output would undergo an independent assessment of its environmental impact. Its certification will include quantified assessments for methane detection and intensity, along with an overall score based on other factors, including the company’s record on corporate governance, ethics, social impacts, human rights, community engagement, biodiversity and climate change.

The push for greater environmental stewardship comes, not just from investors but from end-user customers, too. Earlier this year, Pavilion Energy signed a six-year LNG sales and purchase agreement with Chevron for the supply of some 500,000 mt/year of LNG to Singapore starting in 2023. Under the agreement, cargoes delivered will be accompanied by a statement of GHG emissions measured from the wellhead to the discharge port. At a recent climate summit, Chevron’s general manager of ESG and Sustainability said he anticipates many future commercial deals will include such agreements.

For some companies, the push to meet environmental goals will be met early on by aggressive emissions cuts. Last year, BP, for instance, announced an ambitious goal to achieve carbon neutrality across its global operation by mid-century.

For other E&Ps, the pressure has intensified just in recent weeks. At ExxonMobil – which has announced its own plan to reduce GHG emissions some 30% by 2025, with reductions coming in part from carbon capture and sequestration technology – an activist hedge fund managed to get three nominees on to the ExxonMobil board. The same day, Chevron investors voted for stringent targets to cut emissions from the company’s products, and Royal Dutch Shell was handed a court decision in the Netherlands ordering the company to accelerate emissions reductions and cut its carbon footprint 45% globally by 2030.

Environmental initiatives are already becoming business-critical for E&Ps as they look to attract both investor dollars and end-user customers. The sector can expect more of the same into the mid-2020s and beyond.

Evolving choices around EV battery composition have altered price dynamics in the lithium market, with the two main forms, hydroxide and carbonate, now moving independently to each other, reflecting different use cases and trading patterns. LFP was considered by many industry participants to be a lower priority in the upcoming EV boom. This started to change with the gradual removal of Chinese EV subsidies, which lowered the incentives for local automakers to target only long-range EVs and increased the pressure to reduce costs. Moreover, improvements on the pack design, through the cell-to-pack approach, allowed a bigger portion of the battery pack to be filled with cells which significantly increased energy density.

In the latest of S&P Global Platts Future Energy Podcast, Platts Pricing Director of Metals Scott Yarham speaks to Tianqi Lithium‘s Sales Director Ron Mitchell and Platts Pricing Specialist Henrique Ribeiro to unpack these new trading patterns and what is emerging in the market.

Investors are proving they have climate change and the energy transition on the their minds.

Last week, activist investors got at least two seats on the ExxonMobil board of directors, and Chevron’s shareholders approved Scope 3 emission targets, both which could lead to lower oil and gas production ahead.

The popularity of ESG (environmental, social and governance) investments is soaring. But what does it even mean for a company to adopt that label, and how do we weigh one ESG pledge against another?

Jonathan Chanis, managing member of New Tide Asset Management, believes ESG priorities are here to stay. He thinks regulators have a role to play to make sure these ESG labels mean something but he sees potential risks from regulators getting these reforms wrong.

India’s road to recovery from the pandemic’s deadly second wave may help fast track oil majors’ ambitions to expand their portfolio in Asia’s fastest-growing energy market while at the same time reducing their carbon footprint.

With plentiful funds expected to support an economic recovery from the COVID-19 crisis, CEOs of leading global companies are hopeful a large part of that relief will flow into the energy sector, creating opportunities in both fossil fuels and in clean energy.

“Perhaps a post-pandemic economic recovery anchored around sustainability and climate action could well be the prudent way,” Nitin Prasad, chairman of Shell Companies in India, said in an exclusive interview with S&P Global Platts. “We also believe that there are opportunities to accelerate our activities to help the country recover cleaner and faster, which we are actively encouraging the government to consider.”

The pandemic has neither altered the country’s long-term robust energy fundamentals nor Shell’s commitment to grow its business, Prasad said, and he believes that with every crisis comes an opportunity.

“My vision for India is one with a clear focus on decarbonization and climate action, but in a fair and equitable way,” Prasad said.

The pandemic has encouraged Shell to shift the role of its fuel stations, converting them into safe havens by ensuring proper sanitization, social distancing and contactless transactions.

From hydrogen to biofuels

A study Shell jointly conducted with The Energy and Resources Institute highlighted how the country will need to evolve as energy demand in India is set to almost double by 2050.

In order to transition into a net-zero future, the share of the country’s electricity in its energy mix needs to grow to more than 50% of energy use, with rapid electrification of energy services primarily from renewables.

Fuels as molecules—such as crude oil, natural gas, coal, hydrogen, biofuels and biomass—will meet the remaining energy consumption basket. In addition, liquid biofuels need to surpass petroleum products by 2040 in fueling industry and transport, including hard-to-abate sectors like aviation.

“We believe that hydrogen will play a key role in the net-zero emissions journey of India’s energy system,” Prasad said.

Bill Davis, CEO and lead country manager for ExxonMobil South Asia, said in India’s road to recovery and move towards energy security there be higher demand for lower emissions and affordable energy, and finding hydrocarbon resources domestically will be crucial.

“There is no denying the need to simultaneously pursue further emission reduction efforts and technologies to support the transition to a lower carbon future,” Davis told Platts. “It’s really a question of doing it in a smart way.

Related content—Platts India CEO Series:

ExxonMobil eyes bigger footprint in India’s energy transition journey: Bill Davies, ExxonMobil South Asia CEO

Shell sees opportunity for India to recover ‘cleaner and faster’: Nitin Prasad, Shell Companies – India CEO

India aims to cushion oil shock by doubling strategic petroleum reserves: H.P.S. Ahuja, ISPRL CEO

Cairn Oil & Gas says oil price recovery will support India’s upstream push: Prachur Sah, Cairn Deputy CEO

Retail gas, LNG by trucks, hydrogen figure in H-Energy’s growth vision: Darshan Hiranandani, H-Energy CEO

Hard-to-decarbonize sectors

ExxonMobil is developing technologies to make refining less energy-intensive and is researching breakthroughs to make future solutions like carbon capture more affordable for a wide range of applications.

The transportation sector, being a key component of India’s transition to a gas-based economy, is another areas of focus for ExxonMobil. As India prepares the adoption of LNG as a vehicular fuel, ExxonMobil is working with GAIL to build opportunities that add impetus to that vision.

ExxonMobil expects natural gas to do a part of the heavy lifting to support economic growth following the pandemic. The company is working with leading Indian energy companies to accelerate gas access for industries, transportation and other applications.

“As India transitions to lower-carbon sources, it has concrete emission reduction plans consistent with making energy access more equitable and affordable,” Davis said.

ExxonMobil is one of the world’s largest producers of hydrogen, and as its potential for use in the transition to a lower-carbon future develops in India, Davis believes the company is well positioned to apply its experience, scale and technology to contribute.

“Hydrogen can be useful in hard-to-decarbonize sectors, such as fuel for heavy-duty trucks, and to produce high-temperature industrial heat for steel, refining and chemical industries,” Davis said. “Low-carbon hydrogen from natural gas with carbon capture and storage, or CCS, has cost and scale advantages in the near and medium term.”

Outside the global majors, leading Indian oil companies are also stepping up efforts to ensure they are not left behind in the race.

Shrikant Madhav Vaidya, chairman of Indian Oil Corp., said while IOC’s strategic growth path will focus on its core refining and fuel marketing businesses with a bigger petrochemicals presence, hydrogen and electric mobility will figure prominently in its portfolio over the in the next 10 years.

IOC is pushing ahead with research on carbon capture, utilization and storage technologies, a space where it is seeking global collaboration to meet its Paris climate goals.

“We are at an advanced stage of embracing such technologies for energy transition,” Vaidya said.