The global race to net-zero emissions has swept up some unlikely cheerleaders in the last year: oil and gas companies. It can be tempting to view this as a step in the right direction; after all, oil and gas extraction accounts for most of the fossil carbon emitted to date, and these companies face the rapidly declining use of their main products. Their ideas about how to transition away from fossil fuels should be welcomed – right?
The problem is, few, if any, oil and gas companies have committed to decreasing oil and gas production in line with climate goals (which would be a global annual decline of about 4% and 3%, respectively, according to the Production Gap Report). What is worse: some companies have denied the very idea that reducing oil or gas production would help reduce CO2 emissions.
That is what Royal Dutch Shell argued when battling a recent lawsuit from several Dutch non-profits, including Milieudefensie (the Dutch arm of Friends of the Earth). The lawsuit alleges that Shell is partly responsible for climate change and demands that it reduce its carbon dioxide emissions by 45% by 2030 (compared to 2019 levels). On Wednesday, the court ruled that, indeed, Shell must change its policy to reduce its emissions (including emissions from burning its products), in line with the plaintiff’s request.
During the proceedings, Shell’s hired economists argued that reducing Shell’s oil and gas production “will have no effect on global consumption” and “will not contribute to the reduction of greenhouse gas emissions caused by the use of fossil energy.” (I translated these statements from Dutch.)
These arguments are misleading and not supported by their evidence, as I wrote to the court in December.
Below, I describe three reasons why Shell’s claims are not credible, and why reducing its oil production will reduce CO2 emissions (I use Shell as the example here, but the same argument would apply to any company selling to the world oil market):
Lower oil production leads to lower global oil consumption (and lower CO2)
Reducing production increases oil prices, and increased oil prices lead consumers to use less oil. This shouldn’t be controversial; not only is it an underlying principle of economics, it has also been backed up by empirical findings from the US Federal Reserve and other sources. Importantly, even a small change in the global oil price is enough to have a significant effect on emissions. A federal appeals court in the U.S. ruled as much, overturning the emissions analysis of a new oil development on that basis.
When oil majors give up licenses, it makes a difference
Shell’s economists acknowledge the connection between supply and consumption above, but they argue that this general principle cannot be applied to an individual company. Namely, they suggest that if Shell were to forego its existing licenses to produce, other companies would acquire the oil fields and produce the same amount of oil.
This argument has a deceptive appeal, in part because there are at least some examples where it may be true.
But the consequences of giving up oil licenses is not nearly so simple. If Shell were to transfer its existing licenses to other companies (or return them to the issuing governments), the overall effect would still be to increase costs and reduce supply. As one recent study described, a move away from new and risky projects by the oil majors would likely leave a void in new oil investments, because “other actors in the oil & gas industry, such as private equity investors and national oil companies, do not have the business models or expertise to take their place”. This matters because, to the extent other actors aren’t able to fully take Shell’s place, there would be some delay or higher costs — which would lead to lower production from those new, marginal oil projects, therefore increasing the long-term price of oil. Further, governments could not allow the licenses to be transferred, or re-issued, if Shell were to relinquish them (as is happening in several countries, including where Shell operates). Again, even a small amount makes a difference.
Most importantly, a big move by Shell could change investor risk perceptions
If major oil producers like Shell were forced to start exiting the oil business, investors could be driven further away from oil, and not just from Shell. Investor sentiment on oil has been teetering in recent years, and when investor risk goes up, so does the cost of capital and, in turn, of project development. That increases the cost of oil, decreasing its consumption.
There are multiple ways that a big move from Shell – one of the world’s largest producers – would increase risk perceptions in the industry. Credit risk analysts call these potential types of risk reputational risk, litigation risk, or shareholder action. Even a little bit of increased risk is enough to affect the long-term industry outlook and, in turn, oil prices, leading to reduced consumption and emissions. This is especially important for circumstances where government or legal action may compel them to reduce production – as is the case in the recent Dutch court ruling.
The bottom line
The growing popularity of net-zero emissions among policymakers, civil society and, increasingly, industry actors is a promising development. Credible engagements from high-carbon industries should be welcomed, as limiting warming to 1.5°C requires a swift energy transition away from fossil fuels.
But such commitments must stand up to scrutiny, and it’s more important than ever that we challenge misleading arguments and claims from oil and gas companies. Efforts by oil majors to exit the business – especially when compelled or matched by government policy – will reduce emissions. For Shell, Exxon, or others to claim otherwise is incorrect.