One of the questions we are most frequently asked by investors is – how can we tell if a company is “Paris compliant”? This deceptively simple term touches on a number of complexities and is an interesting lens through which to look at the evolving positioning of the oil and gas industry.

Starting points

If one is to assess if a company is compliant, it is of course necessary to define the meaning of “compliance.” There is no agreed or even commonly used definition of compliance with climate goals at the company level that we are aware of.

However, we would assert that compliance can only be judged on a forward-looking basis and using a reasonable timescale. A company could not be called “compliant” based purely on its current or historic production, as this does not (in itself) tell us anything about what the company has planned for the future. Similarly, reserves estimates alone provide no indication of when they will be produced or how they are being replaced, so cannot give an indication of alignment. Aggregate reserves estimates for the three fossil fuels together (oil, gas and coal) show that there are already far more than can be burned while succeeding in international climate goals, but each company’s reserves are only a small fraction of a total global carbon budget.

We would make three guiding observations on the nature of the energy transition.  Firstly, limiting future temperature rises to “well below 2ºC” as per the Paris Agreement will entail the use of materially less fossil fuels than we consume at present.  Secondly, as to oil and gas, most scenarios assume slower declines in demand for oil and gas than natural production declines from existing fields – implying that some new supply sources will be developed to meet even falling demand, but not all of them. Thirdly, although there are various projections, the actual future pathways of demand and prices are, of course, unknown.

Resilience or compliance?

Given this uncertainty, the lucrative nature of the status quo and that most oil and gas companies do not anticipate global success in achieving climate targets as their base case, the default option to date for most of the industry has been to publicly position itself as resilient. In other words, expecting to sell a lot of oil and gas in the future, but as not being heavily affected even if demand/pricing does fall. Companies can attempt to make themselves as resilient as possible by lowering their leverage – both operational (by pursuing low cost supply) and financial (by having low debt service costs).

This positions the companies as neutral takers of demand trends – they will supply as much oil/gas as they can in any given scenario, but still remain reliant on receiving price signals to determine their sanction activity and therefore running the risk of investing in stranded assets.

Can a company that is willing to invest in production that would take emissions beyond low-carbon pathways be called Paris compliant? We don’t think so. In reality, seeking to improve margins and lower volatility is simply a continuation of business as usual.

Fossil fuel portfolio remains the question even in diversified companies

Moving beyond this, we can look to those companies that are looking to be part of the low-carbon energy mix – particularly as demonstrated by the larger European players. Total, for example, already has a major solar business; Statoil has a major offshore-wind arm. This has the effect of lowering transition risk at the company level, by lowering the proportion of value that comes from fossil-fuel sources. A company can take the alternative route of returning cash to shareholders, allowing them to make the diversification at the investor portfolio level.

But does a relative reduction in fossil-fuel revenues signal Paris alignment? This is partly a question of scale, and partly a question of the remaining fossil-fuel portfolio. As an example, if a company has a renewables business but still seeks growth from high-cost oil & gas assets it could not be said to be Paris compliant; at the other end a company that has left the fossil-fuel industry entirely must be said to be aligned with the aims of Paris. For example DONG, now renamed Orsted, has entirely sold it’s oil & gas portfolio and although the company retains some coal, it will be phased out within 5 years. So, having a renewables segment is not the answer in itself, and we must dig deeper into the potential profile of the remaining fossil-fuel segments.

Transition targets – the devil is in the detail

In a relatively recent development, some companies have sought to link their portfolios to the decarbonising economy by formalising the use of targets in their future production mix, for example Total, Shell and Repsol. So far, the favoured approach has been to set targets in terms of carbon intensity per unit of energy produced, which can be met through a variety of means – lowering flaring, increasing renewable-energy output, shifting from oil to gas, and most likely all of the above. But, by setting a relative intensity target rather than an absolute production target and not linking it explicitly to production costs or a carbon budget, the companies leave themselves room to continue growing oil and gas production and therefore leave open the possibility of overinvestment in high-cost projects. This doesn’t mean that the companies definitely aren’t Paris compliant, but it does mean that they can’t be called that on intensity targets alone.

Prior to the announcement of Repsol’s business-plan update, media reports suggested that they would limit themselves to a fixed reserve life of 8 years[1]. This approach did not make it into the public announcement of the final plan. Even so, despite sounding firm, by allowing rolling continuation of production and exploration without limits on cost, even this approach would not have ensured compliance in itself. It may have signalled a deprioritising of fossil-fuel growth, but even so would have allowed company production and reserves to grow as long as they did so in proportion to each other (reserves life = reserves divided by current production).

So how can a company ensure Paris compliance?

Carbon Tracker has always looked at this question through the lens of production cost. If demand is limited, the most competitive supply will fill it. Therefore a “compliant” company would commit to only sanctioning projects that are sufficiently low cost to fit within a given low carbon budget, announce its intention to do so, and demonstrate this in action. Any excess cash can be returned to shareholders or redeployed into other sectors as the company sees fit. We note that Shell has previously announced that it would only invest in projects that are “climate-competitive” and referenced “compatibility with 2 degrees C roadmap”[2]; this is suggestive of thinking along similar lines, and we would welcome Shell providing further detail about what constitutes a climate-competitive investment and showing how they would implement this aspect. The first company to firmly take this path will set an important precedent.

A justifiable criticism of this approach is the risk of all companies having the false belief that their projects fit within climate constraint, when this cannot be true. Carbon Tracker tries to help resolve this by comparing all global projects to carbon budgets and publishing their distribution between different companies on an equivalent basis, for example as in our “2 Degrees of Separation” reports, of which we have just produced an update.

Unsanctioned high-cost projects cannot be compliant if intended to be sanctioned – IEA NPS as the expected planning baseline

Lastly, we highlight that we are talking chiefly about future projects. Being unsanctioned with less in the way of sunk costs, they are both less likely to fit in the carbon budget and easier for companies to “cancel”. But, being unsanctioned, a company can always argue that they may never be sanctioned. A company is free to stop developing new sources at any point, and if they do so then production will tail off at a lower rate than required to meet 2ºC or even 1.75ºC pathways (those based on a 50% likelihood of success at least). There is also the related argument that proven reserve lives are comparatively short – often in the range of  8-14 years for a private company – implying that companies will be able to “see it coming” and stop developing new reserves ahead of time.

Our answer to this is to refer to the demand expectations of industry. Where companies refer to a demand assumption that they use in their planning, they are generally of a similar order to the International Energy Agency’s New Policies Scenario (NPS) – its central scenario that assumes an evens chance of limiting temperature outcomes to 2.7ºC.

We therefore think it is reasonable to assume that, if the industry is anticipating New Policies levels of demand, the intent or expectation to develop the additional projects above 1.75ºC or 2ºC which would be required by the NPS can be imputed. We therefore believe that investors concerned about the climate and/or transition risks can feel entitled to legitimately challenge such projects, to the extent that a given company might have them in its portfolio.

Carbon Tracker’s recent 2 Degrees of Separation – a way of judging long-term compliance with the Paris Agreement

This is the thinking behind Carbon Tracker’s recent 2 Degrees of Separation update and the Mind the Gap report, which focus on the projects in the increment from lower demand scenarios up to NPS – in other words, projects that don’t fit in a climate-secure budget but which the industry must be expecting to go forward to fulfil its own (higher) demand expectations, and hence which are particularly vulnerable to a misread of demand.


Dialogue between investors and oil-and-gas industry companies will be important as we adapt towards the energy transition. The “comply or explain” principle is common in the field of corporate disclosure. We believe that companies that wish to show their alignment with the international community’s intent to limit climate change must “explain to comply” – detail to shareholders how they will deviate from industry norms to prevent investment in projects that don’t fit within a carbon budget, and how their business plans ensure this in practical terms.

Andrew Grant – Senior Analyst

[1] See for example Bloomberg, “Repsol to End Pursuit of Oil Growth”, May 2018

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[2] See Shell, 2017 Management Day transcript, November 2017

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