Ever since the second half of 2014, energy commodity markets have been defined by significant levels of volatility. From levels of over $100 per barrel between early 2011 and mid-2014, Brent oil prices fell to around $25 per barrel in early 2016, before rebuilding to the current range in 2019 of around $60 to $75 per barrel. Tight oil has revolutionized the supply side of the business, and the issue of decarbonization has risen to greater prominence. An energy transition to a lower-carbon economy appears to be underway, but there are multiple pathways to achieve this transition, which creates some uncertainty as to the pace and scale of change. Climate-related issues have evolved from an environmental concern to also include financial considerations. Our stakeholders have expressed an interest in understanding how Hess’ oil and gas portfolio might be impacted by a transition to a lower-carbon economy.
To help quantify climate-related risks and opportunities – and address investor concerns – many companies are using scenario planning as a tool to assess portfolio resilience over the long term. Scenarios allow the testing of a variety of alternative views of the market as a means to identify areas of potential risk and opportunity worthy of further, more detailed analysis and monitoring. The scenario approach allows companies to communicate to their investors that they understand and have considered future risks and opportunities, which are derived from modeled changes in energy demand, the potential emergence of new technologies, and proposed changes by policymakers to curb greenhouse gas (GHG) emissions.
Because the Task Force for Climate-Related Disclosures (TCFD) recommends transparency around key parameters, assumptions and analytical choices, Hess has chosen to model the three main scenarios detailed in the International Energy Agency (IEA) 2018 World Energy Outlook (WEO) against our own base case, which is explained later in this section. Furthermore, the TCFD recommends that organizations use a 2°C or lower scenario to test portfolio resilience – in other words, a scenario under which global warming is kept to within 2°C of preindustrial levels. Such scenarios usually feature reductions in demand for oil, natural gas and coal; growth in clean technologies; and a reshaping of trade flows, among other assumptions. The Sustainable Development scenario in the IEA’s 2018 WEO (discussed further below), which is part of Hess’s modeling, fits within this recommendation.
Considerations for Scenario Planning
In 2018 Hess senior management approved a scenario planning study to test the resilience of our portfolio against various views of the market. This exercise established a range of energy supply and demand; oil, natural gas and carbon prices; and emissions estimates that are projected to prevail under different publicly available, long-term scenarios for environmental policy and market conditions.
Scenario planning can be approached in a stepwise fashion. For Hess, the first step was to assess transition risks under divergent oil, natural gas and carbon price trajectories. In the next iteration of this analysis, we plan to consider expanding it to include looking at physical risks to our business (e.g., infrastructure) and reputational risk. Going forward, we plan to incorporate carbon asset risk assessment via scenario planning into our regular business planning cycle.
To evaluate potential exposure to our portfolio in a modeled carbon-constrained future, we began by considering the long-range outlook for energy supply and demand. We used the IEA’s 2018 WEO to examine various supply and demand scenarios through 2040 (see www.iea.org/weo2018). These scenarios are recognized as an industry benchmark worldwide, and are, therefore, an appropriate choice for an oil and gas producer such as Hess.
The charts below depict the 2018 WEO’s world energy demand and carbon dioxide (CO2) emissions under the IEA’s three main scenarios.
In the New Policies scenario, which is the IEA's central scenario, worldwide energy use will grow approximately 25 percent between 2017 and 2040. Energy demand for oil and gas is projected to grow by 24 percent during the same period and account for 53 percent of the energy mix in 2040, down slightly from 54 percent today.
The figure below shows changes in global oil demand by sector in the IEA’s New Policies scenario between 2017 and 2040. The chart illustrates that the expected electrification of the passenger vehicle fleet is more than offset by increased demand from the petrochemical, truck and aviation sectors, which will dominate future oil demand growth and continue to create robust demand for oil through the projection period.
In the Sustainable Development scenario (consistent with limiting global temperature rise to less than 2°C), worldwide energy use is projected to experience a modest decline of 2 percent through 2040. Oil and gas are expected to account for 48 percent of the energy mix, down from 54 percent today. The IEA has indicated that oil and gas are still critical to meeting the growing energy demand and that the challenges of achieving the Sustainable Development scenario are substantial, requiring a major reallocation of energy-sector investment capital.
Hess’ Approach to Scenario Planning
Hess has prepared internal guidance that details our approach to scenario planning. This guidance establishes a specified methodology, which we describe below. The guidance also serves as a roadmap for our external verifier to review and verify that we followed our specified methodology when conducting the scenario analysis.
Hess’ approach was to establish a base case (i.e., $65 per barrel Brent oil and $3 per million British thermal units (MMBtu) Henry Hub natural gas, in 2019 real terms) and then run our current asset portfolio and intended forward investments through this model to assess financial robustness. In addition, we applied a sustained $40 per tonne cost of carbon to our assets and intended forward investments. Hess’ base case was then compared against the various oil, natural gas and carbon prices in the IEA’s three main scenarios: Current Policies, New Policies and Sustainable Development.
While we included the three IEA cases in our analysis, the Current Policies scenario is not discussed in our disclosure that follows, as it only considers the impact from current legislation and does not include the likely effects of announced policies, including the Nationally Determined Contributions made for the Paris Agreement.
The three charts below show the oil, natural gas and CO2 prices under the IEA’s New Policies and Sustainable Development scenarios and Hess’ base case. As these charts show, there is a wide divergence in oil, natural gas and carbon prices between the two IEA scenarios. For Hess, oil and natural gas prices (and the underlying demand that drives them) are likely to be the most immediate concern, while the impact of carbon pricing is also relevant.
Our next step was to quantify the financial impact (delta) between the Hess base case and the IEA scenarios. The TCFD recommends that once a 2°C scenario is established, companies should define a base case or business-as-usual outlook for the future. The base case should use the same metrics as the 2°C scenario (e.g., oil demand, carbon prices and other market factors) and share the same fundamental economic foundations. Establishing multiple scenarios allows measurement of the delta between metrics at future points to properly understand the envelope within which risk and opportunity may occur.
Results of the Hess Scenario Planning Exercise
We have tested the robustness of Hess’ asset portfolio and intended forward investments under multiple scenarios, including the IEA’s Sustainable Development scenario. We note that the latter is fully aligned with the Paris Agreement’s aim of holding the increase in the global average temperature to well below 2°C. At the oil, natural gas and carbon prices established in our base case, the Hess portfolio remains resilient, and our pipeline of forward intended investments provides strong financial returns even under the Sustainable Development scenario, the IEA’s most challenging scenario in terms of GHG emission reductions.
While the Sustainable Development scenario projects lower oil demand in the 2040 timeframe, the IEA states that “continued investment in oil and gas supply...remains essential even in the Sustainable Development scenario to 2040, as decline rates at existing fields leave a substantial gap that needs to be filled with new upstream projects” (2018 World Energy Outlook, page 51).
However, with potentially lower oil demand, competition may intensify, and some high-cost producers may be forced out of the marketplace.
We believe our scenario analysis validates Hess’ strategic priorities (as shown in the figure below) to focus investment on high-return, low-cost oil and gas opportunities and to build a focused and balanced portfolio, robust at low prices – thereby providing competitive levels of returns to our shareholders.
We believe this strategy is consistent with the IEA’s Sustainable Development scenario, which envisions a meaningful role for oil and gas through 2040, when oil and gas are still projected to account for almost 50 percent of global primary energy demand.
Seventy-five percent of our investment capital through 2025 is planned to be allocated to our assets in Guyana and the Bakken, where we have a deep inventory of investment opportunities with predicted exceptional returns. Our discovery in Guyana (where Hess has a 30 percent interest in the Stabroek Block) is among the industry’s largest offshore oil discoveries in the past 10 years. The Liza Phase 1 development is projected to breakeven at $35 per barrel Brent oil, and the Liza Phase 2 development is projected to breakeven at $25 per barrel Brent oil. These are anticipated to be the lowest breakeven costs for the industry’s top 50 offshore developments and shale plays (source: RS Energy Group, Offshore First Class: The L.I.Z.A Framework, January 2018). As a result of the low breakeven costs in Guyana and aggressive cost-reduction activities in the Bakken, we plan to structurally lower our cash flow breakeven cost to less than $40 per barrel Brent portfolio breakeven by 2025, so that even if the market experiences reduced oil demand under the IEA’s Sustainable Development scenario, Hess is well positioned to retain our share in the marketplace as a low-cost producer.
Finally, using the lowest oil demand growth rate from the IEA’s Sustainable Development scenario, oil demand is still projected to be 70 million barrels per day in 2040. However, as the chart below illustrates, without any new investment, oil production would halve by 2025. The IEA has repeatedly flagged that there has been substantial underinvestment in future oil supply since oil prices began their decline in 2014. This mismatch between strong oil demand in the near term and a shortfall in new projects risks a sharp tightening of oil markets in the 2020s. The IEA estimates that almost $13 trillion of total oil and gas investment will be needed for oil and natural gas supply between 2018 and 2040 to support the Sustainable Development scenario.
In summary, based on the results of our scenario planning analysis, we believe it is highly unlikely that any of our assets would be stranded or significantly impaired by the CO2 pricing under the most ambitious of the IEA scenarios – the Sustainable Development scenario, which is consistent with the aim of the Paris Agreement. Oil will continue to remain a key part of the world’s energy solution for many decades to come (2018 World Energy Outlook, page 27); and, based on this exercise and Hess’ strategic priority of being among the lowest-cost oil producers, we believe that during the projected period we can continue to monetize our reserves and deliver robust financial performance under a wide range of market conditions.