Our industry as a whole recognises the potential risks as global energy transitions to a less carbon-intense economy.
This includes issues such as the potential for future restriction of funding, shareholder position and stranded assets. We also recognise that balancing the need for energy and reducing GHG emissions will require efficient use of energy and the full utilisation of both conventional and innovative sources of energy into the foreseeable future, particularly if this is to remain affordable and accessible in developed and developing countries. Other global factors too remain important in relation to our industry, including growing demand for energy and provision of energy security in individual countries.
The International Energy Agency (IEA) World Energy Outlook 2016 considers a number of transition scenarios to a low carbon economy, the most challenging of which (IEA 450) restricts global temperature rise to 1.5°C. In this instance nearly 60% of the power generated in 2040 is projected to come from renewables, almost half of this from wind and solar photovoltaics. Even in this scenario, IEA considers there to be "no reason to assume widespread stranding of upstream oil assets, as long as governments give clear signals of their intent and pursue consistent policies to that end" IEA goes on to indicate that "investment in developing new upstream projects is an important component of a least-cost transition, as the decline in output from existing fields is much larger than the anticipated fall in demand".
One of our 2016 Corporate Responsibility (CR) objectives was to further examine the implications arising from the UN Intergovernmental Panel on Climate Change (IPCC) Conference of the Parties, which took place in Paris at the end of 2015 (COP21), as described in our Annual Report and Accounts 2015. We have followed the progress of ratification during 2016 by major GHG-emitting countries such as the USA and China, among others, and we recognise that climate change issues present potential risks to our future activities. In 2016, we conducted a review to better understand those potential risks.
This included a review of the Intended Nationally Determined Contribution (INDC)* reports for all locations in our portfolio. Potential strategic issues include emissions control restrictions (e.g. trading and permitting, levies), potential for stranded assets, securing access to finance, licence to operate, and adaptation by countries and communities (e.g. due to rising sea levels, or change in environmental conditions affecting communities) to the impact from climate changes. Our review was presented to the Board in September and actions for inclusion in our 2017 CR objectives were identified. Climate change in the context of the oil and gas industry is further discussed in the Industry Overview section of our Annual Report and Accounts 2016.
Cairn continues to track risk in all locations in which we operate, including climate change, and believes that for the foreseeable future oil and gas will be important in the energy mix to meet demand and will be of particular benefit for wealth generation and delivery of affordable energy if managed in an ethical manner. In November 2016, COP22 was held in Marrakech, Morocco, and outcomes from this are under review and actions are included in our 2017 CR objectives.
We acknowledge the rising importance of climate change to some of our stakeholders and, in 2016, we have assessed this as 'high' within our CR materiality assessment (see Materiality matrix). This year, we have continued to judge the risk to the Cairn Business from climate change as 'medium' based on exposures across the portfolio, which cover mature basins and developing locations.
In areas where the oil and gas industry is considered mature, such as the UK and Norway, there is clear legislation around climate change and the oil and gas industry, including EU Emissions Trading Scheme Regulations**, with ongoing emission reduction targets by individual countries and collectively by the EU. As such, the climate change risks pertaining to our assets in the UK and Norway, which include our non-operated development projects Kraken and Catcher, are well understood. Future exploration in the UK and Norway appears to be secure against the background of UK and Norwegian reduction commitments and cost of carbon (carbon allowances are allocated under trading schemes to restrict emissions; allowances can be traded at market rate). A short-term challenge is economic downturn and its impact on oil price, with implications for the industry as a whole (see Economics and funding). Ongoing monitoring of risk will be required as these mature locations seek to continue oil and gas activity and reduce emissions simultaneously, while providing energy security in an affordable manner.
Access to funding is not seen as an issue in the short to medium term, given government policies and known legislation and timescales for the sector; indeed, our Kraken and Catcher non-operated developments remain fully funded. In the short term, the marginal cost of carbon is not seen as a significant issue, although it may play a part as assets age and production declines in the medium to long term, precipitating a marginally earlier decision to cease production. We do not foresee funding or carbon cost as impacting shareholder value overall in our mature area portfolio at the end of 2016.
The likelihood of stranded assets due to climate change in mature areas is not regarded as an issue in the short or medium term. There continues to be considerable promotion of exploration and production in mature areas due to the benefits, including economic and social, and recognition that the transition will take some decades. In the short to medium term, asset risks such as proximity to infrastructure and size of discovery outweigh most other risks to project viability and delivery of shareholder value. Longer-term climate change is also likely to drive innovation and improvement in equipment, including during the design and selection stages of projects to remove and optimise emissions. For example, long-term innovation may take the form of low emissions technology and carbon capture. We do not use an internal cost of carbon on the basis that it is not material to our projects at this time but we continue to factor costs into our due diligence and investment proposal processes as necessary; it is an area we continue to monitor to ensure we understand trends and implications.
Given that much of the UK’s health, safety and environment (HSE) related legislation is based on EU Regulations and Directives, including the area of climate change, the UK’s exit from the EU following the 2016 referendum has also been identified as an event to monitor. This may impact not only climate change issues but other CR issues of interest, as the details of ‘Brexit’ become clearer.
Senegal and developing locations
Transition risks in developing locations are closely tied to the need for economic growth to provide local benefits, such as employment and social and economic development. Such countries tend to have much lower aspirations in terms of carbon reduction and will be dependent on investment funds. Market-based mechanisms also tend to play a less central role (e.g. projects under the Clean Development Mechanism of the Kyoto Protocol). Access to investment for companies is often linked with demonstrating a responsible position (in terms of both environmental and social performance; e.g. under IFC Guidance). Again, short- to medium-term stranded assets are unlikely to be a significant issue in respect of climate change alone. There are likely to be other more significant issues, such as cost of delivery of a project in remote or poor infrastructure areas, that will affect the overall value of the project.
At the end of 2016, our principal asset of this type is the Senegal appraisal and exploration project. The project is still relatively early in the value chain but has substantial potential both economically and socially for Senegal. Development and delivery will be less than 10 years, and in the medium term the climate change risks relating to investment, stranded assets and carbon cost are considered low. This is due to the need for development in-country and affordable, reliable energy in Senegal linked to its status as a 'United Nations Least Developed Country'.
In 2016, we reviewed the potential risks, status under the Kyoto Protocol and the Intended National Determined Contributions (INDCs) submitted as part of COP21 in developing locations in which we have an interest, such as Senegal. Senegal aims to generate income to improve infrastructure and deliver benefits to communities and society. The Senegal National Committee on Climate Change has identified priorities, such as the energy sector, describing mitigation and adaption aspects from a climate change perspective. Key actions identified the replacement of solid fuels, rural electrification, use of renewable energy sources and infrastructure improvement in particular. A successful oil and gas industry could assist in generating significant income, which could aid country development, provide affordable energy, inward investment in the medium term and reduce reliance on solid fuels.
Physical risks arising from climate change include the potential for extreme weather, sea level rise and water scarcity. The likelihood of impact on Cairn business, as with other companies, is highly location and infrastructure specific. In terms of our infrastructure, as at the end of 2016 Cairn had no permanent installations; almost all our activities involved offshore mobile equipment.
Local people in our areas of activity may be adversely affected by sea-level rise or degradation in fishing quality/quantity, availability of water or farming. These are social issues that are essentially in the government domain; however, Cairn has a long history of both social responsibility and social investment. For example, water supply issues in India in the location of our land operations were the subject of a major aquifer management programme developed by Cairn.
We received a series of questions from the Financial Reporting Council (FRC) in response to the ClientEarth complaint in late 2016, alleging we had failed to adequately disclose climate change risks to our investors along with routine questions in other areas. We responded in full to all FRC questions in January 2017 and consider our position presented in our 2015 report to be fair and reasonable.
* Countries across the globe adopted a historic international climate agreement at the UN Framework Convention on Climate Change (UNFCCC) Conference of the Parties (COP21) in Paris in December 2015. In anticipation of this moment, countries publicly outlined what post-2020 climate actions they intended to take under the new international agreement, known as their Intended Nationally Determined Contributions (INDCs). The climate actions communicated in these INDCs largely determine whether the world achieves the long-term goals of the Paris Agreement: to hold the increase in global average temperature to well below 2°C, to pursue efforts to limit the increase to 1.5°C and to achieve net zero emissions in the second half of this century.
** The EU Emissions Trading Scheme Regulations require regulated activities such as many offshore installations to restrict emissions of carbon (as carbon dioxide and methane emissions, among others). This is achieved by allocation of allowances that must be maintained and surrendered in line with strict requirements of the regulations.