Upstream & Climate Risk


Powering down – upstream oil & gas and the brave new world of climate risk

The argument over whether anthropological activities are causing climate change is over. According to the latest Intergovernmental Panel on Climate Change Report, there have been unprecedented changes in the Earth’s climate, and continued emissions of greenhouse gases has resulted in over one centigrade of global heating since the beginning of the industrial revolution. A changing climate is resulting in stunted crops, sea level rise, an increase in wildfires and torrential rain which can trigger floods and landslides, often in regions of the planet where people are least well equipped to manage, phenomena which will worsen as temperatures continue to increase.

An industry in flux

Oil price volatility was born at the advent of the petroleum industry. Prices have been on a roller coaster ride since the US shale induced price crash of 2014, followed by the unprecedented drop in global crude demand due to the coronavirus pandemic and the Saudi-Russian oil price war. Now, as we approach 2022 economies are opening up at a rapid pace, resulting in supply chain disruptions and buoyant oil & gas prices. Nevertheless, the upstream oil & gas industry remains under pressure due to a factor not previously at play during previous boom and bust cycles, climate risk.

The emergence of climate risk is now a consideration which is front and centre for governments, regulators and investors alike, who are asking themselves questions about whether it makes sense to continue to support carbon-emitting industries, both from an ethical as well as economic perspective; the spectre of declining oil demand and stranded assets in a world which is transitioning to net zero looms large.

The scale and nature of the transition required in energy markets in order to keep 1.5 degrees within reach is immense; despite rising oil & gas prices, equity valuations of oil & gas companies remain depressed. Probing questions are being asked about materiality of investments into renewables when compared against traditional upstream investments from a capital allocation perspective. There is questioning in the capital markets on where transitioning majors position themselves, leading to activist pressure from the hedge fund Third Point arguing Shell should break itself up into a traditional oil, gas and chemicals organisation and future focussed green company.

In approach, there was a divergence in strategic intent taken by oil majors on either side of the pond, with Shell and BP positioning their response to energy transition as an existential issue, whereas ExxonMobil indicated it does not see a fundamental shift in energy markets, and expects to continue to make strong returns as robust demand fundamentals play out; that was until the activist fund Engine No.1 utilised an equity position of just 0.02% to get three directors elected to the board, in order to pivot Exxon away from their historical position.

Tellingly, Exxon has maintained its dividend pay-out throughout the covid induced downturn whilst ‘transitioning’ oil majors have not. A Bloomberg report suggested the company’s investment strategy will see Exxon’s yearly emissions rising seventeen percent over eight years leading to 2025. So, the question is: who is on the right path, and whose strategy will win out?

A watershed post-Paris

The Paris Agreement was a watershed moment for the global movement toward a greener future. Major countries are already making significant policy announcements committing to climate change targets. The European Union, United States, Canada, China, Japan, New Zealand, South Korea, among others have already made commitments to net zero, and as of today this commitment covers 137 countries, and eighty nine percent of global GDP.

A consequence is that regulatory risks are increasing for banks, asset owners and corporations alike. In addition to political announcements, central banks and supervisors have become increasingly concerned about the systemic risks that climate change poses to the global economic system, as demonstrated by the establishment of the Network for Greening the Financial System (NGFS) in 2017 to provide a coordinated response by regulators to ensure the financial system is robust against the realisation of these risks.

Focusing on the UK, the Prudential Regulation Authority has set expectations for regulated firms to fully integrate climate change within their risk management by 2021. Some of these organisations have been subjected to a stress-test via the ‘Biennial Exploratory Scenario’ (BES) in which their financial exposure has been evaluated under three different scenarios. The UK is not alone in this effort, with other regulators following in close pursuit; Europe is leading the way with Asia not far behind. While lagging, the US has recognised climate as a near-term risk in its latest ‘Financial Stability Report’ and has been strengthening its capacity to assess climate risks and those of the supervised firms.

For asset owners, whereas climate change may have only previously been considered an ethical concern, pension funds will now include in their ‘Statement of Investment Principles’ an explanation of how climate change is considered in the selection, retention and realisation of investments, due to the realisation that climate considerations may pose a material financial risk.

Since October 2021, new regulations reinforce this obligation and requires pension funds to execute scenario analysis and calculate metrics related to the emissions they are financing. In addition to pension funds, insurers and other asset managers will need to explain how they are aligned on climate risk, with the FCA recently concluding consultations on mandating asset managers to issue Task Force on Climate-related Financial Disclosures (TCFD) aligned disclosures.

In addition to regulatory concerns, litigation and reputational risk are a real and present threat to all stakeholders. A bellwether case involving the Australian superannuation fund REST settled a climate change case on the committing to net zero by 2050 and disclosure in accordance with the TCFD recommendations as part of properly managing its climate risks and obligations, a result that will demand attention by pension funds around the globe.

Climate exposure driving action

Recent regulatory changes have led banks, asset owners and managers to begin to aggressively manage their climate risks. Lending and investment into oil & gas is now subject to stress testing that could recognise the impact of stranded assets in the future. Banks are now setting net zero targets, with JP Morgan for example committing to reduce Scope 1 emissions by thirty five percent and Scope 3 by fifteen percent for oil and gas clients by 2030.

Investors are starting their journey on climate change risk management. They have already begun to implement measures to reduce their exposure, such as excluding thermal coal and investments in certain types of oil and gas projects. Furthermore, they have continued to engage with investee companies leading to the appointment of three climate activists to the board of Exxon and Chevron to reduce Scope 3 emission.

As a result, when measuring against a net zero target, there is real risk that companies which are not compliant with Paris will effectively be barred from lending and investment portfolios. In order to manage risks by regulated firms, and in the absence of clear and transparent data quantifying how climate risk may impact the business, asset managers and owners will begin to screen firms without robust climate risk processes out of their investment portfolios. This is becoming more acute as the UK Sustainability Disclosure Requirements are requiring companies to disclose their transition plan which will be used by investors to drive their allocation, engagement and voting decisions.

Mandatory disclosures and the data gap

The main hurdle in the implementation of regulations is a lack of quantification and the existence of glaring data gaps as climate change disclosures from corporates are, on the whole, not robust. This lack of disclosure has led to greater demand for information on climate change risks produced by companies.

The TCFD has become the leading framework under which to report these risks. TCFD reporting provides the most adequate framework for companies to manage their climate-related risks, because the information provided is forward looking. In fact, it allows companies to develop scenario analysis which will be reflected in their price assumptions and projects, allowing them to avoid stranded assets. The recommendations also contribute to a governance structure and risk management which will help them to meet their emissions reduction targets. We believe if well implemented, it could be considered as a de-facto management system which can facilitate the transition of oil and gas companies.


We live in a world where views about our impact on the planet have been transformed. Civil society, political institutions and capital markets have joined forces to demand change in the way business is conducted, and to align with a more sustainable world. Whilst fantastical in scale, recent announcements during COP26 suggests Glasgow Financial Alliance for Net Zero (GFANZ), a consortium of more than 450 banks, asset managers and insurers, announced that it would deliver more than $100 trillion in financing to transition global economies by 2050.

The message to all corporates, and especially carbon emitting companies, is clear: either quantify and disclose the impact of your activities or become increasingly estranged from the world of investment and finance. This, combined with transitional risks to net zero, is already negatively affecting asset values, even before any substantial climate policies have been enacted. This has resulted in investment into carbon-intensive industries becoming increasingly challenged. This is a world that executives and boards at oil and gas companies simply cannot ignore.

When comparing the equity performance of BP, Shell and ExxonMobil, there is no divergence despite radically different approaches to the energy transition debate. However, when thinking about their own portfolio construction, funds and regulated companies will need to consider what approaches are most likely to retain and create value in a world beset by a changing climate. Beyond divestment and engagement, in-sector reallocation will become an increasingly important consideration for decision makers in this space.

There is no doubt the world will continue to consume considerable volumes of oil and gas to 2050 and beyond. The question of where oil production, in particular, will emanate from in a capital-constrained environment is an interesting one to address. Leaving aside the issue of reserve replacement in light of capital constraints, will oil producing power revert to major oil producing countries such as Saudi Arabia and Venezuela? Will oil and gas producing assets be subject to a merit order of production, akin to power generation in the electricity market? These are fascinating areas to investigate.

Nonetheless, while there will be bumps on the road, the direction of travel is clear – business-as-usual for oil and gas companies is no longer viable. Without clear, science-based disclosures, capital providers cannot accurately judge the impact of carbon-emitting company activities on their portfolio, in terms of warming potential, with the only viable outcomes being to divest, blacklist or ignore. As such, oil and gas companies need to not only incorporate robust, science-based climate reporting into financial projections, but also conduct a root and branch review of the operating structure, risk matrix and strategy in order to be fit for this new, rapidly evolving economic environment.

The molecules of oil & gas we use to power our world today have origins in and around the Jurassic era, and unless fossil-fuel intensive companies rapidly evolve their business models to align with the Paris Agreement and now the Glasgow Climate Pact, they are in danger of following the fate of the dinosaurs.


For more information please contact:

Mohammed Chunara, Director, Climate Risk, Acasta Risk

+44 (0)20 3983 9263 or by email: [email protected]

Alba Fuentes Delpon, Manager, Climate Risk, Acasta Risk

+44 (0)20 3983 9263 or by email: [email protected]

© 2021 Acasta Risk

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