Should oil and gas invest in what it knows or what it thinks will be? Should oil and gas invest in what it knows or what it thinks will be?

Deconstructing the role of oil and gas in the energy transition.

It’s no longer news that the energy landscape is in a state of disruption. But change continues to happen at a dizzying pace for the myriad forces affecting it. Evidence of climate change continues to accumulate, and we foresee increasing pressure on governments, consumers and the energy industry to decarbonize the production and use of energy.

Major factors at play are:

• Electrification
• Digitization
• Efficiency
• Decentralization
• Developing markets

Monumental questions line the path toward clean (or cleaner) energy and the future of oil and gas. For example, companies must determine how to balance the financial expectations of investors and growing concerns about climate change. So, should oil and gas invest in what it knows or what it thinks will happen? We took a deep dive to help companies understand the opportunities and risks.

To say that the future of oil and gas is complex is an understatement. We looked at it through three different lenses — consumer, technology and regulatory — and developed four scenarios without preference. They range from a very gradual movement from hydrocarbons to rapid adoption of renewables. We named them Meet Me in Paris, The Long Goodbye, Slow Peak and Critical Gas.

Meet Me in Paris:

Technology improves rapidly; alternative energy quickly becomes cheap enough to displace existing infrastructure.

The Long Goodbye:

Renewables take a place in the market. Oil demand peaks, but stock effects, consumer inertia and continued growth in aviation and petrochemicals keep it from a drastic drop.

Slow Peak:

Peak oil does not happen soon, thanks to developing countries’ demand for petrochemicals, energy-intense industrial usage and aviation.

Critical Gas:

Oil demand peaks and trails off fairly quickly as consumers migrate to electric vehicles. Capital moves toward gas-focused upstream and LNG assets.

The impact of disruptive forces on asset returns

We calculated the cash flows under each of the four scenarios after gathering data on the cost of building and operating oil and gas assets. This enabled us to estimate the rate of return on each asset class. 

The key takeaways

1. Peak Oil Demand is a likely outcome. Battery technology has advanced (and will continue to advance) to a point where EV cost and performance will be competitive with the internal combustion engine. 
2. Natural gas, in combination with renewables has, so far, driven decarbonization. We see significant upside for gas as a power generation fuel.
3. Returns currently available hold up over a wide range of energy transition scenarios.  There are of course predictable variations, based on variations in demand, but it’s our view that a dollar invested in oil and gas assets across the value chain today is still likely to produce fair returns. 

Early indicators of the industry’s future

Electric transportation is an unstoppable force. On a straight cost and performance basis, EVs will soon be competitive with ICE-powered vehicles. But there’s more to the equation than cost and performance. Consumers’ reactions to new technologies can vary dramatically.

Major questions remain. First, it’s not known how quickly consumers will become convinced of the advantages of EVs. And how will oil and gasoline prices unfold? The technology is constantly improving. Costs are falling, and competition may lower the price of liquid fuel. And second, there’s no clear plan in place for building, at scale, the infrastructure required to charge EVs.

We’ve boiled down the various uncertainties to four potential adoption curves, shown in the accompanying chart, based on the timing of the transition from liquid fuels to electricity and the rate at which the transition occurs. The adoption curve in the Long Goodbye scenario is steep, and the curve in the Meet me in Paris scenario, steeper still.

Acceptance of EVs

Paths forward that will work under most scenarios

In the oil business, as in any commodity enterprise, the biggest financial risk is the price of the commodity. Supply can overwhelm demand, prices can crash, and returns can evaporate. But time tends to even out supply and demand. We believe that going forward, demand will be sufficient to support many large players. 

Returns on oil and gas projects are likely to be competitive with returns on alternative energy investments for some time. But the range of possible outcomes is broad, and smart companies will hedge their bets by buying, developing and nurturing options. Major oil companies are already investing in the power sector, electrical vehicle charging and renewable fuels.

Fueling the future

The future of oil and the future of gas have different narratives. For oil, uncertainty dominates. The strategy will be to make the best of what will be. But gas businesses have a window of opportunity to be a market influencer or even a market driver. A competition with renewals will be about technology and financing. Oil and gas companies can use their unique position in the capital markets to promote the growth of the upstream gas business by facilitating investment into a new branch of the gas industry downstream.

The core business lines of the oil and gas sector will be a key part of the energy mix going forward. Not only that, the companies in the industry can count on digitization to continue to drive down exploration, drilling, completion, production and refining costs, complicating the competition between fossil fuels and renewables. The footprint of the energy industry will change, and those changes will present opportunities for oil and gas companies to move their portfolio into new areas. 

In the coming months, we’ll continue to explore the future of the energy industry, with the Fueling the Future series.