Net Zero 2050: How the UK can get Oil & Gas on Track

David Vergara Schleich, Tanya Lim, and Jenny Su

Introduction and Current Policies

In preparation for the 2021 COP 26 Conference in Glasgow, the United Kingdom (UK) published an ambitious white paper entitled “Net Zero Strategy: Build Back Greener” in which it outlines policies to achieve a greenhouse gas (GHG) neutral economy by 2050.1 This makes the UK the first country to implement a legally binding timeline. In line with this strategy, the Government aims to mobilize up to £270 billion in public and private sector funds to transition the Power and Energy sector.2 Crucially, instead of viewing the Oil and Gas sector as an impediment to GHG neutrality, the Government envisions the sector to play a leading role in the energy transition .4 As part of the Net Zero Strategy, the relevant UK regulatory body , the Oil and Gas Authority (OGA), has echoed the urgency to achieve GHG neutrality. In its “Revised Strategy”, the OGA warned that it would exercise its punitive powers should companies fail to comply with the timeline.5 Thus, the objectives of the government’s Net Zero Strategy are two-fold: in political-environmental terms, it is to achieve GHG neutrality to curb climate change and position the UK as a global paragon in environmental governance; secondly, it seeks to walk the fine line between incentivizing and coercing the Oil and Gas sector to accelerate its transition towards carbon neutrality and beyond 2050, towards renewable energies. 

Current Challenges 

The current timeline to achieve net-zero emissions is ambitious. In October 2021, the OGA called on the Oil and Gas sector to “go considerably faster and farther in reducing its own carbon footprint or risk losing its social licence to operate”.6 Government policies have shaped investor’s interest “in sustainable and resilient assets, including renewables”, reflecting their desire not only to reduce exposure to climate change but also to mitigate the risk of having stranded assets as a result of the fast-paced government policy.7 The stock markets consequently reflect this change. The first three quarters of 2020 reflected the downturn of asset values of the oil and gas companies in North America and Europe by $145 billion, approximating to 10 percent of their market value.8 On the other hand, the S&P Global Clean Energy index asset price doubled in 2020, overinflating companies’ expected profits, and giving it a valuation of 41 times.9 This global trend is particularly prevalent in the UK, and the risks have to be carefully evaluated against the pressing need for the British environmental Oil and Gas sector reform. Failure to adopt appropriate pace could reproduce the recent Shell case in which it relocated to the UK due to overwhelming judicial pressure in the Netherlands to rapidly enact GHG cuts, which would be detrimental for the UK economy and the energy transition as a whole.10

Challenges within the Oil and Gas sector must be addressed to enact a successful climate transition policy. Even before the Covid-19 pandemic, the oil industry was under duress. Oil firms suffered from chronic cash shortfalls and resorted to stopgap asset sales and long-term debt to bridge their deficits.11 With the urgency and tone set by the government to shift away from fossil fuels, firms face major economic risks.12 Oil companies currently sit on a ‘carbon bubble’, having 30 trillion in fixed assets at risk of becoming ‘stranded’.13 As the world moves towards a low-carbon economy, fossil fuels lose their value. Companies cannot generate revenue even after absorbing the capital used, turning reserves and facilities into stranded assets, which critically include capital machinery and infrastructure used to extract natural resources. This carbon bubble is estimated to be between $1 to $4 trillion, which could trigger a financial crisis if burst.14 This would lead to energy prices soaring, thus impacting stakeholders across the economy. 

Overall, the challenges of fast-paced energy transition in the UK coupled with a growing carbon bubble, indicate that the status quo poses significant risks to the success of the UK’s green transition. Thus, the authors propose three distinct policy proposals to mitigate these risks and streamline the UK’s energy transition to 2050 and beyond. 

Policy Proposal 1: Fortify and Integrate Carbon Capture Technology Governance 

In the medium-term, the main strategy for the Oil and Gas sector to reduce their net GHG emissions is to develop carbon capture utilisation and storage (CCUS) technologies. To help fund CCUS, the Government created the Carbon Capture and Storage Infrastructure Fund (CIF) in 2021.15 This policy proposal introduces two separate mechanisms : (1) CIF Conditionality and (2) Infrastructure integration.

At the fiscal level, the UK government must attach conditionality in the form of compliance monitoring as part of the CIF’s fund awarding process. This would ensure that CIF-funded infrastructure projects are effective in decreasing acute onsite GHG emissions. For instance, specific metric tons of carbon dioxide equivalent (MTCO2e) targets should be assigned to specific annual milestones (eg. 2025, 2027, 2029, etc.). In case that the specific CCUS target is not met, this policy envisions a corresponding decrease in CIF financial assistance. Moreover, when a company accepts the terms of the CIF funding, it commits to completing the project regardless of punitive fiscal action. 

At the technical level, the UK Government needs to reinforce the relationship between emerging CCUS projects and existing Oil and Gas infrastructure. As has been pointed out, there are significant infrastructural overlaps between fossil fuel extraction and carbon capturing, including existing pipelines that can be reversed to pump carbon dioxide.16 This policy proposal seeks to improve integration by making surveying of potential infrastructure overlap mandatory for the CCUS sector. In the North Sea, this includes the creation of inter-industry working-level groups between Oil and Gas producers and the CCIUS sector to identify common solutions. This includes incorporating these requirements into the CCUS “Phase-2 Background and Guidance for Submissions” licensing criteria.17 This would not only cut costs but also facilitate the Oil and Gas sector’s transition towards CCUS projects.

There are a number of limitations to these proposals. Firstly, these policies encourage the partnership between the Government and the Oil and Gas sector, which could neglect other CCUS start-ups from being awarded funding, thereby stifling innovation. However, given the strict 2050 timeframe, the Oil and Gas sector must exploit every competitive advantage it possesses. The incentives of Oil and Gas companies to achieve this transition timely forecasts the proliferation of joint ventures with infant CCUS firms that develop innovative technologies.

In the long-run, the establishment of a competent CCUS sector in collaboration with the Oil and Gas sector may achieve GHG neutrality but may detract attention from the actual decrease in fossil fuel extraction. In this context, other supply and demand-side policy proposals are required to ensure that the energy transition does not stagnate. 

Policy Proposal 2: Creation of a Consumer Friendly Energy Rating for All Energy Companies 

To address the lack of consumer information when choosing an energy company, a ‘green’ company rating should be implemented by the UK government, through a regulatory body. An energy rating system similar to an energy label on washing machines and fridges would be suitable. A colour-coded rating from A+ to D would be mandatory for energy companies and the rating must be readily accessible to the public. This would assess how ‘green’ an energy company is through three criteria. 

For electricity suppliers, we would consider what percentage of their energy is supplied through renewable energy generation and nuclear power, with a significantly heavier weighting for renewables. For oil firms, it is the percentage of biofuels and liquified petroleum gas compared to crude oil which would be used. The second component will consider how polluting the firm is using the average number of carbon emissions per megawatt-hour of energy produced. This would largely consist of the total number of carbon emissions produced but it would be considered in the context of the energy source. Upper and lower bounds on each fuel type will benefit companies that use the most efficient fuels, but overall changing the fuel type would have the greatest impact. The third indicator will assess how ambitious a firm’s green strategy is by considering the percentage of investment given to achieving the net-zero emissions goals and beyond. This is the percentage of total investment in renewable and alternative energy, green infrastructure, technology, products and services, and pollution. 

There may be certain difficulties, as energy tariffs vary across electricity and gas companies, and varying types of petrol. Fixed rate and variable tariffs are the main two types, although ‘green tariffs have grown in popularity in recent years, adding to the complexity of choosing a supplier. However, understanding the firm’s reputation for energy production can give the consumer a useful idea of what company they should support. This is particularly important as large corporate companies use expensive greenwashing branding to appear environmentally friendly, while in reality their actions go against their professed commitment to green practices. Increased transparency would allow consumers to make better choices regarding their energy and fuel supplier. This policy would also encourage energy firms to invest in alternative fuels, green infrastructure and decrease carbon emissions in order to avoid a poor rating. 

Policy Proposal 3: Correcting Market Mechanisms to Encourage Green Investment and Conservation of Natural Resources

In the long-run, the final step of the solution is to gradually eliminate all tax breaks on consumption including VAT for fossil fuel-generated energy and introduce a zero tax rate for renewable energy technologies and consumption. Tax breaks for fossil fuels are distorting market forces and making oil and gas even more profitable for polluting firms. The internal rates of return on oil are typically 15% to 20% or higher, whereas the internal rates of return for renewables are much lower at 5-6%18 The UK needs to move away from a cost-centric approach and adopt a profit-centric approach regarding renewable energy generation, to make it more profitable and appealing.

The current consumption tax breaks are intended to benefit the consumer, to shield them from high and fluctuating domestic energy bills. The standard rate of 20% for VAT was lowered to 5% for domestic energy supplies.19 However, evidence shows that it is wealthier households who benefit most from the subsidy, as wealthy households use over twice as much heating fuel as the poorest 10%.20 Targeted demand-side policies such as expansion of the Cold Weather Payment and Winter Fuel Payment would be more desirable. The increase in domestic housing bills as a result of increasing VAT on energy supplies will most certainly be an unpopular policy. This is why the increase in VAT should be gradual, in increments of 5% and over a period of two decades, ending at 25%. This gives energy firms sufficient time to adapt their business approach and allows consumers adequate time to adjust. 

Similarly, the VAT rate for domestic renewable energy and clean technologies should be 0%. This would reverse the 2019 legislation that increased VAT from 5% to 20% for insulation, battery storage, and solar installations. Previously, EU legislation demanded the UK to increase the tax rate on renewable technologies, but since leaving the EU, the UK is able to reverse these changes.21 Due to the high barriers of entry to renewables and low profit margins, market forces deter companies from investing in green energy. This policy should take immediate action and should be welcomed by the UK government due to its commitment to net-zero emissions and green infrastructure. 

Conclusion

In order to ensure the UK is able to complete its Net Zero Strategy by 2050 without significant risks to the existing Oil and Gas sector, Government, and end consumers, the authors have presented three policy proposals. In the medium-term, consolidating CCUS governance is crucial to achieving GHG neutrality for fossil fuel extraction by 2050. The demand-side oriented green energy labelling scheme aims to increase transparency and empower households to apply pressure to environmental energy reform. In the long run , the UK must eliminate its market-distorting fossil fuel subsidies in the form of tax breaks in a responsible timeframe to complete the transition to renewable energies. It is only through these proposals that the UK can mitigate risks to the economy whilst also making genuine progress towards a more sustainable future.

Endnotes

  1. Department for Business, Energy & Industrial Strategy. 2021. “Net Zero Strategy: Build Back Greener”. London: HM Government. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1033990/net-zero-strategy-beis.pdf
  2. Department for Business, Energy & Industrial Strategy. 2021. “Net Zero Strategy: Build Back Greener”. London: HM Government. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1033990/net-zero-strategy-beis.pdf
  3. “Revised OGA Strategy Comes Into Force”. 2021. Oil & Gas Authority. https://www.ogauthority.co.uk/news-publications/news/2021/revised-oga-strategy-comes-into-force/
  4. de Brugiere, Maguelonne, and James Robson. 2021. “A Revised MER UK Strategy: Implications For UK Oil & Gas Participants”. Energy Notes. https://hsfnotes.com/energy/2020/06/17/a-revised-mer-uk-strategy-implications-for-uk-oil-gas-participants/
  5. “The OGA Strategy.” Oil and Gas Authority. Last modified February 11, 2021. https://www.ogauthority.co.uk/regulatory-framework/the-oga-strategy/.
  6. “The OGA Strategy.” Oil and Gas Authority. Last modified February 11, 2021. https://www.ogauthority.co.uk/regulatory-framework/the-oga-strategy/.
  7. “MEOS 2021 – News – Page 2 Of 4”. 2021. MEOS 2021. https://meos-expo.com/content-resources/news/page/2/
  8. Eaton, Collin, and Sarah McFarlane. “2020 Was One of the Worst-Ever Years for Oil Write-Downs.” Wall Street Journal. Last modified December 27, 2020. https://www.wsj.com/articles/2020-was-one-of-the-worst-ever-years-for-oil-write-downs-11609077600.
  9. Billy Nauman. “‘Green Bubble’ Warnings Grow As Money Pours into Renewable Stocks.” Financial Times. Last modified February 19, 2021. https://www.ft.com/content/0a3d0af8-7092-44c3-9c98-a513a22629be.
  10. Nasralla, Shadia and Sachin Ravikumar. “Shell Ditches the Dutch, Seeks Move to London in Overhaul.” Reuters. Last modified November 15, 2021. https://www.reuters.com/world/uk/shell-proposes-single-share-structure-tax-residence-uk-2021-11-15/.
  11. Harvey, Fiona. “What is the Carbon Bubble and What Will Happen if It Bursts?” The Guardian. Last modified August 25, 2021. https://www.theguardian.com/environment/2018/jun/04/what-is-the-carbon-bubble-and-what-will-happen-if-it-bursts
  12. United Nations Environment – Finance Initiative – Partnership Between United Nations Environment and the Global Financial Sector to Promote Sustainable Finance. Accessed November 25, 2021. https://www.unepfi.org/psi/wp-content/uploads/2018/08/Waterproof_An-exploration-of-climate-related-risks-for-the-Dutch-financial-sector.pdf.
  13. Livsey, Alan. 2021. “Lex In Depth: The $900Bn Cost Of ‘Stranded Energy Assets’”. Ft.Com. https://www.ft.com/content/95efca74-4299-11ea-a43a-c4b328d9061c
  14. Harvey, Fiona. “What is the Carbon Bubble and What Will Happen if It Bursts?” The Guardian. Last modified August 25, 2021. https://www.theguardian.com/environment/2018/jun/04/what-is-the-carbon-bubble-and-what-will-happen-if-it-bursts.
  15.  Department for Business, Energy, and Industrial Strategy. 2021. “The Carbon Capture And Storage Infrastructure Fund”. London: Department for Business, Energy, and Industrial Strategy.
  16. “Oil And Gas: Carbon Capture, Utilisation And Storage”. 2021. Gov.Scot. https://www.gov.scot/policies/oil-and-gas/carbon-capture-utilisation-and-storage/
  17. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1031856/ccus-phase-2-guidance.pdf
  18. Christophers, Brett, ‘Big Oil Companies Are Driven by Profit – They Won’t Turn Green by Themselves’, The Guardian, 25 May 2021, section Opinion <https://www.theguardian.com/commentisfree/2021/may/25/big-oil-companies-profit-green-renewables-fossil-fuels-net-zero> [accessed 25 November 2021]
  19. ‘How Much Is VAT on Gas & Electricity for Business? | Bionic’ <https://bionic.co.uk/business-energy/guides/vat-for-business-energy/&gt; [accessed 25 November 2021]
  20. ‘Which Households Emit the Most Carbon from Energy Use? | Climate Just’ <https://www.climatejust.org.uk/messages/which-households-emit-most-carbon-energy-use> [accessed 26 November 2021]
  21. ‘Archived Petition: Stop the Increase to 20% VAT for the Installation of Renewable Energy Sources’, Petitions – UK Government and Parliament <https://petition.parliament.uk/archived/petitions/260903> [accessed 25 November 2021]

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