Climate-related issues have evolved from an environmental concern to also include financial considerations. Our stakeholders have therefore expressed an interest in understanding how Hess’ oil and gas portfolio might be impacted by a transition to a lower carbon economy. Although an energy transition to a lower carbon economy is underway, it is widely considered that there are multiple pathways to achieve this transition, creating uncertainty as to trajectories to a low carbon environment and the pace and scale of change.
To help quantify climate-related risks and opportunities – and to provide perspectives to our investors and other key stakeholders – Hess conducts an annual scenario planning exercise as a methodology to assess portfolio resilience over the longer term. This scenario-based approach allows us to assess and communicate to our shareholders our understanding of future risks and opportunities in relation to the potential evolution of energy demand and mix, the emergence of new technologies, and possible changes by policymakers with respect to greenhouse gas (GHG) emissions.
Because the Task Force on Climate-Related Financial 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’s (IEA’s) 2019 World Energy Outlook (WEO) against our own internal base planning case. 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 well below a 2°C increase compared with 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 (SDS) in the IEA’s 2019 WEO, which is part of Hess’s modeling, fits within this recommendation.
Considerations for Carbon Risk Scenario Assessment
To evaluate the potential exposure of our portfolio to transition risks in a carbon-constrained future, we began by considering the long range outlook for energy supply and demand, as well as for oil, gas and carbon prices. We have used the IEA’s 2019 WEO to examine supply and demand and oil, gas and carbon price scenarios through 2040 in the Current Policies Scenario and the Stated Policies Scenario, and through 2050 in the SDS, which are the years through which these respective IEA scenarios extend (see www.iea.org/weo2019/). These scenarios are recognized as a leading industry standard and benchmark worldwide, and are, therefore, an appropriate choice for an oil and gas producer such as Hess.
Such scenarios and therefore our own assessment of carbon risk are premised on a longer term view of energy supply and demand. We expect that recent events related to the global COVID-19 pandemic and near term global oversupply of oil will have a short term impact on the various IEA energy supply and demand scenarios as published in the 2019 WEO. In 2020, we plan to update our scenario analysis to reflect the IEA’s interpretation of the impact of recent market conditions on its longer term forecasts.
According to the IEA, the emphasis on strong early action and the subsequent rapid reduction in emissions means that the SDS is aligned with the Paris Agreement objective to hold temperature rise to well below 2°C, while pursuing efforts to limit the temperature increase to 1.5°C. If technologies that remove carbon from the atmosphere (i.e., those that allow for “negative” emissions) were to be deployed at scale in the second half of the 21st century, then the SDS would provide a 50% chance of a 1.5°C outcome (see the IEA chart just below). The cumulative level of net emissions required to do this would be less than the median level in the 1.5°C scenario assessed by the Intergovernmental Panel on Climate Change.
The group of three charts below depicts the 2019 WEO’s world energy demand and carbon dioxide (CO2) emissions under the IEA’s three main scenarios.
In the Stated Policies Scenario, which is the IEA’s central scenario, worldwide energy use is expected to grow by approximately 24% between 2018 and 2040 (see the IEA chart below). While there is a decline in demand for coal, oil and natural gas in this scenario between 2018 and 2040 – most notably in the European Union (E.U.) – it is offset by increased demand elsewhere during that same period. Ultimately, demand for oil and gas is projected to grow in the Stated Policies Scenario by 9% and 26%, respectively, over that period and account for 53% of the energy mix in 2040, down only slightly from 54% today.
In the Sustainable Development Scenario (consistent with limiting the rise in global average temperature to well below 2°C), worldwide energy use is projected to experience a modest decline of 7% between 2018 and 2040. Oil and gas are still expected to account for nearly half of the energy mix (47%).
While the Sustainable Development Scenario projects lower oil demand in the 2040 timeframe, the IEA states that “continued investment in both new and existing oil fields, even as overall production declines in line with climate goals, is a necessary part of the energy transition envisaged in the SDS” (2019 WEO, page 95).
In terms of the continuing upstream oil and gas investment required to meet such demand, in the Stated Policies Scenario annual spending averages $650 billion between 2019 and 2030 and $730 billion thereafter. In the Sustainable Development Scenario, although fewer new developments are required, continuing investment in both new and existing oil and gas fields remains an essential element of the energy transition. Approximately $510 billion is estimated to be spent on average each year between 2019 and 2030, while $390 billion is spent between 2030 and 2040.
In contrast, since the oil price crash of 2014, upstream oil and gas investment has been curtailed. Investment has ranged between $350 billion in 2016 and $420 billion in 2019, with investment for 2020 now expected to be further reduced to between $300 billion and $350 billion. Even with a major capital reallocation from fuels to power, the IEA’s Sustainable Development Scenario requires upstream oil and gas investment over the next decade significantly above the average over the past five years. The oil and gas industry is a long cycle business, such that this continued underinvestment is a risk that could manifest itself as a medium term supply gap, where recent levels of investment are insufficient to meet medium term demand.
Hess’ Approach to Scenario Planning
The TCFD recommends that, once a below 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 set of metrics as the below 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.
Hess’ approach to scenario planning is aligned with the TCFD recommendations. We have prepared internal guidance that details our approach and establishes a specified methodology. This also serves as a roadmap for our external verifier to review and verify that we followed our specified methodology when conducting this scenario analysis.
Our first step in this process was to establish a Hess base case, which for 2019 was premised off a long term $60 per barrel Brent and $2.75 per million British thermal units (MMBtu) Henry Hub natural gas price, both in 2020 real terms. In addition, we applied either actual carbon pricing for our assets and intended forward investments where a regulatory framework for such exists, or a sustained $40 per tonne cost of CO2. Hess’ base case was then compared against the various oil, natural gas and carbon prices in the IEA’s three main scenarios – Current Policies, Stated Policies and Sustainable Development – running our current asset portfolio and intended forward investments through these varying sets of assumptions to assess financial robustness.
The three charts below show the oil, natural gas and CO2 prices under the IEA’s Current Policies, Stated Policies and Sustainable Development scenarios against Hess’ base case. As these charts show, there is a wide spread of oil, natural gas and carbon pricing across the three IEA scenarios, a key ingredient for informative scenario planning.
Results of the Hess Scenario Planning Exercise
Through our methodology, we have tested the robustness of Hess’ asset portfolio and intended forward investments under multiple energy scenarios, including the IEA’s Sustainable Development Scenario. We note that the latter is aligned with the Paris Agreement’s aim of limiting the rise in the global average temperature to well below 2°C, as the scenario incorporates a 66% probability of 1.8°C stabilization and a 50% probability of a 1.65°C stabilization, without any recourse to net-negative emissions.
In the chart below, the first column shows the net present value (NPV) of the Hess portfolio under our base case commodity and CO2 price assumptions, normalized to 100%, and the second column shows the NPV of the Hess portfolio under the IEA’s Sustainable Development Scenario and CO2 price assumptions as an index to the Hess base case. The NPV of the Hess portfolio under the IEA’s Sustainable Development Scenario assumptions is 20% higher than under the Hess base case assumptions.
This result demonstrates the robustness of Hess’ portfolio against even the most challenging of the IEA’s scenarios, aligned with the goals of the Paris Agreement, driven by our conservative planning assumptions as they relate to commodity prices and the competitive pipeline of future investments in our portfolio.
Validation of Hess Strategy
With the lower oil demand assumed in the IEA’s Sustainable Development Scenario, industry competition may intensify, and some higher cost producers may be forced out of the marketplace. We therefore believe our scenario analysis validates Hess’ strategic priorities to focus investment on high return, low cost oil and gas opportunities and to build a focused and balanced portfolio, robust at low prices.
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.