In the run-up to the US election, many investors had positioned themselves for a ‘Blue Wave’. Yet, as it became clear that Biden’s Presidency would not be accompanied by a majority Democratic senate, oil and gas stocks rallied and renewable energy producer stocks fell. The absence of a senate majority has cast doubt on the now President-Elect’s ability to push through a climate-focused plan that would see an overhaul of federal energy policy and pledge to rejoin the Paris accord. Despite a Blue Wave now looking all but impossible, US energy firms must take decisive action and respond to the necessity for a transition to a low-carbon economy. In our latest Spectrum report, Audra Delport, Deputy Head of Credit Research at the International business of Federated Hermes, explains why US energy companies lag behind their European counterparts in communicating ambitions to achieve net-zero by 2050 and, therefore, where investors should be looking for opportunities.
Last December, the European Union (EU) presented its Green Deal, a roadmap for the bloc to become the first climate neutral continent by 2050. Large European investment-grade oil and gas companies have led the way in communicating ambitions to achieve net-zero since then. As such, many are shifting their strategies towards the energy company scenarios outlined by The Science Based Targets initiative, which presented four potential transition frameworks to help oil and gas firms tackle these issues and define challenges going forward.
For most firms, this involves increasing investment in renewables, electricity generation, biofuels and carbon capture technologies. Repsol, which was the first oil company in the world to announce a net-zero ambition, intends to prioritise value and cash generation over volume in its upstream business, and will assume an oil and gas curve compatible with the Paris Agreement scenario for future decisions on exploration and production.
It is apparent that European companies have made considerable progress in setting targets. But on the other side of the pond, American firms have been less active. Indeed, we often find that, as an investment team, we are the first investors to raise low-carbon transition issues with the US high-yield energy companies that we engage with. However, in the run-up to the election, Joe Biden outlined an ambitious climate agenda, which included delivering a net-zero emissions economy by 2050. This is a U-turn in environmental policy from his predecessor and an indication that US energy firms will need to play catch-up with their European counterparts. Even without a Blue Wave, there remains the prospect of stricter limitations on use of federal land as well as tighter limits on methane and flaring emissions.
Following the election, Occidental became the first US energy company to announce its ambitions to become net-zero by 2050, including scope 3 emissions. Few others have announced similar ambitions and those that have are only including scope 1 and 2 emissions, although some firms have set medium term targets that aim to reduce carbon intensity and flaring.
The difference between the regions can be explained in part by the respective political environments in the EU and the US, increased shareholder pressure for carbon reduction in Europe and the fact that US firms are more conservative when setting long-term targets if it is not clear that existing technology can help deliver them. It is also harder for upstream producers – of which there are many in the US – to aim for carbon neutrality and to control scope 3 emissions: all the European companies that have announced targets are integrated energy firms.
Finally, the structure of the US and European energy markets differ. While the European market consists mostly of large, integrated players, the US space contains many more firms – some larger ones, but also an abundance of smaller shale companies. The oil-price crash this year means that many of these small firms have had to focus on surviving, with less time and resources available for making long-term strategic decisions about the energy transition.
As the energy transition accelerates, it will become even more important for oil and gas companies in the US to clarify their strategic responses. Engagement with these companies is valuable because it allows us to develop a far more detailed overview of management teams’ thinking, culture and processes around climate-related risks. It also provides insights about current and future strategic planning, and the capital allocations that companies are using to both mitigate and capitalise on this fundamental issue.
The energy industry sits at a critical point in history, with US firms facing a unique set of challenges. While the anticipated climate policy from a Biden administration may well be less aggressive than some positioned for in the election run-up, there remains a significant risk for US energy firms that do not communicate how a low-carbon transition will impact business models in the years ahead. For investors, we believe that it will be with the companies that demonstrate a willingness to alter their long-term strategic thinking, where opportunities may lie.