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Internal activism, Afghanistan’s last bastion and hydrogen hopes

Dollars and sense: internal activism
‘Green’ investment funds and public pressure are forcing big oil firms to change their behaviours, but immediate material change will be limited, while we await and expect further regulatory changes.

This year’s AGM season provide tumultuous for the world’s largest publicly-listed energy firms. Activist ‘green’ hedge funds have used their positions to compel major players to progress on their decarbonisation credentials. Such firms have always been vulnerable to criticisms from climate activists and environmental NGOs.

But the rising salience as climate change as a political issue, coupled with the trend toward a greater focus on companies’ social and environmental credentials, has lent credibility to climate activists operating in the financial world.

Hedge funds such as Engine No. 1 have led the charge by forcing board appointments and environmentally-conscious resolutions at some of the biggest oil firms, including Chevron and Exxon Mobil. These efforts are positioned as moves to maximise shareholder returns and to ensure that energy firms are well-equipped to weather global transitions to renewables. This is a trend we will doubtless see continue as climate change’s impacts are further felt across the world and activists emulate the like of Engine No. 1.

We are also seeing developments of the regulatory environment around listed firms’ environmental reporting requirements in both the UK and the US. For example, the next few years will see the progress along the FCA’s roadmap concerning firms’ obligations around climate and ESG reporting. The roadmap includes reporting requirements for listed entities aimed at preventing greenwashing. From this accounting year, it is already the case that large publicly-listed firms should report their approach to measuring and managing climate-related impacts and risks, and the FCA looks committed to expanding the set of firms affected.

Across the Atlantic, the SEC appears similarly committed to mandating that public companies report climate risks around their behaviours. Although it is already the case the case that oil and gas firms must report on their carbon emissions in the US, this regulatory shift is symptomatic of greater desire by regulators and governments to force companies to disclose the climate impact of their activity. As a sector long negatively associated with carbon emissions, we expect more stringent regulatory mandates to be placed on oil and gas firms in the coming years.

Major economies’ efforts to reach net zero carbon emissions are proving politically contentious across the world. Mandating more open climate reporting will help provide governments with greater political cover to make necessary policy changes. The tightening of ESG reporting requirements, however, can shift the onus for action to a fight between business and government to one within the boardroom.

Though oil majors have been exploring how they can convert their existing facilities to expand their renewable energy production capacity, ‘green’ policies by firms will only go so far. Increased regulation, both in the form of reporting requirements and of minimum climate standards necessary for listing, will likely be a permanent fixture. Governments and activists will both look to listing requirements to bring the battle to the boardroom.

“We welcome the new directors to the board and look forward to working with them—constructively and collectively on behalf of all shareholders.”

Exxon Mobil spokesperson, in response to election of Engine No. 1’s nominees Gregory Goff and Kaisa Hietala.

Power play: Afghanistan’s last bastion
The stunning fall of the Afghan government over the last week has sent shockwaves rippling across Western governments, with 20 years of military, human, and financial capital appearing to have been for nought in the fight for control of the country.

US President Joe Biden has made clear that he sees no more direct role for US forces in the country despite acknowledging the surprising speed and scale of the Afghan government’s defeat. And while UK Defence Secretary Ben Wallace too has bemoaned the state of affairs in the country, the reality is that there is no political will in Britain. However, one pocket of resistance to the Taliban remains – Afghanistan’s Panjshir Valley.

Panjshir’s most famous son, Ahmad Massoud, announced on 16 August that he planned to lead a new anti-Taliban movement from the region, the sole territory that has not fallen to Taliban control over the last week. The Panjshir has welcomed fleeing minorities from other parts of the country, special forces units abandoned by their military leaders, and vice president Amrullah Salleh, one of the only senior leaders from the Western-backed government not to flee the country. Protected by significant peaks and a loyal population, it is not the first time that resistance to the Taliban has been left to the Panjshir Valley.

The region famously never fell to the Taliban in the pre-US invasion civil war. It became the core of the ‘Northern Alliance’ against the Taliban that was led by Ahmad Massoud’s father, Ahmad Shah Massoud, better known as ‘the Lion of Panjshir’.

Ahmad Shah Massoud was assassinated two days before the 9/11 attacks, by al-Qaeda operatives posing as Western journalists. The killing was ordered by Osama bin Laden as assistance for his Taliban hosts and to shore up the al-Qaeda-Taliban alliance before the terrorist attacks that did so much to change Afghan and world history. That his son is now left to fight the Taliban without direct Western assistance – effectively the same situation which Ahmad Shah Massoud found himself in, having pleaded for support at the European Parliament just months before his assassination – demonstrates how little impact Western intervention has had on Afghanistan’s underlying divisions.

The younger Massoud notably finds himself without the same broad alliance among Tajiks and Uzbeks that his father was able to rely on. Even before the government’s collapse, the Taliban made inroads in northern Afghanistan far beyond what it ever achieved before the US-led invasion. Meanwhile the Taliban has made clear it seeks international recognition, and even made noise about adjusting its medieval practices ever so slightly to such support. However, it ultimately remains the reprehensible terror group that it has always been.

If there is to be any international support for an anti-Taliban effort now or in the future, Ahmad Massoud and the Panjshir Valley may prove the sole conduit for hope that Afghanistan can avoid another decade of darkness under Taliban rule.

“This situation over the short and long-run, even in case of total control by the Taliban, will not be to anyone’s interest. It will not result in stability, peace and prosperity in the region. The people of Afghanistan will not accept such a repressive regime. Regional countries will never feel secure and safe.”

Ahmad Shah Massoud, ‘Letter to the American People’ (1998)

Policy review: hydrogen hopes
The UK government launched its first its plans for a ‘world-leading hydrogen economy’ on 17 August, declaring its intent to secure more than 9,000 jobs in the sector and unlock £4 billion in investment by 2030. Hydrogen has long been linked with the green agenda, as the gas produces no carbon emissions when burned.

However, hydrogen comes in various varieties – and the debate over how to support the sector’s development largely breaks down into two camps over these: advocates of ‘green hydrogen’ derived from electrolysis and ‘blue hydrogen’ derived from natural gas but in which the carbon dioxide in this process is captured and securely stored or disposed.

The government’s hydrogen plan declares its preparation to offer subsidies in support of hydrogen production but crucially demurs on whether it will subsidise green or blue hydrogen, or both, only “committing to providing further detail in 2022 on the government’s production strategy”. A public consultation on “a preferred hydrogen business model” is now underway.

Advocates of both forms of hydrogen production will be lobbying the government in line with their preference, with ‘blue’ advocates keen to demonstrate its lower cost and ‘green’ supporters advocating for its potential as a carbon-free energy source, with no long term storage costs even if presently it is significantly more expensive.

The cost difference to the UK could be significant, as the government’s strategy lays out that it plans to offer effective ‘feed in tariffs’ in which hydrogen producers receive a payment to bridge the difference between the cost of production and the price at which they sell it on the market. It does caveat that this market price cannot be lower than the price of natural gas, but the price differential between gas and ‘green’ hydrogen is significantly wider at present than between gas and ‘blue’ hydrogen.

Blue hydrogen’s advocates, however, have an additional tool at their disposal in addition to the cost basis, which will be subject to advancing economies of scale in electrolysis technology (though some have already voiced concerns about reliance on Chinese technology in this space). Namely that blue hydrogen offers a route to extending the lifeline of the North Sea’s hydrocarbons industry – something already endorsed by the UK’s oil and gas industry.

With the public purse under post-pandemic pressure and the Conservative’s levelling up agenda, subsidies for blue hydrogen may well prove a potential panacea for a number of areas of concern, but selling their potential will require a sustained and joined up effort from both legacy industry and new hydrogen players.

“I believe that water will one day be employed as fuel, that hydrogen and oxygen will constitute, used singly or together, will furnish an inexhaustible source of heat and light” Jules Verne

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The fate of Brazil’s petrol taxes, the key to Britain’s hydrogen agenda and the core of OPEC+

Policy preview: the fate of Brazil’s petrol taxes
“Brazil, Land of the Future and always will be!” Stefan Zweig

Brazil is not set to hold its next presidential election until October 2022, but the campaign is very much already in full swing with incumbent President Jair Bolsonaro, a right-wing firebrand, facing a stern challenge from former president and Workers’ Party (PT) leader Lula da Silva, a left-wing firebrand. The pair are all but certain to face one another in the second round (Brazil’s presidential elections include a run-off between the two most popular candidates if no one receives a majority in the first round). There are ample tales, told elsewhere, about both candidates’ alienation of the centre ground, but at this stage one can bank on one theme uniting them: changes to Brazil’s unpopular PIS/COFINS taxes.

The PIS/COFINS taxes are among the most important in the Americas, essentially serving as Brazil’s equivalent of a European-style value-added tax (VAT). As with all tax matters, they are actually significantly more complex, but distilled most simply the two duties amount to a 9.25% levy on the price of end-stage goods that is used to finance the country’s societal programmes and welfare system.

Both Lula and Bolsonaro are populists, and neither will campaign for a reduction of the programmes PIS/COFINS is used to finance. But Bolsonaro has already made clear that he desires to eliminate the applicability of the two taxes to fuel prices. Indeed, he unilaterally suspended the taxes on diesel for March and April and said that he would remove it from household gas bills. The suspension of the tax on diesel has been a demand of the country’s truck drivers strike movement, which brought much of Brazil to a halt in the months before the 2018 presidential election after oil prices were liberalised.

Lula is also likely to campaign on such a policy, though he has not formally announced it yet. During his first term as president, he passed and signed legislation making not just key food staples such as rice and beans exempt from PIS/COFINS, but also key agricultural inputs such as fertilisers and seeds. Lula must win back those voters who abandoned his PT following the corruption scandals under his successor, Dilma Rousseff, who was ultimately impeached and removed from office. Their defection to Bolsonaro put him over the top in 2018 and Lula knows winning them back will be key to his electoral hopes. Pledging to lift the PIS/COFINS taxes on all retail petrol sales may well be his play to do so.

Bolsonaro plugged the hole caused by his temporary suspension of the tax on petrol by raising bank taxes, something Lula himself would approve of were it not for the country’s highly polarised political environment. Fuel taxes may well be set to vanish from Brazil’s landscape, but what replaces them is unlikely to be preferable to most investors.

Dollars and sense: The key to Britain’s hydrogen agenda

“Water will one day be employed as fuel, that hydrogen and oxygen which constitute it, used singly or together, will furnish an inexhaustible source of heat and light, of an intensity of which coal is not capable.”

Jules Verne

With the UN Climate Change Conference that the UK is set to host, better known as COP26, beginning on 1 November, speculation is rising as to how UK Prime Minister Boris Johnson aims to set the stage. The conference offers the opportunity to turn the page on the Brexit debate and the COVID-19 pandemic, with a new launchpad for the government’s agenda of ‘levelling up’ the north and laying out a framework for how the economy can grow robustly while making the progress necessary to make the target of net-zero emissions by 2050 feasible.

If the Ministry of Business, Energy and Industrial Strategy (BEIS) is to be believed, hydrogen will be at the fore of the UK’s push into the new green economy.

On 8 April, BEIS Secretary of State Kwasi Kwarteng announced a partnership between Norway’s Equinor and Britain’s SSE to explore building a hydrogen-powered power station at a cluster of new sites – known as the Humber Renewable Energy Super Cluster Enterprise Zone – outside Hull in northern England. The announcement undoubtedly raised a few eyebrows, given that there are no commercially viable hydrogen power plants in operation anywhere in the world.

Nevertheless, SSE and Equinor are not alone in exploring hydrogen’s promise, with Scottish Power announcing on 12 April that it is seeking to build a renewables-powered facility to produce hydrogen, on the outskirts of COP 26’s host city, Glasgow. A number of other firms have stated their intention to explore the market as well.

Hydrogen has long been seen as a potential balm to the emissions issues of energy generation. The argument has been boosted by the development of infrastructure to transport and implement liquefied natural gas (LNG) for power generation over the last decade, largely displacing far more polluting coal. However, hydrogen is significantly more expensive than LNG, and the export of LNG has been effectively subsidised by a number of countries as they squabble for market share.

What then is driving the economics behind Scottish Power considering producing hydrogen, and SSE and Equinor considering building a power plant powered by the stuff? Much the same solution, subsidies, in the form of ‘contracts for difference’ (CfDs).

CfDs are essentially pledges to maintain a stable price to the generator. Given hydrogen power plants’ cost of generation is likely to be above the prevailing market price until the sector is developed, CfDs would provide security to the developers of such power plants that they can recoup their investment. CfDs have already been used to fund other green investments in the UK. Their use will need to expand significantly to develop a hydrogen market, but if COP26 is to mark a new page for both the UK economy and the global climate challenge, the launch of such a policy is precisely what to expect.

Power play: the core of OPEC+
“Now we have a chance not just to produce and sell as much as we need to, but to throw American shale overboard. Our budget is much more stable than Saudi Arabia, and is ready for low oil prices, unlike the Kingdom’s.” Dmitry Kiselyov, Head of Russian State Media, February 2020

Russia and Saudi Arabia are the two countries with the most at stake in the global crude markets. True, the United States has produced more barrels of crude for much of the last decade – driven by the shale boom – but its economy is more diversified and better able to resist the volatility seen in crude prices in recent years. This logic is not new – it underlined the 2016 agreement for Moscow to effectively join the Saudi-led cartel, the Organisation of Petroleum Exporting Countries (OPEC), in a structure known as OPEC+. The partnership undergoes regular spats, and there were genuine concerns it would rupture until the COVID-19 pandemic again put oil prices in a tailspin at the start of 2020.

As the pandemic appears to be receding in the face of the global vaccination programme, however, the chafing is very much back. When OPEC+ agreed its latest continued cuts at the beginning of March, Russia received a small increase to its output limit, some 130,000 barrels per day (bpd). The partnership is not necessarily set for immediate rupture: Russian oil officials have quietly said they will be willing to extend cuts further, if another small increase in Russian production is allowed.

But the release of a report on the country’s oil industry from the Russian Ministry of Energy (MinEnergo) this month highlights that it is not long for this world.

Put simply, Russia has had too little investment in new oil production over the last decade. Its efforts to expand into deep-offshore and shale drilling have been stymied by US sanctions imposed on such activity since 2014. While state oil company Rosneft has grown into one of the world’s largest producers (second on a bpd-basis behind Saudi Aramco), this has largely been through consolidation of the domestic Russian oil industry’s existing ‘brownfield’ sites rather than development of new ‘greenfield’ oil resources.

The MinEnergo report notes that Russian oil production is currently set to peak in 2027-2029, and rapidly decrease from there on. While the OPEC+ deal continues for now, Moscow will be looking to Saudi Arabia’s own wind-down of its further voluntary cuts, which will see 1 million bpd come back online by July. Russia is therefore unlikely to be able to fight for market share in the short term, let alone the medium and long-term. On the other hand, the importance of the fight for oil market share is growing to the Saudi leadership, as a possible lever to respond to the Biden Administration’s calls for human rights reforms.

OPEC+ is not necessarily set for an immediate end – it may stumble on to deal with the pandemic a while yet. But Moscow and Riyadh are ultimately likely to again compete for market share, a move that could effectively constrain oil prices over the long term.

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