Oil prices are ripe for a ‘carbon intensity’ benchmarking
The world will continue to rely on fossil fuels until 2050, despite great efforts to decarbonize and grow renewable energy.
Our forecasts are that demand will not peak before the next decade, and it is therefore incumbent on the industry and policymakers to ensure fossil fuels consumed are incentivized to come from the lowest carbon-intensive sources. This could become an important point of differentiation for Middle East oil producers.
Auditable measurement of upstream carbon intensity, supply chains and manufacturing along with effective market prices will be required to help market participants navigate the energy transition and address demand for fossil fuel consumption with lower emissions.
Valuing ’low carbon oil’
Oil and gas companies and investors alike are responding to calls for less carbon-intensive energy sources and investment opportunities, which has begun to translate into capital flows toward supply sources with lower carbon intensities.
In July last, the Oil and Gas Climate Initiative (OGCI) – a consortium of 12 member companies that includes major national oil companies such as Saudi Aramco, CNPC, and Petrobras, with combined crude oil output of approximately 25 million b/d – announced its target to reduce the collective carbon intensity of its upstream operations by 9 per cent by 2025.
Banks, sovereign wealth funds and other sources of external capital have declared intentions to reduce carbon footprint of their portfolios while maintaining competitive returns. Upstream producers will be required to consider carbon intensity when making development decisions driven by regulatory and economic factors.
The foundational metric necessary for market participants is ‘carbon intensity’ – the ratio of carbon-equivalent emissions to unit of output. Applied to the upstream oil industry, carbon intensity refers to the quantity of emissions per barrel of oil produced (kg CO2eq/barrel).
Oil production is a highly complex process involving dozens of phases and emissions sources, which vary widely from field to field. According to the Environmental Protection Agency in the US, around 80 per cent of overall upstream emissions come from the flaring and venting of natural gas and the energy required for onsite drilling and pumping.
The Bakken shale field in the US and the Kirkuk field from Iraq have outsized carbon intensity, which is largely driven by above-average volumes of gas flared per barrel of oil produced.
Calculating flaring and venting emissions can be straightforward, provided good metering is installed. Conversely, combustion emissions associated with drilling and pumping are more complex and depend on factors such as the age, depth and pressure of the reservoir, as well as the gravity of the crude.
Lower oil price producers, such as those in the Middle East, may look to minimize the cost of extraction by reducing the energy required. However, this may not be strongly correlated to the carbon intensity and may not incentivize producers to switch to renewable sources of energy without further incentives or regulation.
Additionally, the energy or supply chains and manufacture should also be considered when comparing the relative carbon intensity of crudes. Heavier crudes may require more energy to move and process them into finished products.
S&P Global Platts Analytics ran a pilot study covering 50 oil fields of various natures and locations and the relationship between modeled carbon intensity and crude gravity was immediately evident.
Upstream carbon emissions price
Pricing has proved an effective mechanism for driving market outcomes. We have differentiated sulfur content in gasoline and gasoil and priced it accordingly. The IMO 2020 legislation reduced sulfur in marine bunker fuels and, in advance of implementation, Platts launched VLSFO assessments to introduce transparency into price and product availability.
Similarly, the market could introduce carbon intensity as an attribute of fossil fuels, supported with similar regulation that has seen lead and sulfur removed from gasoline.
Establishing upstream carbon intensity of individual sources of crude (and gas) will be the first step in enabling markets to quantify a differential between the price of a “standard barrel” and the price of a carbon adjustment.
Many Middle East crudes have a lower carbon intensity than crudes from other geographies. As such, a crude like Abu Dhabi’s Upper Zakum would have a carbon intensity approximately 9.5 kg CO2eq/b lower than the estimated global average.
Using the current EUA carbon price of around $30/mt, Upper Zakum would attract a premium of $0.28/b. Conversely, Iraq’s flaring-intensive Kirkuk field would fetch a discount of $0.75/b due to its higher-than-average carbon intensity.
Show up in prices
As the market for low-carbon oil matures, prices will likely reflect the associated upstream carbon intensity, with crudes of lower carbon intensity trading at a premium to those of higher carbon intensity. Setting carbon intensity specification and default intensity for crudes without auditable data will drive up the value of lower carbon-intensive crudes and incentivize market participation.
Providing greater transparency into the carbon intensity of upstream oil production will help producers access markets, better understand the risk of stranded and underutilized assets, and evaluate price risk as they seek to navigate the energy transition.