The future of fossil fuels
In today's post I talk to David Knipe who used to work in BP's Oil and Gas business and is now part of Oliver Wyman's Energy team and Sustainability platform. While it is clear that we need to wean ourselves off our dependence on fossil fuels, David offers a bit of reality check on the idea that we can immediately switch to a set of alternative energy sources. He offers some practical advice on what the interim stages of the transition might look like. All roads in our discussion seem to lead back to the need for some form of carbon tax to incentivize producers and consumers to switch to low carbon alternatives. I provide a few calculations later in the post for what this might mean for the economics of this industry.
Natural gas as a stepping stone to decarbonization
David sees natural gas as a stepping stone in the decarbonization effort since it is has less than half the carbon intensity of coal and oil and is a very versatile commodity that can be liquified, stored, shipped or piped from source to consumer. Hydrogen is also going to play a major role in the decarbonization efforts of heavy industries and David believes that so-called blue hydrogen made with natural gas is going to form a vital bridge while we are waiting for the arrival of a scaled solution to green hydrogen (made with renewables-based electricity).
Carbon taxes on fossil fuels
In my previous post, I highlighted the risk of corporations and financial institutions attempting to create virtual or internal carbon markets which were not rapidly backed up by real-world carbon taxes levied by governments. Real-world carbon taxes serve the purpose of raising revenues to fund difficult areas of transition in the economy, but more importantly are the quickest way to eliminate the price differential between low-cost-high-carbon products and their high-cost-low-carbon alternatives. The proof that carbon markets are not currently working is evident from the absence on any material emissions-related tax revenue being raised globally and the fact that consumers are still opting for high-carbon products because the low-carbon equivalents are typically more expensive (even after they have been scaled).
If we take oil as an example, it is pretty simple to calculate what the economics would look like with the imposition of carbon taxes. The emissions associated with a barrel of oil are roughly 400 kg of CO2-equivalent. So a carbon tax of $100 per-tonne-CO2-equivalent would add $40 to the price of a barrel of oil. At the time of writing, the price of a barrel of oil was roughly $60. So in the event that the $40 tax was fully passed onto the consumer the price of oil would rise from $60 to $100. Alternatively, if only half of the price increase was passed onto the consumer, the price would rise to $80 and the profit margin of the oil producer would fall by $20. The full price increase would only be passed on to the consumer in the event that no product substitute was available. The hope would be that some low-carbon substitutes would start to appear leading to the compression of profit margins on the higher-carbon product leading to a gradual shift to the low-carbon solution.
Gas flaring and venting
Gas flares are used by oil companies to dispose of the methane that leaks out during the oil extraction process. The below is a screenshot of a dashboard I created using spectral imaging satellite data from the Earth Observatory Group showing gas flaring picked up on infra-red part of the spectrum:
David described how each yellow dot on the map is like a flame on a giant bunsen burner. Allowing the gas to "vent" into the air would be even worse than burning it since methane is 86 times more potent as a greenhouse gas than carbon dioxide. Hence, oil companies often choose to set fire to it instead. David stated that the emissions associated with flaring and venting add up to something like 3 times the emissions for the global aviation industry. According to my data, the range is anywhere between 0.5 and 2 billion tonnes of CO2-equivalent.
The reason that oil companies don't capture the methane is that it is often more expensive to do so compared to setting fire to it which comes at pretty much no cost (to the company). Returning to the subject of carbon taxes, if governments were to impose a $100 per-tonne-CO2-equivalent tax on flaring then the industry would suddenly be faced with a tax bill of $50-200 billion annually. I suspect this would lead to a rapid clean up of the problem as it became more expensive to flare or vent the methane than to capture it and sell it.
This would no doubt also lead to the clean up of the data and new verification procedures to ensure that the emissions calculations associated with the taxes were accurate. Fortunately, in the case of flaring it is impossible for companies to conceal their emissions from the steady gaze of orbiting satellites.