A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS: A Guide for Oil and Gas Companies and Investors for Navigating the Energy Transition - Ceres
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A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS: A Guide for Oil and Gas Companies and Investors for Navigating the Energy Transition
ABOUT CERES Ceres is a non-profit organization that is mobilizing many of the world’s largest companies and investors to take stronger action on climate change, water scarcity and other global sustainability challenges. Ceres directs the Investor Network on Climate Risk, a group of 124 institutional investors managing $15 trillion in assets focused on the business risks and opportunities of climate change and water scarcity. Ceres also engages with 100-plus companies, many of them Fortune 500 businesses, committed to sustainable business practices and the urgency for strong climate and clean energy policies. For more information, visit www.ceres.org or follow on Twitter@CeresNews. ABOUT AMY MYERS JAFFE Amy Myers Jaffe is a leading expert on global energy policy, geopolitical risk, and energy and sustainability. Jaffe serves as executive director for Energy and Sustainability at University of California, Davis, and as senior advisor, energy and sustainability to the Office of the Chief Investment Officer of the Regents, University of California. She is associate editor (North America) for the academic journal Energy Strategy Reviews and serves on the editorial board of the Journal of Economics and Energy and Environmental Policy. Jaffe’s research focuses on sustainable investment, corporate investment strategies in the energy sector, and oil and gas geopolitics. Jaffe is also a global fellow at the Woodrow Wilson International Center for Scholars in Washington D.C. ABOUT CERES’ CARBON ASSET RISK (CAR) INITIATIVE Persistently low oil prices, the success of the Paris Agreement, and the rapid evolution of clean energy technologies have combined to present the oil and gas industry with a significant risk to its business model. Ceres’ Carbon Asset Risk Initiative (CAR) aims to improve long-term shareholder value by encouraging fossil fuel companies to adapt their strategies to take carbon risk into account. Learn more by visiting www.ceres.org/carbonassetrisk or by contacting Shanna Cleveland at cleveland@ceres.org. Graphic design by Sarah Mahoney. © Ceres 2016
TABLE OF CONTENTS
EXECUTIVE SUMMARY.. ................................................................................................... 3
INTRODUCTION.............................................................................................................. 6
WHY SCENARIO PLANNING IS ESSENTIAL FOR EXAMINING CLIMATE RISKS............................ 9
A PRIMER ON SETTING UP A SCENARIOS ANALYSIS EXERCISE............................................. 13
THE SCENARIO CREATION PROCESS................................................................................. 15
Basic Components of a Scenario Exercise Process.. ................................................................................ 15
Establishing a Base Framework for 2 Degrees C Scenarios.. .................................................................... 17
The Elements of a Best Practice 2 Degrees C Scenario .. ......................................................................... 18
Understanding the International Energy Agency (IEA) Reference Case .................................................... 18
Conceptualizing Abatement Opportunities, by Category of Emissions Reduction Strategy ......................... 19
Consideration of Emissions and Abatement Potential, by Sector.. ............................................................ 22
UTILIZING KEY 2 DEGREES C SCENARIO INDICATORS AS GUIDEPOSTS IN
CORPORATE PLANNING . . .............................................................................................. 23
Case Study: ConocoPhillips …………................................................................................................. 26
CLIMATE RISK DISCLOSURE CONTEXT AND BEST PRACTICES.. ............................................. 28
COMPANY CLIMATE CHANGE READINESS: WHAT ARE INVESTORS LOOKING FOR?................. 31
APPENDIX: SEC CLIMATE DISCLOSURES OF MAJOR OIL & GAS COMPANIES.......................... 34
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 1
2 | WWW.CERES.ORG
EXECUTIVE SUMMARY
For decades, investors have been engaging with fossil fuel companies around the risks and
opportunities associated with climate change. These investor-led initiatives have ranged from
efforts to increase company investment in renewable energy to improving operational efficiency to
addressing methane emissions and beyond.
However, for much of that time, companies to include policymakers, analysts, and other
largely dismissed investor concerns about market actors. The goal of this initiative has
the potential for dramatic shifts in business- been to ensure that the fossil fuel industry,
as-usual market dynamics due to global in which these investors hold major stakes, is
action on climate change. Fossil fuel prepared for the transition to a low-carbon
companies expressed skepticism about global economy.
the need to factor in the possibility of a
Key among the steps that investors called
broad, global set of initiatives that would
for is an assessment of the impacts on a
lead to meaningful policy intervention on
company’s portfolio and business strategy
climate change. Nearly without exception,
of policies and restrictions consistent with
the world’s leading oil and gas companies
achieving the globally agreed upon target
have based long term business planning
to limit global average temperature rise to
on a business-as-usual, rising oil demand
no more than 2 degrees Celsius above pre-
outlook. Given that the industry regularly
industrial levels. This request achieved new
invests in projects with multi-decadal time
urgency when the 21st Conference of the
horizons, the decisions companies make
Parties to the United Nations Framework
today will help determine their financial
Convention on Climate Change achieved
viability far into the future. Widespread
unanimous agreement and outlined a
assumptions that the future would resemble
clear path to achieve this target in Paris
the past created a false sense of certainty
in December 2015. On the corporate level,
and optimism regarding technology and
pressed by shareholders and governments,
climate risk, leading, in cases, to inefficient
a group of European and international
deployment of capital.
companies has formed the Oil and Gas
In 2013, a global coalition of investors Climate Initiative (OGCI) to “catalyze
representing $3.5 trillion in assets raised collective action by those most committed
the stakes. Convinced of the growing global to climate change action and to advance
consensus for action on climate change and technological solutions through collaborative
informed by the work of academics and programs.” The group’s priorities include
analysts, these investors joined with Ceres, creating a shared roadmap for reducing
the Institutional Investors Group on Climate emissions in line with a 2 degrees C target,
Change and the Carbon Tracker Initiative including controls on methane leakage from
to outline the concept of “Carbon Asset oil and gas production, and conducting
Risk” and set forth steps that fossil fuel research and development (R&D) on carbon
companies should take to assess, disclose capture, use and storage. The group recently
and mitigate vulnerabilities. Investors initially announced a commitment to create a ~$1B
sent letters to 45 of the world’s largest fossil joint fund for R&D on carbon capture and
fuel companies and have since broadened storage and energy efficiency.
and deepened their engagements with
companies and expanded their dialogues
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 3
In 2015, buoyed by the success of
shareholder resolutions in Europe that
included, among other things, a request for
scenario analysis consistent with achieving
2 degrees, investors formed a transatlantic
partnership to file 2 degree scenario
resolutions at nine U.S. companies including
ExxonMobil, Chevron, Occidental Petroleum,
Devon Energy, Anadarko, Noble Energy, First
Energy, AES, and Southern. While climate
risk shareholder resolutions generally
averaged 20% support in the U.S., this set
of resolutions achieved an average of 38%
with high votes of 49% at Occidental and
42% at Anadarko and AES. Investors with
over $10 trillion in assets under management
publicly declared their support for the
resolution at ExxonMobil leading to the
highest shareholder support for a climate
risk resolution ever achieved there, 38%.
Although the fossil fuel industry is familiar
with forecasting and scenario analysis,
many companies have voiced uncertainty
over how to approach conducting a 2
degrees scenario analysis. Investors have
also identified a need for clear guidance
that will assist them in assessing which
of their portfolio companies are taking
this key strategic challenge seriously. This
paper proposes the basis for 2 Degrees
Scenario Analysis, the Key Components for
a 2 Degrees Scenario Analysis Framework,
examples of best practices to date, the
basics for meaningful climate disclosures,
and key questions for investors to ask when
engaging with companies on the analysis.
The heart of this work begins with the Key
Components For a 2 Degrees Framework,
set forth on the next page.
4 | WWW.CERES.ORGKEY COMPONENTS FOR A 2 DEGREES FRAMEWORK
A meaningful 2 degrees scenario analysis will contain five key components as
represented below:
1. ESTABLISH CLEAR PARAMETERS
Time scale
Scope
Drivers/Influences
2. ALIGN WITH 2 DEGREES
Compare CO2 levels under reference case to CO2 levels required for 2 degrees
Evaluate and explain abatement options chosen as compared with IEA 2
degrees or other 2 degrees reference scenarios
Discuss how abatement options compare with current trends and how
technology or policy could impact them
3. ASSESS THE IMPACTS
Quantify range of impacts each scenario has on existing classes of assets and
planned capital expenditures
Identify key factors that contribute to risk
4. INTEGRATE INTO CAPITAL AND STRATEGIC PLANNING
Test against company reference scenarios
Create key indicator roadmap
Develop strategies to increase portfolio resilience (e.g. ConocoPhillips, Total)
Involve broad, cross-functional teams & engage with board
Monitor (quarterly) and update
5. DISCLOSE & ENGAGE
Disclose methodology and results of scenario analyses
Identify material risks and disclose in financial statements
Engage with investors to explain risks compared to peers & other sectors
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 5INTRODUCTION
Policy makers, investors and scientists gathered in Paris in
December 2015 concluded that new efforts were needed if
the planet is to avoid catastrophic climate change driven by
the accumulation of greenhouse gases in the atmosphere.
Over 184 countries submitted commitments to reduce their
greenhouse gas emissions during the climate talks with
195 countries agreeing on a goal to limit the rise in global
temperatures to well below 2 degrees Celsius and to pursue
an even more ambitious target of 1.5 degrees Celsius. In
November 2016 the Paris Agreement entered into force and
The Paris Agreement its goal of keeping global temperature rise well below 2
goal of keeping global degrees Celsius is already shaping national policy decisions,
with major economies such as the United States, China and
temperature rise well Europe actively working to shift away from fossil fuels to less
below 2 degrees Celsius carbon-intensive fuel sources.
is already shaping the Many corporations around the world, including some
of the largest international oil and gas companies,
national policy decisions have not fully incorporated the adoption of a binding 2
of major economies – the degrees C climate accord into their business planning.
In some cases, executives from those companies have
world is actively working expressed a view that a 2 degrees C cap on climate
to shift away from fossil warming will not prove achievable. Yet for the past two
decades or more, energy companies have operated
fuels to less carbon- under a set of assumptions about the future business
intensive fuel sources. environment that are looking increasingly unrealistic.
Irrespective of whether governments actually achieve a 2
degrees C cap on climate warming, it cannot be ignored
that many governments are making major commitments
to the low carbon transition by tightening regulations and
performance standards designed to reduce the use of oil
and coal. But perhaps just as significantly from the point of
view of a global transition in energy usage, societal patterns
for fuel use are also changing through the advent of digital
technologies that are proving to be either energy saving or
altering choices among different fuels. Given the long capital
horizons in the oil industry, where investments made today
may not pay off for decades, it is imperative that the industry
be particularly attuned to the potential for disruptive change.
In considering how the business landscape for the energy
sector may change given these trends in the coming
decades, companies need to consider multiple variables at
once.
Uncertainties in the Outlook for Oil Demand
Typical business-as-usual forecasts for energy heavily weigh
a number of factors. Generally speaking, global economic
growth is assumed to expand by between 2 to 4% a year
6 | WWW.CERES.ORGbetween now and 2040, in line with Citibank relate that losses in global GDP
projections from the International Monetary could be even higher, at as much as 5% per
Fund (IMF). Such a forecast has embedded annum, as declines in crop yields accelerate
in it a high growth rate for the developing in Africa and sea level rise intensifies coastal
world, driven by urbanization and flooding and related damage.2 These
modernization across Africa, Latin America, forecasts highlight the internal inconsistency
ASEAN, China and India. ExxonMobil’s in forecasts that project both large increases
forecast, for example, assumes 2.8% growth in global emissions and oil use as well as
per annum in global GDP to 2040 or roughly steady economic expansion, since any failure
a tripling from 2000. The International to sufficiently curtail oil use and emissions
Energy Agency sees world GDP growth would likely be accompanied by large
averaging 3.5% a year to 2040, including economic losses attributable to climate
4.6% GDP growth in Africa and an average impacts in some geographies or key sectors,
of 4.5% for the entire developing world. It registering over time in slower global
pegs developing Asia, including China and economic growth.3
India, at 5.2% compound average annual
Beyond economic trends, there are other
growth in real GDP.
key variables in projecting fossil fuel use.
In recent years, however, unexpected Oil use forecasts exhibit a high correlation
events have greatly influenced market to changes in populations. Most forecasts
trends, adding an additional layer of assume a growth of 0.9% a year per annum
uncertainty to these business-as-usual to reach 9 billion people by 2040, related
forecasts. The collapse of China’s stock to medium variant rates projected by the
market in 2015 raised questions, for example, United Nations. Africa is expected to nearly
about expectations of continuing strong double its population over this period, with
economic expansion in China. Political other large additions coming from India,
upheavals such as Russia’s invasion of Southeast Asia and the Middle East. But
Crimea and the UK vote to exit the European climate change, rising concerns about food
Union (Brexit) has also cast a cloud over security and massive migrations from war
the economic outlook for both Europe and torn, weather-afflicted or disease-ravaged
countries highly dependent on exports regions in the Middle East, Africa and Latin
to the EU such as China and Brazil. Mass and Central America may complicate the
migration will also impact economic trends future landscape for demographic trends.
as will major natural disasters such as the
Finally, another highly influential element
tsunami and related Fukushima nuclear
to oil demand forecasting is the set of
accident in Japan. It is hard to capture
assumptions related to the impact of wealth
these black swan events in long-term
effects on vehicle ownership and use. To
forecasting but their impact can be highly
the extent that forecasts project too high or
material in economic outcomes. A 20%
too low a correlation between GDP growth
lower GDP outcome by 2050, for example,
and car use, forecasts for oil demand can
would translate into over 10% lower global
become unduly skewed.
oil use number over the forecast period.
In addition, some important organizations A study by University of California Davis
such as the World Bank have highlighted found that one of the most sensitive
the macroeconomic risks posed by climate elements influencing oil demand forecasting
change. OECD estimates for global GDP
losses range from 0.7% to 2.5% per annum 2 Citi, Energy Darwinism II: Why a Low Carbon Future Doesn’t Have to Cost the Earth, 33
(August 2015).
to 2060.1 Other organizations such as 3 Notably, despite the clear negative economic impacts that accompany higher levels
of global average temperature rise, only Statoil, among its oil peers forecasting GDP and
oil use, has attempted to account for this impact on GDP forecasts in its current scenario
1 Dellink, R., Lanzi, E., Chateau, J., Bosello, F., Parrado, R., and de bruin K. (2014). analysis. As Statoil explained, “To underline and illustrate the gradual negative economic
“Consequences of Climate Change Damages for Economic Growth: A Dynamic Quantitative impact as a result of increasing climate costs, we assume that GDP growth declines
Assessment,” OECD Economics Working Papers, No. 1135, OECD publishing. towards 2040.” Statoil, Energy Perspectives, 8 (June 2015).
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 7Figure 1: Simulated Impact of percentage change in Vehicle Miles Traveled on global oil demand by 2050.
Source: University of California, Davis.
100
30% Higher VMT
90
80
70
60 50% Lower VMT
50
Baseline
40
30
20
10
0
0 5 0 5 0 5 0 5 0 5 0
200 200 201 201 202 202 203 203 204 204 205
outcomes is the uncertainty surrounding sizable impacts on oil prices, for example,
vehicle adoption rates. In the developing as was seen during the Asian financial
world, adjusting vehicle adoption rates and crisis in 1998, after the September 11
urban saturation levels by 25% dropped terrorist attacks in 2001, and again in
final oil demand by 13%, according to UC the aftermath of the global banking
Davis’ global transportation oil modeling. UC crisis in 2008. Moreover, unrecognized
Davis also tested the sensitivity of changes uncertainties can lead to misallocation
in expected rates of miles traveled by of capital, as seen in recent years with
vehicles by the International Energy Agency billion dollar write-downs in Alaska, the
New Policies reference case and found Russian Arctic, the Caspian Sea region and
that a large increase or decrease in just the Saudi natural gas initiative. Current
this one variable could impact oil demand low oil and gas prices have spurred
projections by millions of barrels a day in bankruptcies in the Canadian oil sands and
either direction (see Figure 1). curtailed expected returns in many global
Given the range of uncertainties liquefied natural gas mega-projects in
surrounding these kinds of factors, Australia and elsewhere. Such write-downs
are prompting institutional investors to
companies can benefit from considering
question managements’ abilities to assess
multiple variables at once, to fashion
uncertainties adequately using traditional
strategies that will be resilient in all
methodologies.
possible cases. Unexpected, sudden
changes in oil demand levels can have
8 | WWW.CERES.ORGWHY SCENARIO strategy that meets a particular contingency
or set of contingencies. It is to develop a
PLANNING IS ESSENTIAL base strategy that will be successful under
many sets of possible market conditions.4
FOR EXAMINING CLIMATE Scenario planning helps companies
monitor events as they unfold to test the
RISKS effectiveness of the company’s ongoing
Scenario planning is a disciplined strategy and to allow the company to be
method of imagining possible future prepared to change course if necessary.
environments that companies might face Scenario analysis differs from sensitivity
over a set time period. It allows corporate analysis because it does not examine in
executives to explore and plan for isolation how changing one major variable
more than one possible future. It allows or influence would impact the economic
companies to examine what outcomes outcomes of a strategy or project. Sensitivity
they can expect under a wider range analysis is often used to test whether a
of economic, regulatory and societal capital investment in a particular project
conditions under varying operating or a range of projects will continue to be
strategies. Scenario planning is used in profitable if one variable were to change. So,
the oil industry as a process to identify and for example, oil companies use sensitivity
evaluate issues that need to be addressed analysis to test capital investment under
as part of the strategic planning process. conditions where commodity price levels
Scenario planning differs from other kinds over the life of the project might deviate
of planning methods such as contingency from the business-as-usual forecast for
planning, sensitivity analysis, and decision that commodity price. Sensitivity analysis
under uncertainty analysis by its ability to might also be applicable to test whether
integrate a wider number of uncertainties a business strategy or capital investment
into one more simplified methodology that would make sense if a new tax, for instance,
allows relationships between many elements a price on carbon, were to be instituted over
to be explored more systematically. It is a time frame under study for the strategy or
uniquely suited to the task of assisting investment.
companies in preparing for a variety of
lower-carbon futures. Scenario analysis also differs from
decision making under uncertainty
Scenario analysis differs from modeling, in which a structured set of
contingency planning which creates probabilities of outcomes are quantified and
alternative actions to use in response examined with a formal mathematical model.
to one factor that may be of high Uncertainty modeling provides a statistical
concern. In contingency planning, parties framework to measure how likely uncertainty
consider their base case projection and about a certain variable or set of variables
consider how to manage an exception or is to influence outcomes. The models can
contingency that might arise in that base incorporate the range of probabilities that
case. Contingency planning allows firms some conditions may exist or occur and
to assess the impact of sudden market express uncertainty as a range of values
changes or disruptions. By contrast, scenario that can be used in a computer simulation
analysis explores alternative futures that (often a Monte Carlo methodology). Also
are comprised of many uncertainties that measured is a risk tolerance threshold value
are considered simultaneously, and jointly for decision making and the value of new
as a comprehensive whole, as compared information to the decision-making process,
with similar variables organized around e. g. all information is not equal when
the business-as-usual worldview. The goal
in scenario analysis is not to develop a 4 Recent shareholder resolutions have referred to this concept as “portfolio resilience.”
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 9making decisions and considered also in light of flexibility
of decision making. Value of additional information depends
on the level of uncertainty and the payoffs for the venture.
Decision under uncertainty modeling is an effective tool in
geological assessment.
Scenario analysis allows practitioners to capture
new states of reality that might result from wider
changes such as major events or shocks, technology
breakthroughs, or political upsets or changes in societal
values. In scenario analysis, variables do not need to remain
constant per se and there is no limit to the number of
Scenario planning variables that can be altered. An entire range of possible
differs from other kinds combinations of factors can be captured and considered
simultaneously and compared to a business-as-usual
of planning methods reference case. In this way, scenario analysis provides a
better tool to avoid tunnel vision or groupthink. It is a good
such as contingency
alternative for strategic planning in industries that are subject
planning, sensitivity to great uncertainties and possible disruptive technology
but might tend toward excessive optimism in forecasting
analysis, and decision the future by simply casting the past forward as a trend line.
under uncertainty This pattern of analysis is endemic in the oil and gas industry,
which is both a cyclical industry but also one that believes
analysis by its ability and relies upon the premise that the large scale nature
to integrate a wider of its incumbent infrastructure prevents sudden changes.
The companies’ energy planners believe the cost and scale
number of uncertainties of their asset base provides considerable momentum for
into one more simplified continuity. This may have been true at one time, but in recent
years, several disruptions have appeared on the horizon that
methodology that resulted in material impacts on the industry and its economic
performance. The highly negative consequences of the failure
allows relationships
to recognize and plan for the possibility of such disruption
between many elements have been evident in the coal industry and the electric power
sector, illuminating some of the risks to which oil and gas
to be explored more companies similarly are exposed.
systematically. Scenario analysis also helps leaders identify drivers
of change that might serve as key indicators that
strategies will have to be adjusted. This is in contrast to
general operating assumptions that change will occur only
gradually. Because oil and gas are cyclical industries, reliance
on historical data is common and has left the oil industry
vulnerable to uncertainties about the extent to which the
future may not resemble the past. Scenario analysis increases
readiness to consider a wider range of possibilities about
what the future might hold, protecting against groupthink and
promoting the challenging of conventional wisdom. Scenario
planning can help companies to challenge deeply held beliefs
and assumptions and develop a clearer view of the future
among executives and directors. It can help leadership better
understand the key levers it has to influence outcomes under
alternative futures and inform board oversight.
10 | WWW.CERES.ORGScenario analysis is a particularly fine-tuning each scenario allows management
effective approach to consider the to actively evaluate and prioritize which
business risks associated with a 2 trends will be most impactful to individual
degrees C climate accord because it business lines and to identify critical
allows for a multi-pronged consideration uncertainties that need to be addressed
of a wide range of factors that may have through resilient strategies. Scenarios can
an influence on the business environment be used to overcome overconfidence,
under a global climate accord. Some groupthink and mischaracterized optimistic
of those features would include new outlooks by forcing management to prepare
regulations, technological innovation and strategic alternatives for a wider range of
changing societal values and changing possible market conditions rather than a
priorities that lead to new patterns of singular business assessment.
behavior. Scenario analysis is most useful Scenario analysis allows companies to gather
in situations with high uncertainty that market intelligence within a structured
challenge managers’ and directors’ ability to framework that defines potential strategic
forecast the future or to effectively adjust challenges, giving the strategic planning team
strategy. This is particularly important given a stronger methodology to use in identifying
that the outlines of exactly how a 2 degrees trends and possible disruptions that may
accord might impact energy markets and affect the business overall or specific
industry are only just emerging, and much business units. Once constructed, planning
uncertainty surrounds the topic both on teams can look at how organizational,
a global scale and on a regional as well as operational and financial requirements might
national level scale. vary under different business conditions, as
MIT’s Sloan Management Review notes some imagined by different scenarios, to identify
conditions that describe what the energy actions that would strengthen the company
industry has faced in the past. In reflecting under all possible conditions that might be
upon these conditions listed below, these likely to emerge – i.e., so-called “no regrets”
organizations who have experienced them or “resilient” strategies.
would gain the most from scenario planning: McKinsey & Company notes in its assessment
• Too many costly surprises have of the benefits of scenario analysis that teams
occurred in the past must be vigilant to avoid “availability bias,”
that is, the tendency to make decisions based
• The industry has experienced on information that is already known or most
significant change or is about to easily gathered. Proper scenarios analysis
goes beyond national markets to regional
• There are strong differences of
and global trends and encourages the
opinion, with multiple opinions having
inclusion of a broader range of information
merit
than might otherwise have been gathered
• Competitors are using scenario by individual business units. Scenarios can
analysis 5 allow for integration of economic trends with
technological developments, demographic
Well executed scenario planning can help and cultural shifts and possible geopolitical
a company review the widest possible developments. Using a scenario analysis
range of trends that are likely to affect the format also forces management to consider
company’s business by more systematically futures that won’t mirror the past, thereby
allowing management and directors to overcoming stability biases. It can also guard
identify interconnections between emerging against underestimation of the chances of
developments and markets. The process of failures.
5 Scenario Planning, A tool for strategic thinking, MIT Sloan Management Review, January
15, 1995, Paul J.H. Schoemaker.
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 11Figure 2: Old v. New Forces Impacting Long Term Oil Demand
(adapted from IEA 450 Scenario and New Policies Scenario data)
~ 103.5 MB/D
NEW FORCES IEA New Policies Scenario
120
Technology
Growth of Alternative Energy
~ 90 MB/D
Current Demand Millennials Reject Vehicle Ownership
110
Legislative + Tax Policy
Energy Efficiency
(energy per GDP declining)
100
~ 74 MB/D
IEA 450 Scenario
90
80 Population Growth
Expanding Global Middle Class
Emerging Economy Expansion
70
OLD FORCES
60
Many energy companies “stress test” project in the banking system in the aftermath of the
capital investment decision making against 2008 financial crisis.6 In the case of climate risks,
defined risks such as oil price volatility or companies are not treating the current levels of
a range of carbon prices, in many cases policy and regulatory action being undertaken
currently between $60 a ton and $80 a ton, as a result of the Paris Agreement or the
to ensure that the internal rate of return for accompanying low carbon technologies that are
each project receiving approval is sufficiently coming to market as tail risks that are unlikely
robust under different potential market to occur. Rather, companies are trying to craft
conditions. Companies might also consider corporate strategies that will be most successful
how to hedge against low probability tail and resilient under the widest range of possible
risks and take specific actions designed to business environments.
limit exposure to such risks. This kind of
“stress testing” differs in context from the
kind of “stress testing” often referred to 6 In the U.S. context, “stress tests” are developed by the Federal Reserve pursuant to the Dodd
Frank Act and accompanying regulations and may be modified each year.
12 | WWW.CERES.ORGA PRIMER ON SETTING geographic region should include all areas
where the company operates, produces,
UP A SCENARIOS purchases services or goods, sells its
products or may be subject to costs or
ANALYSIS EXERCISE regulations imposed by governments or
markets.
Before beginning a scenario process,
organizers must create parameters for the Drivers and Influences
exercise. In determining the parameters,
In considering the construction of scenarios,
organizers must consider the types of
participants will need to cover the drivers
uncertainties that will influence the business
and influences on their industry or question
or question to be studied. Factors such as
of inquiry. This can be done by creating a
product or infrastructure life cycles and
team either internal or external, or both,
rate of technology change are relevant, as
with expertise in relevant areas. A critical
are expected political leadership transition
question for the team to consider is: who
cycles, important events, business cycles
are the key influencers of outcomes? This
and usual planning horizons for capital
can range from customers and suppliers to
expenditure that influence the strategy
regulators, competitors, disruptive entities
development process. It is also important
and technologies, and governments. Is
to acknowledge and avoid the potential
there a role for advocacy groups or other
for groupthink at the outset by seeking to
civil society stakeholders? Will investors
consult a diverse range of expert analysis
or capital markets be influential? Are there
and by including outside experts to
other players that might bring about a
challenge ingrained assumptions.
change in an issue or the overall business
Time Scale climate such as scientists, media, or the
courts? Are there changes from other
First and foremost, a time scale needs to
industries that might alter outcomes?
be set as a parameter for the exercise.
Decisions need to be made regarding Other kinds of influences might require
whether the scenario is intended to cover expert opinion or surveys. Drawing upon
immediate business decisions or long range these types of outside opinions provides
planning. For the latter, business cycles a key reality check against internally held
and time scale for development of new views. There are fundamental factors such
technology, as well as life of capital stock, as rates of economic growth, demographic
are key considerations. For long range trends, geopolitical developments and
scenarios covering decades, it is possible to environmental factors, as well as scientific
consider multiple layers within a scenario of and technological advances such as artificial
decadal trends; thus, for example, from the intelligence, automation, 3D printing,
present to 2020, 2020 to 2030, and 2030 biotech and other health breakthroughs for
to 2040 for a study that would cover 2016- which internal experts may not have the
2040. fullest access to competitive information.
A good scenario exercise will identify the
Scope inter-connections between such factors
Another parameter that needs to be set and possible outcomes that might emerge
in advance of creating scenarios is the from combinations of trends shifting in one
scope for analysis. This can entail defining direction or another. Scenario construction
the geographic region and other variables might revolve around a combination of these
related to the competitive outlook to be drivers and influences, contrasting a positive
considered, such as certain technologies, scenario and a negative scenario or focusing
sectors, products or markets. The around high or low continuity or level of
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 13change or turmoil. Comparing scenarios Importantly, the time frame for events
with alternative outcomes for one or two and technologies needs to be realistic.
factors that are highly uncertain but also How long would it take to deploy a new
very material is another organizing structure product? What conditions would be needed
to create scenario comparisons. for it to happen quickly or slowly? How
do current company forecasts compare to
Once established, scenarios must be
current and projected rates of growth and
examined for consistency and plausibility.
market penetration for various emerging
Does the scenario include sensible
technologies? Such themes need to be
motivations and reactions for major players?
tested by a critical process that reviews
Could the pairing of various outcomes inside
conclusions and vets them based on latest
a scenario happen in the way contemplated
knowledge.
– e.g. Do drivers follow the fundamentals of
economics? Are there any trends that are
mutually exclusive? Would political actors
remain in power if they took that action?
14 | WWW.CERES.ORGTHE SCENARIO BASIC COMPONENTS OF A SCENARIO EXERCISE PROCESS
CREATION A scenario exercise can be structured around four main
sections: starting point and global overview; deep dives
PROCESS for key issues; challenges to paradigms; and syndicate
work to frame scenario storylines. The exercise begins with
The process for developing
either one or several presentations providing an overview
scenarios can vary from
of the prevailing outlook on the current and future
group to group, but many
business environment by external expert(s) or planning
planning organizations
professional(s), such as the company’s chief economist.
prepare a workshop or
The purpose of this part of the exercise is to set up the
war game framework for
boundary conditions for the reference scenario, its time
scenario construction
scale and its key drivers.
to elicit a wide range of
inputs and perspectives. These stage-setting overview presentations are
Others use informal polling followed by a provocation-response-discussion format
instruments such as that stimulates consideration of alternative views or
electronic surveys to elicit consideration of factors of what might go terribly wrong
external expert testimony with the mainstream view, or at least how it might happen
on the probabilities of a alternatively. The provocations should be structured to
wide variety of factors that consider key uncertainties, issues and challenges to the
might be influential to the paradigm, including alternative views on stakeholder
question to be studied motivations; political, regulatory and/or legislative trends;
using scenario analysis. and technology influences.
A combination of both
approaches is also possible. The format of each provocation is a short (e.g., 15 minute)
primer by a relevant topical expert or executive who
is asked to present five provocative statements he or
she might have on key issues and dilemmas related to
the overviews that have been presented and how these
alternative issues might be solved. These five key high
priority issues can be technical, economic, geopolitical,
environmental, geophysical/geographic, political,
social, historical, cultural, etc. The presenter should
consider what are the enablers and blockers of these
issues and dilemmas and what are the key stakeholder
involvements. The goal of the presentation is not to be
“right” but to be provocative to stimulate debate. This
“provocation” presentation is followed by a brief (e.g.,
10 minute) reflection/response by two discussants who
each provide comment or critique on two or three top
issues they believe are most relevant from the provocative
presentation. This is followed by a somewhat longer (e.g.,
30 to 45 minute) discussion among the whole group. Key
observations throughout these sessions are recorded
as single points by a rapporteur on post-it squares
(hexagons) that can be compiled flexibly in multiple ways
on white boards.
The next part of the exercise is to build a critical map
where the hexagons are grouped on a white board by
theme/related dilemmas and solutions and possibly
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 15over a distinct timeline (such as decadal, for e.g. high technological change, a globalized
example). The scenarios leader can circle economy and strict regulation versus low
the groupings of hexagons along a theme technological change, high regional barriers
and related dilemmas, stakeholders, issues and loose regulation. The Uncertainty-Impact
and solutions, and name the theme for the matrix facilitates the delineation of multiple
group to view. So, for example, if there were archetypal scenario outlines by creating four
multiple hexagons about issues related to how quadrants (see diagram page 18).
smartphone users might be doing something
Participants can then be divided into four
in a different way – say, travel, purchasing,
groups (called syndicates, under the Shell
banking and communications – the theme to
system, for example), each one assigned
be categorized and circled on the white board
to a specific archetypal quadrant. The
might be digital developments and trends.
groups/syndicates then gather separately
Once the scenarios leader has organized the for a discussion of the main themes, inter-
various themes on the white board, the next connections and timelines along the
step is for this leader to establish “connectors” archetypal quadrant to which they are
by drawing arrows between one theme and assigned. Then each individual syndicate/
another if such conceptual connections group sketches a storyline/scenario that
make sense. For example, if one theme was is consistent with their quadrant (say,
about new regulations on energy efficiency low economic growth/low technology
and another was about energy technology development for one quadrant versus
innovation, an arrow might be drawn from high economic growth/high technology
regulations to technologies or between the development for a second quadrant versus
themes of government-led economic stimulus high economic growth but low technology
and economic growth. Issues/themes that have development, and so on). Syndicates can
no logical connections can be placed in the refer to the critical map for inputs and add
corner of the whiteboard for consideration. new inputs as needed. Storylines should
include what developments will happen
Once the critical map is constructed, it can be
within defined timeframes and why, for
presented to the group by telling the ideas or
example, in the 2020s, the 2030s and 2040s.
“story” laid out on the whiteboard. The verbal
They can be drafted into power point slides
relaying of the critical map does not need to
or written on flip charts. Once the scenarios
be a linear story or scenario itself but rather
are developed and recorded, the larger group
it can be simply a description of the themes
should be reconvened for discussion. Each
with their associated dilemmas and how they
group/syndicate should appoint a leader to
lead to different pathways involving other
present that scenario to the larger group.
inter-connected issues. The presentation of the
General discussion of each scenario can
critical map process should include discussion
follow if time is available.
of missing points or remaining questions about
the items encompassed on the critical map. It is possible to utilize the workshop
framework to construct scenarios just among
At this point, the group will construct (or the
a small set of executives from the strategic
leader can recommend) an Uncertainty-Impact
planning department, either with or without
matrix. For best practice, we recommend a
polling input from external experts. One
matrix with two fundamental uncertainties,
major oil company, for example, surveys
e.g. for example, high economic growth versus
a wide set of oil and geopolitical experts
low economic growth as one axis. Other
from academia, consultancies and financial
axis options would be high technological
institutions to collect data to use as inputs
change versus low technological change,
during their strategic planning teams’ internal
or a world of globalized cooperation and
construction of scenarios. Companies can
relatively free trade versus a world with
also utilize data and input from individual
strong regionalization with barriers and
internal business units in the same manner.
turmoil. A larger number of fundamental
uncertainties can be combined, if desired,
16 | WWW.CERES.ORGFigure 3: Use of an Uncertainty-Impact Matrix to outline possible scenarios based on rate of technological
innovation and degree of regulation stringency
Stringent Regulation
Technological Innovation
Current Policies,
Extensive Technological toward 2° Scenario,
Breakthroughs Extensive Technological
Breakthroughs
Regulation Stringency
Stringent Regulation
Current Policies,
toward 2° Scenario,
Limited Technological
Limited Technological
Breakthroughs
Breakthroughs
ESTABLISHING A BASE FRAMEWORK FOR 2 For the purposes of this report, we suggest
DEGREES C SCENARIOS as illustration a four-quadrant matrix that
As discussed above, a good way to organize considers rate of technological innovation
scenarios is to structure them around an and degree of regulatory intervention (see
Uncertainty-Impact matrix that can facilitate Figure 3).
the delineation of multiple archetypal Thus the four quadrants can be defined as
scenario outlines by creating four quadrants.
Quadrants should be based on the major • Quadrant One: Current Policies and
outlines that an organization thinks will high innovation
influence the development of a 2 degrees
• Quadrant Two: High regulatory
C world outcome. Some choices used by
intervention and high innovation
fossil fuel companies have focused on rate
of technological innovation, degree of • Quadrant Three: Current policies and
regulatory intervention in markets, level of low innovation
international cooperation or conflict, and
• Quadrant Four: High regulatory
extent of globalization versus protectionism
intervention and low innovation
and regionalism in economic activity and
trade.
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 17The latter quadrants might seem carbon abatement opportunities in a
inconsistent with a 2 degrees C scenario systematic fashion, it is possible not only to
world but it is useful to postulate the kinds consider what would constitute a realistic
of other events that might lower emissions scenario for abatement actions to be
substantially without resort to those taken in combination with each other but
particular levers, such as a severe slowdown also to calculate the cost of carbon that
in economic activity through natural would be necessary to stimulate these
disasters or large changes in travel behavior actions. McKinsey & Company, for example,
– e.g., due to social change; external shocks published a study in 2009 called “Pathways
akin to the attacks of September 11, 2001; to a Low-Carbon Economy” that focused on
diseases that discourage travel, such as technical abatement opportunities costing
SARS or the Zika virus; or a major energy less than 60 Euros per ton of CO2 equivalent
disruption like an oil crisis. (tCO2e) of avoided emissions.
There are numerous studies that provide
THE ELEMENTS OF A BEST PRACTICE 2 background information or combinations of
DEGREES C SCENARIO policies that will be needed to achieve a 2
In constructing a 2 degrees C scenario, degrees scenario. Reviewing these reports
the first step is to determine what the can be helpful in thinking through the kinds
level of total emissions would be under of levers and influences to include in an
the reference case and compare it to the exercise that would be most useful to the
lower level of emissions that are required to planning organization.7
achieve the 2 degrees C target. In publicly presenting and publishing their
Obviously, there is more than one way to own business-as-usual forecast and 2
lower emissions to the target level but degrees scenarios, some companies have
a reasonable scenario will consider not put their own results into context by laying
only the least cost or most realistic ways out comparisons with the International
to reduce emissions but the policies and Energy Agency’s 450 ppm scenario, which
incentives that might be needed to achieve is equivalent to a 2 degrees scenario.
them. Some practitioners begin their Such comparisons are a helpful way to
exercise by considering the cheapest ways contextualize company specific views that
to lower carbon emissions, but sometimes inform investors and financial analysts about
that least cost path might not be the easiest possible influences on the future business
in political or social terms. Monitoring environment and the strategic direction of
compliance within a small, concentrated the company.
high-emitting industry, for example, might
be easier for governments than monitoring UNDERSTANDING THE INTERNATIONAL
individual household changes even if the
ENERGY AGENCY (IEA) REFERENCE CASE
latter abatements might be less costly per
Another way to think through what is
unit of carbon emitted.
required for a 2 degrees C scenario is to
There are several good sources that provide consider the business-as-usual reference
cost of abatement curves for greenhouse case and analyze which features of the
gas emissions by industry and sector or
by geographies. A good starting point for 7 World Energy Outlook 2015, International Energy Agency, Paris; Pathways to a Low-
Carbon Economy, McKinsey & Co, 2009, http://www.mckinsey.com/business-functions/
constructing a 2 degrees scenario is to sustainability-and-resource-productivity/our-insights/pathways-to-a-low-carbon-economy;
consider the broad categories covered in Stanford Energy Modeling Forum, Climate Change Control Scenarios, https://emf.stanford.
edu/projects/emf-22-climate-change-control-scenarios; Statoil, Renewal scenario, http://
these studies and develop one’s own opinion www.statoil.com/en/NewsAndMedia/News/2016/Pages/EnergyPerspectives2016.aspx;
or views of what could be accomplished in Sonia Yeh, UC Davis, https://its.ucdavis.edu/blog-post/uc-davis-climate-modeling-we-can-
cut-carbon-by-2030-in-sync-with-state-goals/.
each of them. By examining the technical
18 | WWW.CERES.ORGreference case drive the higher emissions For example, the IEA New Policies scenario
outcome of that case. By doing so, it calculates 75 million b/d of that 2040 oil
becomes clearer which drivers and demand will come from the transportation
assumptions would need to change in order sector, roughly 6 million b/d higher than
to achieve a 2 degrees scenario. ExxonMobil’s 2015 projection to 2040
in transportation related oil demand of
The International Energy Agency (IEA)
69 million b/d. ExxonMobil’s transport
publishes the most well-known and widely
demand forecast includes a projection that
cited scenarios, which include a Current
population expansion, combined with the
Policies, New Policies, and 450 parts per
rising middle class in the developing world,
million (450 ppm) scenario among others.8
will lead to a steep increase in the global
Although the IEA’s scenarios have been
vehicle fleet to 1.7 billion vehicles, up from
criticized for being too slow to recognize
825 million in 2010. Both ExxonMobil and
trends and being overly optimistic about
the IEA assume high growth in oil use from
the advancements of carbon capture and
the commercial vehicle sector, supported
sequestration, they provide a well-known
by global economic expansion, supported
reference point for review. The drivers
by rapid economic growth in China and
of emissions in the International Energy
India. ExxonMobil, for example, sees an
Agency (IEA) reference case (New Policies
added 3 million b/d of oil demand by 2040
scenario) include the projection of a
coming from the heavy trucking sector
large expansion in economic middle class
while demand for oil for aviation, marine
populations throughout the developing
and rail is projected to rise by 7 million b/d
world. Closely coupling population growth
of oil equivalent by 2040. Neither of these
with increases in oil consumption, the IEA
scenarios is compatible with achieving the
scenario posits that this expansion will drive
2 degrees target, but they provide critical
a significant increase in oil use over the next
information about how current policies and
three decades.9 As a result, the IEA projects
dynamics would need to be changed in
oil demand will rise by 14% to 103.5 million
order to reach climate targets.
b/d in 2040, up from 90.6 million b/d in
2014. Under this scenario, global greenhouse
gas emissions from energy use would total CONCEPTUALIZING ABATEMENT
37 gigatons, well above the 19 gt target OPPORTUNITIES, BY CATEGORY OF
needed to hold global temperatures to an EMISSIONS REDUCTION STRATEGY
increase of 2 degrees C. In the IEA’s New In thinking about 2 degrees C scenarios, it
Policies reference scenario, demand for all is easiest to consider what are the drivers
fossil fuels increases over the forecast period of expected emissions from the reference
but growth in coal is slow and natural gas case and how might these drivers be
makes significant gains in the world primary ameliorated either through new policies,
energy mix. These underlying assumptions improved technologies or changing
about the connection between energy patterns of use.
demand and oil demand would need to be
altered to develop a 2 degrees analysis, and To illustrate what kind of features might
many oil and gas companies have already reasonably be included in a 2 degrees C
adjusted their forecasts based on current scenario exercise, we suggest breaking
data and trends. down the range of abatement opportunities
into broad categories to gain a better
8 The 450 ppm scenario is based upon the level of CO2 in the atmosphere that would
understanding of the kind of levers that
be necessary to provide an opportunity remain within the 2 degree limit that was initially might be used in creating lower emissions
established under the Cancun Agreement.
scenarios. National carbon reduction plans
9 This scenario assumes that oil will be used to meet demand rather than lower carbon
resources and thereby accounts for significant emissions levels that are looking more typically include this same exercise.
uncertain with the adoption of the Paris accord.
A FRAMEWORK FOR 2 DEGREES SCENARIO ANALYSIS | 19Figure 4: Net emissions reductions (in million metric tons CO2e) achieved in 2020 from high abatement scenario
Source: U.S. Biennial Report, Rhodium Group estimates
Forest and
6500 Land Use
Uncertainty
6210
6000
5880 -463
5500 -105
-90
-135 5087
5000 17% Below Levels
(5265)
4500
4000
Reference CPP Other Methane HFCs High Abatement
Emissions Energy CO2 Scenario
Actions Emissions
In 2014, the Rhodium Group published an 3. Adjusting terrestrial carbon, e.g. the
outline of options for the US government status of carbon from land use change
ahead of COP 21. The diagram shows that such as reforestation/deforestation
the U.S. planned to achieve the highest and agricultural activity
level of abatement via the Clean Power
4. Behavioral or lifestyle change
Plan (CPP), which would regulate emissions
from the electric power sector, in addition
Energy and Fuel Efficiency
to promoting conservation of forestland,
There are a number of levers that exist
reducing methane emissions from the oil
to enhance energy efficiency throughout
and gas sector and regulating HFCs (see
multiple economic sectors, including the
Figure 4).
industrial sector, the transportation sector
Generally speaking, abatement opportunities and the residential-commercial sectors.
conceptually fall into four major categories: In 2015, the IEA published a “bridge”
scenario showing that improved energy
1. Energy and fuel efficiency efficiency in buildings, industrial plants,
2. Switching to alternative fuels with a and transportation could contribute 49%
lower carbon intensity of the additional GHG reductions needed
from the energy sector by 2030 to meet
20 | WWW.CERES.ORGthe Paris goal.10 A sound 2 degrees scenario What role will electrification of transport
should reflect existing trend lines for energy play? How long would scale up of these fuels
efficiency and how they might change and infrastructure take? What regulatory
through regulation, technology, costs and policies are likely to affect the adoption of
other drivers. A broad calculation might alternative fuels?
include modeling the changes in energy
intensity per unit of GDP and how it would Land Use Changes and Terrestrial
have to change over time. How would such Carbon
reductions in energy intensity be achieved? Forests and soil act as natural sinks for
Under each scenario storyline, what are the absorbing carbon emissions. Thus, land use
expectations for vehicle fuel efficiency for changes that reduce the amount of forest
passenger vehicles and commercial trucks? land or hinder soil’s absorptive capacity
What might change the rate of efficiency? have consequences for reducing carbon
What is technically possible and at what accumulation in the earth’s atmosphere.
cost? What role will the current trend A thorough 2 degrees scenario should
to automation and digitization mean for consider the fate of forest land and whether
energy efficiency in manufacturing or other agricultural practices will include methods
industries? For vehicles? Or in the household that enhance soil’s ability to absorb carbon
sector? How might changes in building such as the use of biochar. A 2 degrees
materials or lighter weight materials for scenario can factor in reported data on
cars impact energy efficiency? What kind of events or levers that decrease deforestation
legislative or regulatory changes are on the such as new regulations of the timber
horizon that might alter energy efficiency industry, an international agreement to
practices? These are the kinds of questions regulate deforestation (including aid
that can be considered in constructing what or credits for developing countries that
efficiency gains would be needed under a 2 cannot finance monitoring) or the creation
degrees scenario. of an efficient carbon offsets market that
promotes reforestation activities by high
Low Carbon Fuels emitters.
In considering a 2 degrees scenario, it is
important to consider what opportunities Behavioral Changes
might exist to shift to lower carbon sources A 2 degrees scenario can consider
of fuel in major sectors. Since the electric mechanisms that might be utilized to
power sector represents one of the largest change consumer behavior in a manner
sources of global greenhouse gas emissions, that makes significant reductions in carbon
a 2 degrees scenario should consider what emissions. This could be technological,
changes might be made in the composition such as smart meter technology that helps
of fuels used to generate electricity. What households conserve energy use, or multi-
is the highest level of the use of renewable modal digital applications for smartphones
energy possible under different scenarios and vehicles that provide information to help
in the power sector? How would the shift individuals avoid fuel-wasting congestion or
to different fuels take place? Are current encourages the use of public transportation,
models for structuring and operating power ride sharing and last-mile bicycling. A 2
grids likely to be cost-effective and reliable degrees scenario can also consider the
in emerging markets or are alternative effectiveness of “Smart Cities” programs
models more likely to be developed? For designed to make large urban areas more
the transport sector, what low carbon fuels livable and reduce emissions through
will be available and over what time frame?
10 IEA, World Energy Outlook: Special Report on Energy and Climate Change
(2015) available at https://www.iea.org/publications/freepublications/publication/
WEO2015SpecialReportonEnergyandClimateChange.pdf.
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