By Gerard Kreeft
French oil and gas giant TOTAL continues to attract attention in how its core business model is changing the industry: providing a blueprint how to transition an oil company to an energy company and at the same time guaranting financial success to its shareholders. The repercussions will be certainly felt in Africa, where TOTAL’s future growth is expected. Now the company produces approximately 1/3 of its oil and gas production (approx 900 000Barrels of Oil Equivalent per Day (BOEPD)) on the continent and by 2030 is expected to grow by one-third.
Important is to note how TOTAL will grow. Patrick Pouyanné, TOTAL’s chairman and chief executive, now says that by 2030 the company “will grow by one-third, roughly from 3Million BOEPD) to 4Million BOEPD, half from LNG, half from electricity, mainly from renewables.” This, according to IEEFA (Institute Energy Economics & Financial Analysis), is the first time that any major energy company has translated its renewable energy portolio into barrels of oil equivalent. So, at the same time that the company has slashed “proved” oil and gas from its books, it has added renewable power as a new form of reserves.
Adding Reserves
In the summer of 2020 Total announced a $7Billion impairment charge for two Canadian oil sands projects. This might have seemed like an innocuous move, merely an acknowledgement that the projects hadn’t worked out as planned.
Yet it opened a Pandora’s box that could change the way the industry thinks about its core business model—and point the way towards a new path to financial success in the energy sector. While it wrote off some weak assets, it did something else: TOTAL began to sketch a blueprint for how to transition an oil company into an energy company.
Each of the oil and gas majors spilled red ink last year, and most took significant write-downs. But TOTAL’s tar sands impairments were different. The company wrote off “proved reserves,” or oil and gas that the company had previously deemed all-but-certain to be produced. Proved reserves long stood as the Holy-of-Holies for the oil industry’s finances—the key indicator of whether a company was prepared for the future. For decades, investors equated proved reserves with wealth and a harbinger of long-term profits.
Because reserves were so important, the Reserve Replacement Ratio, or RRR—the share of a company’s production that it replaced each year with new reserves—became a bellwether for oil company performance. The RRR metric was adopted by both the Society of Petroleum Engineers and the U.S. Securities and Exchange Commission. An annual RRR of 100% became the norm. But TOTAL’s write-off showed that even “proved” reserves are no sure thing, and that adding reserves doesn’t necessarily mean adding value. The implications are devastating, upending the oil industry’s entire reserve classification system, as well as decades of financial analysis.
How did TOTAL reach the conclusion that “proved” reserves had no economic value? Simply put, reserves are only reserves if they’re profitable. The prices paid by customers must exceed the cost of production. Given current forecasts that prices would remain lower for longer, TOTAL’s financial team decided those resources could never be developed at a profit.
TOTAL’s strategy is based on the Sustainable Development Scenario(SDS) for medium/long term, developed by the International Energy Agency (IEA). Taking the “Well Below 2 Degrees Centigrade” SDS scenario on board, TOTAL has in essence taken on a new energy classification system. By embracing this strategy TOTAL is the only major to have seen the direct benefit of using the Paris Climate Agreement to expand its renewable energy base.
On the renewables front, TOTAL has confirmed that it will have a 35 gigawatt (GW) capacity by 2025, and hopes to add 10GW per year after 2025. That could mean an additional 250GW by 2050.
A key to TOTAL’s success is its willingness to devote capital to projects at an early stage. Its renewable investments include:
- 50% portfolio of installed solar activities from Adani Green Energy Ltd., India;
- 51% Seagreen Offshore Wind project in the United Kingdom;
- Major positions in floating wind farm projects in South Korea and France.
Expect that TOTAL will also expand its renewable portfolio in Africa in the coming months.
Renewables in Africa
This could prove to be a double-edged sword for TOTAL and Africa: stimulating new renewable energy and oil and gas projects- if they have a high return on investment. TOTAL’s lead in taking on board renewables as part of its reserve count, will surely set a precedent for other renewable projects in Africa, helping the continent move forward with the Energy Transition. Projects not meeting this investment grade will not be treated so kindly.
Yet the increased speed of the Energy Transition is not necessarily good news for Africa. The greening of Europe, for example, could in the short and medium term have a boomerang affect in Africa. The major oil companies including Shell, TOTAL, BP and Equinor could in fact reduce oil and gas activities in Africa.
Are Africa’s oil and gas assets competitive and worthy of development if compared to other global projects? Why? Simply because the oil and gas majors are choosing low carbon prospects and natural gas projects on a massive scale, leaving many potential prospects in doubt. A prime example is TOTAL’s mega-large LNG project in Mozambique is expected to cost at least $20 Billion and produce up to 13Million tonnes of LNG per annum.
Energy scenarios released by both BP and TOTAL are predicting a sharp decrease of oil production, adding to the view that exploration budgets of the majors will not be a priority item. Instead as TOTAL has explained, low cost, high value projects are the goal: Squeezing more value out of its various African assets, especially in Nigeria and Angola to ensure a prolonged life cycle.
The Norwegian energy research company Rystad, reminded the investment community, in September 2020, that the oil and gas majors are actively pruning their oil and gas assets, stating: “The world’s largest oil and gas firms could sell or swap oil and gas assets of more than $100Billion in order to adjust and transform to cleaner sources of energy”.
The Rystad Energy Study covers a wide geographical spread and includes ExxonMobil, BP, Shell, TOTAL, ENI, Chevron, ConocoPhillips, and Equinor. The eight companies may need to divest combined resources of up to 68BillionBOE, with an estimated value of $111Billion and spending commitments in 2021 totalling $20Billion.
The key criteria for determining whether a major oil company would benefit from staying in a country are the company’s cash flow over the next five years, the potential growth in its current portfolio, and its presence in key E&P growth countries towards 2030. Based on this, Rystad claims that majors may seek to exit about 203 varied country positions and, as a result, reduce their number of country positions from 293 to 90.
How will renewables and oil and gas prospects in Africa be judged? Do the various state oil companies have the management skills to properly assess their energy transition scenarios? Do they have highly qualified, independent consulting companies providing them with advice ?
Many of Africa’s new fledging state oil companies, have been proxies to the international oil majors. In the process, they haven’t developed technical knowledge, capability and expertise to manage and implement oil and gas projects. Being hostage to the whims of the oil majors is no formula to ensure that a country’s oil and gas assets are to be developed. Certainly not, when the window of opportunity to develop oil and gas assets could be closing within the next 20-25 years.
There is the stern warning and key conclusions coming from a recent report authored by David Manley and Patrick R.D. Heller for the Natural Resource Governance Institute:
- “If national oil companies follow their current course, they will invest more than $400Billion in costly oil and gas projects that will only break even if humanity exceeds its emissions targets and allows the global temperature to rise more than 2 o “
- “Either the world does what’s necessary to limit global warming, or national oil companies can profit from these investments. Both are not possible.
- Investments by State oil companies could pay off, or they could pave the way for economic crises across the emerging and developing world, and necessitate future bailouts that cost the public. Some oil-dependent governments in Africa, Latin America and Eurasia are making particularly risky bets with public money.
- Many national oil companies have incentives to continue spending big on new oil and gas projects. As a result, company officials might not, on their own, change course to account for the energy transition away from fossil fuels toward green energy, nor make investment decisions that serve the interests of citizens.
- Governments—through finance and planning ministries, presidential offices and public accountability bodies—must act to promote a more sustainable economic path.
- Governments should understand the extent of national oil companies’ exposure to decline in oil and gas prices;
- Revisit rules on cash flows into and out of state-owned companies.
- Require or incentivize lower-risk investment decisions .
- Benchmark and measure national oil company performance, improve corporate governance, and report consistently to citizens.”
Some key conclusions
- Recently IRENA (International Renewable Energy Agency) and AfDB (African Development Bank) have jointly announced support of low carbon projects to enhance the energy transition. IRENA in its Global Renewable Outlook states the sub-Sahara Africa could generate as much as 67% of its power from indigenous and clean renewable sources by 2030. In the energy transition this would increase welfare and stimulate the creation of up to 2Million green jobs by 2050.
- Certainly public-private partnerships should be part of this mix. Governments to ensure a broad basis of support and energy companies who have the know-how and project management skills. A key bonus for oil/energy companies is knowing that renewables can be added to the reserve count.
- “TOTAL hasn’t abandoned oil and gas, and its hydrocarbon investments may prove problematic over the long term. But its renewable investments will add ballast to the company’s balance sheets, keeping it afloat as it carefully chooses investments, including oil and gas projects, with a high economic return.
- Meanwhile, its competitors that stick to the old oil industry business model will have no choice but to continue to develop hydrocarbons—even if their “proved” reserves ultimately prove to be financial duds.”
Note: Portions of this article have originally been published on the site of IEEFA (Institute Energy Economics & Financial Analysis)https://ieefa.org/ieefa-is-oil-giant-total-an-emerging-leader-of-the-energy-transition-shows-how-to-pivot-from-an-oil-company-to-an-energy-company/
Gerard Kreeft, BA (Calvin University, Grand Rapids, USA) and MA (Carleton University, Ottawa, Canada), Energy Transition Adviser, was founder and owner of EnergyWise. He has managed and implemented energy conferences, seminars and university master classes in Alaska, Angola, Brazil, Canada, India, Libya, Kazakhstan, Russia and throughout Europe. Kreeft has Dutch and Canadian citizenship and resides in the Netherlands. He writes on a regular basis for Africa Oil + Gas Report
