The
Economics Of Climate Change Management In The Petroleum Industry
BusinessWeek
By
Paul E Hardisty
Introduction: Change Is Coming
Academics,
scientists and researchers tend to be a highly conservative
bunch, routinely qualifying their findings with
caveats and warnings about incomplete data, scientific uncertainty,
and imperfect models. They are taught this from the outset
of their careers – to question, to balance the facts,
to examine the sensitivities of their conclusions to changes
in input assumptions. So when the vast majority of the world’s
leading climate researchers pronounce that their findings represent
an unusually strong consensus, and that they are 90% certain
that human activity is the chief cause of observed and future
predicted climate change, it would do us well to listen. That
many of these same scientists have been warning us about rapid
shifts in planetary weather cycles for over 30 years, to little
effect, highlights how difficult this issue is to understand,
and how easy it is to ignore.
But
with the current issuing of the Intergovernmental Panel on
Climate
Change (IPCC) Fourth assessment report1, the UK’s
Stern Review on the economics of climate change2, and more
popular mainstream works by notables such as Al Gore3 and Tim
Flannery4, a broad and sweeping change in world public opinion
seems to be underway – climate change is real, and it’s
very serious. The scientific consensus, built around the IPCC
reports, but backed up by literally thousands of peer-reviewed
publications in the most prestigious and conservative scientific
journals, predicts that the impacts of this phenomenon are
going to be felt everywhere, in different ways, for a long
time: shifting rainfall patterns, more violent storms, sea
level rise, drought, floods, and widespread species extinctions
are all predicted, their severity conditional on how quickly
and effectively we can act to reduce emissions. Change is coming,
and fast.
The Petroleum Industry And Climate Change
Led
by the Kyoto Accord, and increasingly spurred by shifting
public
opinion, national, state, and local governments across
the globe are rapidly developing and enhancing legislation
designed to reduce atmospheric emissions of the insulating
green house gases (GHGs), principally carbon dioxide (CO2)
and methane (CH4), that cause radiative forcing, slowly warming
the planet. In Alberta, Canada’s oil and gas producing
province and home of the Athabasca tar sands mega-reserves,
the government has just announced a new CDN $15/ton tax on
GHG emissions from facilities emitting more than 100,000 tons
of CO2e (carbon dioxide equivalent) which exceeding mandatory
12% reduction targets5. The EU has announced a new goal of
cutting emissions by 30% from 1990 levels by 2020. A new administration
in Washington in 2008, Democrat or Republican, will almost
certainly bring a nationwide carbon reduction programme of
some sort to the world’s largest consumer of petroleum
products, and largest producer of GHG. Full engagement of the
world’s largest economy will have a resounding effect
on the way the rest of the planet approaches carbon regulation
in the coming decades.
In
response, many petroleum companies, large and small, are
now moving
to implement emission reduction programmes, and
prepare themselves for a lower carbon future. Petroleum sector
activities are estimated to produce about 1.2bn tons of CO2e
annually6, chiefly from refinery operations, venting of CO2
in natural gas streams, and the continued widespread flaring
of gas. While the burning of oil is a major contributor to
the world’s total loading of GHG (total emissions are
now over 40bn tons per year of CO2 equivalent, about 26bn tons
of which are from burning of fossil fuels)1,2,7, natural gas
is among the cleanest burning fuels currently available, and
is seen as an important bridging fuel on the road to a lower
carbon world economy6. The petroleum sector’s role in
developing secure supplies of this cleanest of hydrocarbons
is a major positive contribution to the effort to tackle climate
change.
The supply of energy aside, the petroleum industry is now
paying more attention to its own GHG footprint throughout the
exploration, production, refining and product delivery life-cycle.
The American Petroleum Institute (API) recently published guidelines
on sustainability reporting, which include GHG emissions as
one of the main reporting criteria8. Among the many major global
companies that have announced programmes to substantially cut
their GHG emissions are Shell, BP, Statoil, and recently ExxonMobil.
All recognize the need to prepare for what now seems almost
inevitable, that some sort of significant global tax on carbon
emissions is coming, sooner rather than later.
The Economics Of Managing Change
A
proposition is defined to be economic if it improves human
welfare. That
is, the total benefits of the action exceed the
total costs, to all of society9. Maximization of human welfare
is the rational objective of economics. To be complete, economic
analysis must therefore include the costs and benefits not
only to the company, but to society. This means including the
cost of damage to publicly owned assets, such as the environment.
Traditionally, however, a firm’s internal financial analysis
has not included accounting in dollar terms for the damage
inflicted to the environment. Only by examining the effect
of these externalities on decision making can companies understand
the true effect and the true economics of their decisions10.
To
put this into context, consider the external cost of GHG
emissions.
According to Stern2, the predicted value of the
damage inflicted upon the world’s economy by climate
change could be as much as 5 – 20 % of global GDP every
year, for all time – a cost to society of trillions of
dollars annually. Depending on emissions trajectories over
the next 50 years, this equates to a median expected damage
value (or social cost of carbon) of $85/ton CO2e, although
several studies suggest much higher values2. So a purely private
investment decision which results in the production of an addition
1mn tons of CO2e per year, actually ignores $85mn a year in
costs which others (society) must bear.
In many cases, investment in energy and water efficiency,
for instance, can result in net cost reductions for the company,
in addition to reductions in emissions2. In comparison, the
current cost of commonly available offsets is in the range
of $3-5/ton CO2e. More costly methods, such as gas stream CO2
capture and sequestration (CCS), for example, may cost operators
as much as $15 to more than $50/ton CO2e 6,11. So from an economic
perspective, measures to reduce GHG emissions which focus on
efficiency, energy use reduction, waste minimization and offsets,
can be highly attractive now, with benefits (measured as costs
savings to operators plus the value of the external damage
avoided) strongly outweighing costs. This is particularly the
case for new projects or project upgrades currently being contemplated
or designed. Design changes which reduce emissions can be implemented
now at much lower cost than retrofits forced on operators later.
For offshore developments, for instance, retrofitting emission
reductions equipment in future will be far more costly, in
current dollar terms, than the same measure included at the
original design stage. Understanding the future likely trajectory
of carbon costs is becoming vital to project decision-making.
Justifying
more aggressive GHG reduction measures requires a longer-term
perspective, and a view on what changes in legislation
and taxation are likely. With evidence of the severity of the
impacts of climate change mounting, and heightened public awareness,
there can be little doubt that carbon taxes (in one form or
another) will eventually be levied in most, if not all parts
of the world. Stern’s figure of $85/ton CO2e is useful
in that it provides an indication of the true cost of emissions
to the world’s economy2. However, Stern does not explicitly
account for the full value of damage to the environment itself.
Other studies have suggested that the true damage-avoided value
of carbon could be as high as $200/ton CO2e or higher11,12.
At these levels, many of the more costly GHG reduction technologies
and approaches become economic propositions for society.
Example – LNG
Facility Design
LNG
is highly energy intensive to produce. The process of compressing
and refrigerating the gas uses as much as one Joule
of energy for every eight Joules of energy produced, producing
about 0.2 to 0.3 tons of CO2 per ton of LNG. For a new facility
comprising two 7.5mn tons/year trains, using a feed gas containing
approximately 10% CO2, conventional design, at full operational
capacity and venting CO2 to atmosphere, would produce approximately
20mn tons of CO2 each year. In social economic terms, using
Stern’s $85/ton CO2e, this would reduce the overall value
of the project by $1.8bn each year over the expected 30-year
project life. Even using the benchmark Alberta Government carbon
tax of about $15/ton CO2e, the impact is still significant
at $0.3bn/year. Anticipating that the external damages caused
by GHG production will come to be recognized and valued at
some point during the life of the project, alternatives for
reducing GHG emissions should be considered.
A combination of measures, including removing CO2 from the
gas stream and re-injecting it into the producing formation,
waste heat recovery for steam and power generation, selection
of efficient turbines for compression, and energy efficiency
optimization throughout the process, could be used to reduce
the overall GHG impact. Through these design changes, GHG emissions
can be reduced by 7mn ton/year, at an anticipated capital cost
to the project of $0.7bn. Over 75% of this cost is for carbon
capture and storage (CCS), a unit cost of about $10 to $15/ton
CO2e over the anticipated life of the project. Other studies
of CCS around the world have suggested costs of in the order
of $10 to $50/ton CO2e5. The design changes also reduce the
use of fuel gas in the facility and improve reservoir performance,
resulting in improved project revenues.
With conventional financial analysis, this expenditure would
be difficult to justify. However, the benefit of these measures
to the rest of society, using $85/ton CO2e, would be $0.6bn
a year, a present value (PV) of $11bn over 30 years at a social
discount rate of 3.5%. Thus, for every dollar invested, society
as a whole is more than $18 better off (in terms of damage
avoided). Even at $10/ton CO2e, the proposition is economic.
Set in terms of managing future carbon taxes, whatever form
they take, such an analysis provides a useful decision-making
tool, allowing companies to assess planned spending on GHG
emission mitigation with the future expected costs of emissions
curtailment measures (taxes, cap-and-trade schemes), and the
real social economic benefits which are produced. Speculating
on the future of global carbon management, there is every possibility
that as time goes on, the cost of carbon emissions which firms
will have to directly bear will start to converge towards the
true social cost of the damage that those emission cause.
Conclusion
Whatever
one’s perspective on the uncertainties surrounding
climate change, it appears certain that the petroleum industry
will be required to manage its GHG emissions more comprehensively
as time goes on. Many companies are already establishing their
own internal emissions reduction targets. With a focus on design
and process efficiency, significant reductions can be achieved
at relatively low cost, in many cases actually reducing overall
costs to operators, and improving profitability. But only by
considering whole life-cycle economics, and the projected value
of GHG emissions, either as damage avoided or as some form
of carbon tax, can the petroleum industry fully understand
the implications of investment decisions, and better manage
its operations in this period of profound change.
References
1. Intergovernmental Panel on Climate Change (IPCC) Fourth
Assessment Report, 2007.
2.
N Stern, 2006. The Economics of Climate Change – The
Stern Review. Cambridge University Press.
3. A Gore, 2006. An Inconvenient Truth, Bloomsbury, London.
4. T Flannery, 2005. The Weathermakers. Text Publishing, Melbourne.
5. Alberta Government, 2007. Climate Change and Emissions
Management Act. Specified Gas Emitters Regulation 139/2007.
6. Intergovenmental Panel on Climate Change (IPCC). 2004.
Carbon Capture and Storage
7. S Pacala, and Socolow, 2004. Stabilization Wedges: Solving
the Climate Problem for the Next 50 Years with Current Technologies.
Science Vol 305, 968-972.
8. American Petroleum Institute (API) and International Petroleum
Industry Environmental Conservation Association (IPIECA), 2005.
Oil and Gas Industry Voluntary Sustainability Reporting. API,
Washinton, DC.
9. D Pearce, 1981. World without End. World Bank. Washington,
DC.
10. P E Hardisty, and E Ozdemiroglu, 2005. The Economics of
Groundwater Remediation and Protection. CRC Press, NY.
11. T E Downing, D Anthoff, R Butterfield, 2005. Social Cost
of Carbon: A Closer Look at Uncertainty. UK Department of Environment,
Food and Rural Affairs (DEFRA).
12. D Pearce, 2005. The Social Cost of Carbon, in Helm, D
Climate Change Policy. 2005. Oxford University Press.
Paul
E Hardisty is Global Director, Sustainability, for WorleyParsons,
helping
clients worldwide deliver more environmentally, socially
and economically sustainable projects. He is a Visiting
Professor of Environmental Strategy at Imperial College,
London, UK,
Adjunct Professor of Environmental Engineering at the University
of Western Australia, and has worked in the Middle East
for the last 15 years. Petroleumworld
not necessarily share these views.
Editor's
Note: This article was written originally for Middle
East Economic Survey, VOL. L, No 33, 13-August-2007. Petroleumworld
reprint this article in the interest of our readers.
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