Tougher carbon regulation on the cards for over half of global oil and gas reserves - News Releases

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Tougher carbon regulation on the cards for over half of global oil and gas reserves

Nearly half of global reserves concentrated in a handful of MENA countries with a medium carbon policy risk profile

Key Ideas

Operators in the oil and gas sector in the Americas, Europe, and Oceania most exposed to transition risks from national carbon policies
Nearly half of global reserves concentrated in a handful of MENA countries with a medium carbon policy risk profile
Lower carbon policy risks in frontier economies, but Asia exhibits a diverse carbon policy landscape

While the recent cyclones in Mozambique and the Bay of Bengal grabbed headlines for their impact on oil and gas companies, it’s easy to overlook the influence of carbon regulation on the sector. Governments across the globe are in the process of imposing more stringent regulations to mitigate the effects of climate change; identifying the risks associated with these policies, known as transition risk, is vitally important to operators as the world moves towards a low carbon economy.

Over 50% of global reserves sit within countries considered ‘high risk’ by our Carbon Policy Index, which scores 195 countries on their potential to step up greenhouse gas emissions reduction policies.

Applying the index to our Corporate Exposure Tool (CET), which draws on our sister company Wood Mackenzie’s commercial data on global reserves, assets and companies, we can see that operators in the oil and gas sectors in the Americas, Europe and Oceania are most exposed to risks from national carbon policies.

Most countries in these regions are classified as ‘high risk,’ but pockets of ‘extreme risk’ jurisdictions do exist. The highest risk oil and gas producing countries are Norway (4th highest risk overall), Austria (5th), New Zealand (6th) and South Korea (7th). Here, the risks are higher that future costs and compliance burdens for investors and operators will rise. In the worst-case scenario, this could entail assets being left stranded if they are too costly to extract.

Overall, our analysis shows that global transition risk is largely clumped together: relatively little global production is located in low or extreme risk countries (see figures below). This is because while most of the world has ratified the Paris Agreement, few countries have committed to the ambitious action needed to meet the accord’s stated goal of limiting global warming to 2°C. Most oil and gas companies will encounter risks of some degree of policy intervention, but the majority of reserves are found outside of the most stringent jurisdictions. There are also lower carbon policy risks in frontier exploration countries in Africa, reducing entry risk for operators in those locations.

FIGURE 1: Lower transition risks in MENA, Africa and Asia

FIGURE 2: Over half of oil and gas reserves located in jurisdictions with more stringent national carbon polices

Dynamic global carbon policy risk landscape

Using the CET to look at the spread of oil and gas reserves, there’s good news and bad news for O&G investors and operators. On the upside, political resistance and scepticism towards cutting GHG emissions are key factors in the stable carbon policy environment of MENA (Middle East and North Africa), which holds a significant share of global reserves in just four medium risk countries.

The figure below breaking the Index down into its three pillars highlights that MENA countries are, on average, rated low risk for their emissions gaps (Pillar 1). This is because all the oil and producing nations in MENA either lack binding targets or have set goals reducing emissions from a business-as-usual (BAU) trajectory that effectively allows them to increase emissions. No MENA counties have passed a domestic climate change mitigation law or shown significant support for renewables, which would increase their Pillar 2 risk. Their medium risk scores in Pillar 3 are largely driven by having carbon intensive and highly energy inefficient economies. The policy environment in MENA countries is likely to remain consistent, with little intervention over the next decade.

FIGURE 3: Economic transition and emission gaps driving higher Carbon Policy risk scores in most regions

The carbon policy risk landscape in Asia is the most diverse as countries are at very different stages of development. For example, the regional leader South Korea has an established emissions trading scheme (ETS), while Vietnam (ranked 72nd in the index overall) and Thailand (117th) have implemented carbon taxes. Following a series of city-level pilots in China (37th), a national ETS began operating in 2018 and, despite only covering the power sector, is already the largest scheme in the world.

We expect more Asian countries to adopt carbon pricing to encourage a shift away from coal towards developing natural gas resources. Conversely, Myanmar (195th) has chosen not to adopt any form of GHG emissions reduction target at all and is unlikely to do so in the foreseeable future.

There are lower transition risks in African frontier economies. All African countries have set BAU emission reduction targets that allow their economies – and overall emissions – to grow and very few have passed legislation to decouple emissions from economic growth. Weak governmental institutions and ineffective governance mean this situation will not change in near future.

Most countries in Europe, the Americas and Oceania have climate legislation in place, binding targets that reduce emissions in real terms, and carbon pricing initiatives. In many of these jurisdictions, we expect regulations to tighten; however, these measures can also be rolled-back.

The United States (38th) ‘is currently classified as high risk in the index, but this will shift if it officially withdraws from the UN Paris Agreement in 2020 as planned. This will change the index’s global risk landscape by removing around 20% of global reserves from the highest risk categories, as the US is reclassified as a medium or even a low risk country.

The risk profile in Oceania is also set to change. Following the Coalition’s re-election in the May 2019 Australian federal election, we expect the government to pursue more lenient carbon emissions reduction targets throwing the future of carbon pricing in Australia (35th) into uncertainty.

Role of sector critical in many oil and gas exporting countries

Carbon is measured at the site of consumption, not production, but oil and gas extraction can still contribute a significant proportion to national carbon budgets via fugitive emissions site energy generation, and transport. Indeed, many major oil and gas exporting countries will be able to achieve the bulk of their own carbon reduction targets by eliminating flaring.

The oil and gas sector has an important role in keeping the world on a 2°C pathway. Whether this goal will be achieved by voluntary arrangements, market mechanisms or direct intervention will be determined by the future political direction of the major energy-consuming nations. To reflect these developments, our Carbon Policy Index is updated annually to capture new pieces of legislation, policy decisions, and trends in energy consumption.