GLOBAL CLIMATE CHANGE: a new investment opportunity?

It is no longer debatable if or how much global climate change will impact future oil and gas industry financial strategies. Climate change already has had an impact, but no one is ready to quantify it other than to acknowledge that large pools of capital, billions of dollars, are looking for a home in some part of the climate change milieu.

A Google search for climate change and oil/gas investment produces many pages of sources, showing up like so many venture capitalists on the computer screen. The American Petroleum Institute’s website now offers a variety of what it calls “Climate Challenge Programs,” including actions for its members to take with company operations, help in estimating and reporting emissions, and encouragement for investing in more climate research/development programs.

While API still attaches the term “challenge” to its climate change programs, industry observers, consultants, and executives interviewed by OGFJ said the industry increasingly is seeing opportunities, and those certainly will be part of future capital investment strategies for all parts of the industry, but particularly the majors on down through the midstream companies.

Following the Bali climate change talks at the end of 2007, the United States re-entered the international discussions on a successor treaty to the Kyoto Protocol that will be hammered out in 2009 when there is a new US president and an expected new acceptance of global warming as a fact of life. This will further assure climate change’s place in the financial plans of just about all major industries, and particularly oil and natural gas. Global climate change investment expert Douglas Cogan, with Risk Metrics Group’s research/analysis unit, said the Bali developments matter to investors big time.

Bringing greenhouse gas (GHG) emissions under control presents a formidable technological and financial challenge that will require an effective ‘decarbonization’ of the global economy over the next 50 years. Banks can begin by factoring in a market price for carbon dioxide (the main greenhouse gas) in lending and investment decisions. – Corporate Governance and Climate Change – Banking, Ceres, January 2008

“First, it means that global warming is no longer a debate about science, but rather one about politics and economics,” Cogan wrote last December on an Internet blog. “Second, it means that carbon emissions are going to become a big factor in global trade, with industrial countries earning credits for clean technologies that they help finance and deploy in emerging markets. [Finally,] and most important, it means that carbon will come with a market price on emissions, which will have a profound effect on future investment decisions.”

The so-called clean tech space has grown as a result of climate change evolving into something that is cutting across all industries and investor groups. Institutional investors have paid a lot more attention, according to Mercer’s Craig Metrick, who heads the HR consulting firm’s institutional investor services unit.

“Climate change is a liability out there that companies are going to have to deal with. The changes coming are going to be significant.”– Tom Campbell, Pillsbury Winthrop Shaw Pittman

“There are new products being launched quite often today, and it is hard to keep up with all of them,” Metrick says. “I think that is definitely driving the supply side of the market, and it definitely has an influence on the demand side. It is also partly public policy and partly investors looking at the opportunity to increase their returns or perhaps green tech is a way to get into private equity or hedge funds where they haven’t before. In this case, it serves a dual purpose by aligning an environmental mission with a good investment opportunity and killing two birds with one stone.”

The still-emerging sector of capturing, storing, and putting to productive use carbon dioxide (CO2), or “carbon sequestration,” promises some of this two-for-the-price-of-one advantage in the response to climate change for energy companies, including the current race to perfect what is still developing technology.

For example, Schlumberger now boasts “multidisciplinary teams” with decades of experience in what it calls “subsurface evaluation and management techniques” to provide various sequestration and storage services. “Schlumberger has directed research/development efforts toward this new frontier,” the global energy services firm says on its website under its “carbon services” section.

“If you look at [last fall’s] Congressional proposals, such as the Lieberman-Warner Bill, most of the regulation is upstream. The farthest it gets downstream is at the power plant level or at the refinery gate or import terminal, and for gas at the gas processing unit.”– Bill Bumpers, Baker Botts LLP

Industry people see this as one of the key challenges that should be transformed into sizable opportunity, given that keeping more CO2 out of the atmosphere and then putting it to work to enhance oil production can allow oil companies to play a role while greenhouse gas (GHG) emissions are curbed for a period of several decades. Some would construe this as a no-brainer investment opportunity.

What other industry has more experience with pipelines and injections and withdrawals of liquids and gases underground? A Houston energy attorney asked rhetorically. Who has dealt more with emissions and drilling environmental curbs?

“These firms can invest in the new technology and invest in the research that goes along with climate change.” – Richard Faulk, Gardere Wynne Sewell LLP

“In a post-carbon world, you’re still going to have the same energy infrastructure you have today,” says Bill Bumpers, a Washington, DC-based attorney and environmental partner with the Houston law firm, Baker Botts LLP. “If you look at [last fall’s] Congressional proposals, such as the Lieberman-Warner Bill, most of the regulation is upstream. The farthest it gets downstream is at the power plant level or at the refinery gate or import terminal, and for gas at the gas processing unit.”

Bumpers and other Texas-based industry representatives we interviewed for this story believe that most of the oil and gas industry will be ready and engaged with climate change as a natural extension of working the oil patch. They say that, historically, the industry has worked through significant change in the past, and they will be able to adapt again, as necessary. In addition, they still have ample time – up to 20 years or more – during which they will still be providing the vast bulk of the world’s energy.

With its expertise in handling carbon, capturing waste heat, dealing with emission mitigation, and withdrawing and injecting gas in coal seams, the industry already has a focus for future stepped-up investment, according to some of the lawyers, consultants and financial community sources who spoke to OGFJ. The body of knowledge and literature on climate change for the petroleum sector is already sizable, and growing. API has its “Compendium of Greenhouse Gas (GHG) Emissions Methodologies for the Oil/Gas Industry,” which can be used when there is a market for trading GHG emissions credits (See separate listing of resources accompanying this article.)

There will be plenty of uncertainty, and that means more risk, according to Richard Faulk, who chairs the litigation department as a partner in the Houston law firm Gardere Wynne Sewell LLP, but there also will be corresponding benefits from cap-and-trade for the companies with sufficient resources and skills. “These firms can invest in the new technology and invest in the research that goes along with climate change.”

An example of what Faulk thinks eventually will be the rule for the industry in seeking to exploit the benefits of climate change is ExxonMobil’s experiment in Nigeria using leftover dry gas after extracting natural gas liquids as an operational energy source through an entirely new technology that the company has developed. The promise, assuming full worldwide application, according to people like Faulk, is to reduce GHG emissions 5% globally. Faulk calls it a “huge, huge bit of technology.”

Consultants and attorneys caution that the industry most likely will move on climate change investments slowly and carefully, and companies are likely to apply their usual detailed scrutiny before taking any plunges. In that regard, companies should apply their core competencies and leverage their spheres of leadership.

Carbon sequestration and storage is another example of an area where oil and gas executives can find new investments that address the climate change challenge in a sector where they feel comfortable.

“The potential is so large, the capital is going to flow to all sectors, and that involves traditional oil and gas, and new energy forms, and how to use energy more efficiently. The capital is growing; there is no shortage.” – Joseph Stanislaw, independent consultant

Tom Campbell, a partner with Pillsbury Winthrop Shaw Pittman and former general counsel with the National Oceanic and Atmospheric Administration (NOAA), thinks there are lots of opportunities, especially in areas such as sequestration, but he is also very aware of growing liabilities that companies are going to face, too.

At the risk of sounding self-serving for himself and his legal colleagues, Campbell recommends that the major oil and gas firms need to budget significantly for environmental lawyers and expanded research/development programs.

“Climate change is a liability out there that companies are going to have to deal with,” Campbell says. “The changes coming are going to be significant.”

Schlumberger is working hard to unlock the carbon capturing puzzle, and it is one of a number of major global companies putting considerable investment into efforts, such as the study of carbon capture and sequestration technologies at the Massachusetts Institute of Technology. This is an industrial consortium dating back to 2000.

“What I see now from the oil industry is that it is acknowledging that it [climate change] is coming and its inevitability is being accepted. The planning is beginning,” Campbell says. “I think people in the industry ought to be going about locking up the storage capacity throughout the nation’s oil fields. They should look at trading long-term rights for the pipeline infrastructure so it can be used for CO2 transportation.”

Campbell calls the current time the “recognition phase,” the time companies need to realize they still have plenty of time. Don’t panic. “But once they recognize what the opportunities and risks are, they need to move quickly into the planning and exploration. After that, there will be time for strategic development, and ultimately for implementation.”

Oil and gas companies will be increasingly pressured to find ways to make money on climate change, or to absorb the added costs. It may not be impacting costs now, but there is little debate about the costs getting much greater in the years ahead.

As a result some companies may seek consolidation as a way of dealing with the future; the competition will become more intense for acquiring good assets that are, at minimum, carbon neutral. A convergence of climate change and global security may also prompt reorganizations, consolidations and restructuring. Investment decisions will have to be broadened.

“I don’t think the traditional E&P area is going to suffer at all,” says Joseph Stanislaw, PhD, a co-founder of the Cambridge Energy Research Associates (CERA) who is now an independent consultant. “There is a lot of capital available, and some of it will want to be in the traditional oil and gas sector because we’re going to need [fossil fuels] for a long time to come, and their prices may go up and attract more capital. But there is also a lot of venture capital that wants to be in the new technologies,” he said.

“When you examine it closely, there is a lot of capital in both sectors; a lot of capital chasing solar, wind, and biofuels, and there is just as much capital trying to find new independent E&P companies to go out and find oil and gas reserves,” added Stanislaw.

“There is a lot of capital, period. It is clear that the energy needs of the future are so large, the appetite so big, that the industry is going to be hard pressed to meet all this latent demand. The potential is so large, the capital is going to flow to all sectors, and that involves traditional oil and gas, and new energy forms, and how to use energy more efficiently. The capital is growing; there is no shortage.”

Stanislaw and others like him who get around the industry globally run into groups all the time that have hundreds of millions of dollars, and if they can find the right team of four or five people, they would go look for oil and gas. They don’t see any capital constraint at present for what they dub “the right projects.”

“Actually, I see a lot of money moving in that wasn’t there before, so there is more money going toward the oil and gas sector,” Stanislaw says.

Reducing GHG emissions will require capital spending increases and a change in investment patterns relative to a government reference case, according to a McKinsey & Company December 2007 report for The Conference Board, “Reducing US Greenhouse Gas Emissions: How Much at What Cost?”

And one of five major areas that McKinsey highlighted as producing the needed GHG reductions will involve “reducing the carbon intensity of electric power production.” This is also where the petroleum industry can find its biggest investment opportunities.

“Given the timing of investments relative to savings, the economy might well encounter periods of significant visible costs, with the costs and benefits shared unequally among stakeholders,” McKinsey’s executive report said. “Nonetheless, a concerted, nationwide effort to reduce GHG emissions would almost certainly stimulate economic forces and create business opportunities that we cannot foresee today and that may accelerate the rate of abatement the nation can achieve, thereby reducing the overall cost.”

Last year, Lehman Brothers formed a new unit in its firm called the Global Council on Climate Change and appointed one of the global investment bank’s partners, Theodore Roosevelt IV, as chairman of the unit. “Prudent risk management dictates that this is an area where we cannot afford to be wrong,” said Richard Fuld, Lehman CEO.

Lehman published a white paper in 2007 by John Llewellyn and Camille Chaix, “The Business of Climate Change II.” It concluded that while inaction is always an option, to turn climate change into opportunities would take timely, strategic moves.

“In our judgment, the science is no longer the central point of discussion,” said the Lehman report by its senior economic policy advisor, Llewellyn, and his colleague, Chaix. “What concerns most businesses and investors now is how policies will evolve,” they said.

“As responsibility for climate change policy starts to be assumed by finance ministries and treasuries, the cost of policies will become a primary preoccupation. Economics will increasingly become a central consideration in policy design. Hence, analyzing the climate change policy issue in the way that we think treasuries and ministries of finance will increasingly come to do, should provide the best guide both to the types of policies that will be implemented and to their implications for asset prices.

Those investors and businesses that make the right predictions in terms of climate change policies may be able to anticipate the directions of asset prices and turn climate change and the evolution of climate change policy to their advantage. OGFJ

About the author

Richard Nemec is OGFJ’s West Coast correspondent based in Los Angeles. He can be reached at [email protected].