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May 04, 2023

US oil and gas companies learn to live with higher standards

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Pressure from investors, customers and governments is pushing the industry to improve its environmental performance. It is one of the factors driving consolidation

9 minute read

Vice-Chair, Americas

Vice-Chair, Americas

Ed examines the forces shaping the energy industry globally

The standard shorthand for political allegiances in the US divides the country into red (Republican) and blue (Democratic) states, but those designations are fluid. Ohio, a state that President Barack Obama won with about 51% of the vote in the 2012 election, has moved towards supporting Republicans, and was won by President Donald Trump with 53% of the vote in 2020. Colorado, which also voted about 51% for President Obama in 2012, moved in the opposite direction and voted 55% for President Joe Biden in 2020. Its last Republican governor left office in 2007.

Colorado's shift from a Democratic-leaning "battleground state" to a "Democratic stronghold" has been reflected in the positions on energy policy taken by the voters and elected officials. Oil and gas companies have faced increasingly onerous restrictions on their operations, and are threatened by additional regulatory burdens in the future.

Among US states, Colorado is a top-six producer of crude oil and a top-ten producer of natural gas. Other significant oil and gas producing states are typically more accommodating towards the companies that are responsible for that production. Colorado's demanding regulatory environment does not seem likely to stop the state's oil production growing over the next few years. But it is helping to shape the structure of its oil and gas industry.

Chevron this week announced a vote of confidence in Colorado's future as an oil and gas producer, agreeing to pay US$7.6 billion in shares and assumed debt for PDC Energy, a Denver-based exploration and production company. PDC has a small position of about 25,000 net acres in the Permian Basin, but the majority of its acreage and production is in the Denver-Julesburg Basin in Colorado.

The deal represents a significant diversification for Chevron, which today has about 75% of its upstream net present value in its top four areas: the US Permian, Australian LNG, Kazakhstan and the US Gulf of Mexico. Acquiring PDC adds a fifth major group of assets in the DJ Basin.

At the presentation for the deal announcement, regulatory threats to that business were high on the list of analysts’ concerns. In 2019, Colorado passed the most radical overhaul of its oil and gas regulations in decades, changing the priorities for state regulators from promoting industry development to "public safety, health, welfare and the environment", and giving cities and counties the authority to control oil and gas development.

Other changes in recent years have included a ban on routine flaring and venting, setback rules preventing most wells being drilled within 2,000 ft of homes or schools, new requirements for oil and gas producers to cut their greenhouse gas emissions over time, and the state's first comprehensive oil and gas development plan.

This year, there was an attempt in the state legislature to reform air quality rules and permitting in ways that the oil and gas industry warned "would functionally prohibit new permitting for most industrial processes in the state." That proposed law was substantially revised before being passed, and Dan Haley, President and CEO of the Colorado Oil & Gas Association, said the amended bill would "allow for us to continue producing some of the cleanest molecules of oil and natural gas on the planet."

Even so, the originally proposed bill was a sign that the pressure on the industry remains. Kait Schwartz, Director of API Colorado, another industry group, commented when it was introduced: "It feels like Groundhog Day, with this measure only the latest in a yearslong series of legislation that aims to completely halt natural gas and oil production in Colorado."

Chevron, however, believes it can work with the state's politicians and regulators. Mike Wirth, Chevron's chief executive, gave an interesting answer on the subject on the call for analysts to discuss the deal. It is worth quoting at length:

"I think both companies have demonstrated a respect for the higher expectations that have been expressed by the citizens of Colorado, by the elected officials in Colorado, and frankly, our industry is holding itself to a higher standard as well. Our expectations for our own operations have risen. Rather than view this as some sort of confrontation, I think we’ve viewed it as a way to raise our own game."

PDC has already been highly successful in securing permit approvals, obtaining about 1,000 in Colorado in the past nine to ten months. Its Colorado acreage is almost entirely in Weld County, where its approvals will enable it to continue development at current levels into 2028.

For Colorado's industry overall, the tighter regulatory environment seems unlikely to stop production growing. Wood Mackenzie expects growth of about 18% in Colorado's crude oil production over 2022-28, only a little less than the 23% growth we expect for the US Lower 48 states as a whole.

For natural gas, we expect the state's production to be broadly unchanged over the same period. Colorado will lag behind states including Texas, Louisiana and New Mexico, where we are forecasting growth, but we are not expecting its production to collapse.

Where Colorado's stricter regulations do seem to be having an impact is on the structure of the industry. More burdensome regulatory requirements are one of the factors driving consolidation.

"The result of all of the regulations so far has been to force significantly more planning and commitment by operators, and it's not an easy environment for small companies to navigate," says Ryan Duman, a principal analyst in Wood Mackenzie's Lower 48 Upstream team.

"Following this deal, there will be only three significant companies effectively active in Colorado: Occidental Petroleum, Chevron and Civitas. There are a handful of smaller companies, but anyone with any sizeable position or production has been eaten up. If you don't have very robust environment, health and safety and regulatory teams, you can't operate there."

It's a point that can be extrapolated to the US national picture. President Biden's moves in his first few months in office that would have restricted oil and gas production have largely been abandoned. By last year, he was actively trying to encourage increased output, and his administration's recent decisions, such as the approval for ConocoPhillips’ Willow project in Alaska, have tended to support that goal.

However, pressure on oil and gas companies for higher environmental standards is still there, from investors and other stakeholders, including the federal government. As Chevron's Wirth noted, "our expectations for our own operations have risen." The charge on methane emissions from many oil and gas facilities that was included in the Inflation Reduction Act, passed last year, will add to that pressure.

Scale almost always helps with managing regulatory burdens. Escalating demands for improved environmental performance will be one of the key factors driving consolidation in the US oil and gas industry in the months and years to come.

President Muhammadu Buhari of Nigeria spoke at the commissioning ceremony for the Dangote refinery in Lagos. The refinery, which has a capacity of 650,000 barrels per day, is intended to turn Nigeria from an importer into a significant exporter of oil products. Next year Nigeria could be a small exporter of gasoline and a more significant exporter of diesel. Along with more capacity also coming on stream in the Middle East and China, it will contribute to the easing of world product markets that has sent refining margins tumbling since last year, and could drive them lower still by 2024.

Sustainable Aviation Fuel will "never achieve the price of [conventional] jet fuel", the chief executive of Boeing told the Financial Times.

Mikhail Mishustin, prime minister of Russia, visited China this week for a summit meeting, but left without a clear commitment to the Power of Siberia 2 pipeline project. The proposed pipeline would run from the Yamal peninsula in northern Russia, providing an alternative export route for the region's gas, which has until last year mostly flowed west to Europe. Analysts have said China is holding out for a better deal, using its leverage now European markets have been largely closed to Russian pipeline gas.

Drax, the UK power generation group, has announced it plans to open a new North American headquarters in Houston for its Bioenergy with Carbon Capture and Storage (BECCS) business. It has already identified two sites in the southern US for new BECCS plants, and is evaluating nine more in North America. BECCS, burning biomass such as wood pellets for power generation at plants where the emissions are captured, can be a technology for removing carbon from the atmosphere, depending on the origin of the feedstock.

Ørsted is working on a similar carbon capture project for its Asnæs wood chip-fired power plant and its Avedøre plant's straw-fired boiler in Denmark.

Plastic recycling can release significant quantities of microplastics, a new study has found.

And finally: Damon Albarn, the lead singer of Blur, has apparently offended his neighbours by installing a heat pump at his country house in Devon.

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"I think this whole ESG movement is really trying to do through the financial sector what they could never achieve through the ballot box. And so they are trying to do an end-run around the constitutional system. And they’re really trying to change policy, they’re trying to change society, and they’re trying to change the scope of people's rights. And so in Florida I just signed anti-ESG legislation, which said things like no ESG criteria in our [state] pension fund." — Governor Ron DeSantis of Florida, announcing he was running for president in next year's US elections, explained his position on the use of ESG (environmental, social and governance) factors in the financial sector. He was responding to a question specifically about financing for gun stores, but broadened his point into a wider argument about ESG in general. The legislation signed into law in Florida earlier this month includes provisions blocking the use of ESG factors in investment decisions by state and local bodies, "ensuring that only financial factors are considered to maximize the return on investment".

Like last week's chart, this one comes from presentations given in New York and Toronto recently by Wood Mackenzie's Metals and Mining team. It shows planned and actual capital spending by the big five Major mining companies, illustrating their commitment to maintaining financial discipline. As a result of these spending plans, we expect their total production to be broadly flat for nickel and copper. Above-ground risks and restrictions on access to resources are among the factors holding back their ability to invest in production growth. In Chile and Peru, for example, they have plenty of brownfield options for investment in copper, but the regulatory environment has been too volatile in recent years to make progress. So to the extent that demand for those metals rises, the additional supplies will have to come from other sources. To make possible a transition to net zero emissions by around 2050 — which is probably necessary to limit global warming to 1.5 °C — the growth in metals supply would have to be even faster.