Shaping Reality: A Tale of Two Narratives


The oil industry’s main narrative remains one of increasing hydrocarbon demand requiring higher levels of investment to supply it.  But it is coming under increasing pressure to adapt to the context of 21st century energy. A counter-narrative has emerged that goes beyond low-carbon science and policies,  It’s based on the growth of  competition from utility-scale renewables, strategic ideas from analyst groups such as “Unburnable Carbon” and major moves in the “post-oil” vision of key players such as Saudi Arabia. If narratives shape reality, rather then reflect it, then this contest between ideas of energy scarcity and energy competition will form the future direction of the industry, and determine a new business model.

A recent research report from Chatham House energy fellow Professor Paul Stevens announces that the Big Oil business model is dead.

It’s a long report, but it has interesting data and a sustained theme of concern that the oil and gas business is not adapting to the world ahead.


Stevens summarises the core of the “Big Oil Business Model” as a focus on three areas:

  • Maximising shareholder return – mainly via portfolio-based project management and a strict adherence to progressive dividend policy
  • Maximising bookable reserves and volumes – securing future volumes via increased reserves and reserves replacement, and investing heavily in production growth
  • Reducing costs via outsourcing: almost all major industrial firms have cost reduction as a focus, but the oil company model is particularly associated on retaining only a core capability internally, and the dominant use of market purchase for technical skills.

And he highlights its three main problems:

  • Managerial flaws: a highly consensus-based industry prone to synchronized investments, disinvestments, and over time the loss of technical edge due to outsourcing
  • Upstream and Downstream problems: In the Upstream, limited or no access to low-cost reserves, except on terms highly favourable to national oil companies (service fees and no access to oil price upside). In the Downstream returns were historically a drag on upstream profitability, although a partial hedge in times of low oil prices
  • Capital Investment risk: blocked access to low-cost reserves, but retained desire for increasing bookable reserves, resulted in major increases in capital employed, mostly in high-risk megaprojects. Since 2000 this has made the major oils relatively unappealing as an investment class due to decreasing returns on capital.

Putting this all together, Stevens produces a historical picture of the industry to date.

IOC v2

He concludes with some proposed solutions for the IOCs to consider to avoid continued deterioration including mega-mergers, diversification, technology reinvestment and contraction to smaller operations. And he cautions that the old oil cycle has probably changed due to technological moves in energy, and geo-political shifts such as the Paris climate accord.

In this new world, the only realistic option for the IOCs lies in restructuring and realizing many of their current assets to provide cash for their shareholders. This means inevitably, however, that they must shrink into the remaining areas, functionally and geographically, where they can earn an acceptable return. This requires a major change in the corporate culture of the IOCs.”

In many ways this is an orthodox historical critique of the industry. The counter is that despite fearsome odds, the technological audacity of the industry engineering culture allowed new sources of world energy to be accessed.

Steven’s pessimism for the industry is also challenged by the industry and analysts such as IEA, who see longer-term demand for oil and gas to be much more robust than expected due to resilience of the need for fossil fuels and the global population expands.

What is different this time though, as Stevens points out in his final section, is the growing concerns around “stranded carbon” and other decarbonisation issues. Stevens himself believes that the biggest issue regarding stranded assets for the oil industry are not the financial or economic ones, which can be managed, but

… this ‘financial’ argument ignores what might be termed a ‘moral’ one. It can be argued that the IOCs have a moral responsibility to ensure the burning of their carbon does not produce catastrophic results in terms of climate change”

Stevens suggests that, maybe for the first time, there might be a struggle about who owns the future oil industry narrative. In the past, that has been driven solely by the industry itself. Now, a growing cadre of decarbonisation analysts, technology firms, think-tanks and investment bodies may have increasing influence on it.

And the debate is moving from traditional debates regarding climate science and carbon policies.

Its shifting towards differing assumptions on energy competition, asset values, investment strategies and the implications of economic stress tests in a 2degC world.

Are these competing narratives important?

A recent publication from the Royal Society of Arts and Commerce (RSA), in the context of the moral case for investing or not in fossil fuel companies, makes the point that when heads of the oil industry “make predictions, they shape rather than reflect reality”. It’s an important point.

It suggests that when industry leaders develop and communicate a narrative, their subsequent actions then impact the real world ahead of them. They then either drive the reality because they have control, or they confront a different reality and have to react to it.

What is the industry narrative, and how does it shape its reality?

And if there is a new counter-narrative, what is it, and does it change reality?

The Industry Narrative

The meta-narrative that drives oil industry behaviour is a deep belief in both oil scarcity, and increasing long-term hydrocarbon demand. This propels a profound bias for investment to discover or purchase new reserves via acquisition, and to maintain growth via production volume increase.

If we look again at Stevens’ chart, we can see that after the oil supply shocks in the Middle East of the 70s and early 80s, oil traded in a relatively narrow band of pricing of $25-35/bbl nominal, until the late 1990s. In 1998 the Asian financial crises prompted a relative 50% drop in oil price to as low as $11/bbl as global GDP growth was impacted.

The industry narrative however assumed longer-term demand growth, and that supply shocks and/or OPEC output constraints would cause prices to rebalance.

This produced a series of mega-mergers to gain assets at rock-bottom prices. Oil companies believing strongly in the narrative, eg BP, saw a great opportunity to acquire assets at rock-bottom prices and accelerate production growth. Firms with a more pessimistic faltering belief, eg Arco, were willing vendors and sold out.

History, numbers in hindsight, shows the acquirers to have been right in terms of demand and oil price, as after 2000 the price began a long upward move that carried on until 2014. Why?

A demand thesis is pretty conclusive on this and provides a one word answer: China. The chart below from the latest GMO quarterly newsletter (a financial analysis firm) uses Chinese iron ore demand to illustrate the scale of the demand that Chinese industrialisation placed on oil and other commodities in the 2000 – 2014 timeframe.

As supply took time to respond, prices rose and were sustained.


As global demand grew, and prices rose, the narrative then focused on increasing major investments to grow reserves and production further across a range of projects of increasing complexity.

Post the mergers industry capex took a sharp turn, with an order of magnitude increase in CAGR, as the chart shows.

Capex bbl

By 2013 the main companies were investing almost 20% of their asset base per annum in major projects to increase production growth and replace depleting oil reservoirs.

The main vehicle for this investment by the large oil companies was megaprojects. These were aimed at developing the largest available reservoirs in unconventional, deep-water, the Arctic and other areas.

The chart below is a composite analysis, and covers the period 2000 – 2013, ie post merger and pre-oil price collapse for major oil companies as shown and indexing year 2000 at 100. It shows aggregate capex and production from the companies, with the context of oil and gas price and industry costs.

Capex Index

The data indicates how difficult it is to achieve the volume growth aim outside the major oilfields in the Middle East, or via oil shale activity in the US. Even with a three-fold increase in oil price, and five-fold surge in capex, oil production remained flat, as most projects over-ran cost and schedule significantly. Put another way, a productivity factor decrease of five times as complexity increases.

Whilst oil demand growth may well continue, the industry needs to reflect on how it intends to increase production effectively going forward. Even with the tail-wind of sustained high oil prices the majors were unable to create volume growth either organically or via acquisition.

The inventory of existing hydrocarbon assets needs to be monetized profitably, and replacement reserves accessed. The vehicle of high risk mega-scale projects to do this is unlikely to be the primary route that oil companies or their investors can use again in the future, even with price spikes.

The chart also indicates three major sub-narratives of the period:

  • Golden Age of Gas – certainly up until 2008-09 and some time beyond, a “golden era” of gas was assumed. This fitted the growth agenda generally, the beginning of a recognition of the need to decarbonize to some extent with gas as a bridge to future, and the increasingly gaseous nature of the oil major portfolios (partly in response to limited oil access). This narrative is likely to continue as it has some support on both sides of the decarbonisation agenda, although pricing expectations are likely to be revised.
  • Service Costs driving project capex: there is indeed a feed-back loop from high capex into input costs – via demand spikes, and contract pass through of labour and material costs. However, there is a growing recognition that megaproject over-run due to scale and complexity is a far larger influence over costs in general (see here and elsewhere). Service company costs are not the major factor in determining capex price levels – project size and complexity is.
  • Investment structure – even at the height of the oil price increase in 2012-13, company ratios started to show the strain of the high investment / flat production outcomes. Coupled with progressive dividend policies, some investors signaled alarm at the sustainability of the scale of the capex model that the scarcity / volume narrative requires.

Current Status of Narrative

After two years of price decline from $100/bbl in June 2014 to $45-50/bbl in May 2016, the narrative is mostly unchanged, continuing with its reality.

Oil prices have dropped and stayed low, but supply disruptions in the near term and production decline in the medium term are likely to “rebalance” the sector this year or next – rebalance meaning oil prices in the $60-80/bbl range.

The industry is almost pathologically pro-cyclical, and is structurally pre-disposed to major capital investment to replace reserves and reverse natural decline, and generate new volumes of hydrocarbon.

The narrative will be mainly about the most efficient method of achieving this: via acquisition, via cost management with suppliers, through geographical focus and value chain optimization and by more efficient project delivery.

The narrative will therefore remain centered on the “how” to achieve growth, not the why.

The New Counter-Narrative

As Stevens and others have pointed out, the decarbonisation agenda presents new issues and narratives for the oil industry to deal with. One can argue they have been there for a long time, since the early 1990s for example, but the complexity of new narratives and depth of challenge have increased substantially in the past 3-5 years.

The key point is not whether the decarbonisation agenda or climate change analysis is “correct”. The point is that the oil industry now has to deal with a competing narrative of increasing sophistication and investment that looks to “shape the reality

What are its key elements?

Traditionally the alternative energy narrative or prediction has centered on science and policy. Whilst rational, it was essentially flat and abstract, and seen as politically driven.

As such it suffers from high-profile skeptics such political and industry leaders, and from the more widespread “tragedy of the horizons” as Mark Carney, Governor of the Bank of England, put it. Its consequences are far in the distance, conceptual and difficult to be mobilized about.

International governmental policy on decarbonisation is also broadly supportive, but lack of progress on carbon taxes, potentially slow developments post Paris COP21, and the reversal of various initiatives eg in the UK and Europe on renewable energy programs also suggests wider doubts about a viable medium-term alternative to hydrocarbon investment.

That is likely to remain the case, as progress in the scientific and policy arena has been slow and continues to be debated back and forth. Global events such as extreme weather may bring the horizon far closer, but that still may not be enough to generate rapid adjustment.

What has changed in the past few years, though, has been a widening of the narrative into the technological, financial, and economic arena.

Technology-based energy from rapidly declining unit costs of solar cells and wind turbines has caused a proliferation of renewable energy firms providing utility-scale power. Growth of these sectors may be moderate or large depending on the analyst, but their presence is now established – investments in the global renewable power sector were $330bn last year, higher than the hydrocarbon equivalent.

Whilst many renewable energy firms have succumbed to hype and over-investment, and many more will do the same, the presence now of an established industry sector means it is generating its own, positive, narrative of the future. This may or may not agree with the oil industry equivalent, and to the extent they compete, their own narratives of growth will inevitably clash.

That the Chinese government five-year plan (FYP 2015) and various US state utilities are looking increasingly to renewable firms for more home-grown technological energy highlights its agnostic nature.

The advent of the electric vehicle (EV) is also part of this phenomenon. Whilst the technology is in a junior phase, the narrative around EVs has the language of inevitability of widespread adoption. Tesla corporation sets increasingly audacious (and derided) goals for production and adoption – but in a further case of narrative-shaping, major car manufacturers have now accelerated EV introduction plans, and the Chinese government has also subsidized EV development and infrastructure programs.

Densely-urbanized mega-metropolises in China and increasingly in India with media smog and air-congestion images are making their leadership consider electric grid-based solutions perhaps faster than expected.

The storyline around alternative energy adoption therefore appears to grow in veracity as the actual large-scale technology starts to become commonplace. Elon Musk’s grand vision for EV adoption may fail in the precise numbers, but succeed in the shaping narrative.

Allied to the technological counter-narrative, are various strands of the financial and economic.

Financially, investor activism is the most prominent, with sovereign wealth funds in Norway and Saudi Arabia, plus for example the Rockefeller Brothers Fund and Gates Foundation in the US looking to diversify or divest their portfolios from oil and gas. Institutional advisors such as ISS and Glass Lewis are also supporting calls for more transparency in oil company accounts to assess the risks from decarbonisation more explicitly, eg in explicit stress tests in annual reports.

But over the past few years a number of private and non-profit organisations and think-tanks supporting the alternative fuel agenda have also arisen. These companies – such as CarbonTracker and CriticalResource – are at pains to note they are analysts and not activists.

They have collected industry experts in finance and engineering, and aim to challenge the incumbent fossil fuel industry using the same data and expertise that they employ – proposing alternative financial strategy options rather than reflexive opposition.

It is these groups, along with various other organisations, who have developed the concept of “stranded carbon”, or “unburnable carbon” forcing newer scenarios and options for the industry and governments to consider.

This is not a language that the oil industry would ever have invented or communicated.

Their latest reports on the coal and oil industry come to broadly similar conclusions – even at high oil prices, the fossil fuel companies would be better off in investment (NPV) terms from ex-growth strategy. That is, reduce capex significantly and via disciplined decline manage cash-flow more efficiently to increase overall returns to shareholders, during this transition to new forms of the energy. And at the same time reduce the burden of carbon released to the atmosphere.

The core of this narrative is that these decisions have to be made now. Transition is inevitable, only the timing is debated. But as the incumbent industry plans its investment on long-scale horizons of decades, key choices or decisions need to be articulated and discussed immediately.

From original resource discovery to field start-up normally takes over ten years for megaprojects, and pay-back a further decade or more depending on outcome. Thus assets being sanctioned today will take over 20-25 years to pay-back under routine assessments – but carbon taxation assumptions, or “stranded asset risk” for example, will have to be developed in more detail for investors to price these uncertainties now.

The collapse of the US coal industry this year as a consequence of long-term pro-growth strategies suddenly encountering a fall in Chinese demand and energy policy shift will continue to be used as a cautionary tale.

Finally economic counter-narratives linked to the “post-oil” world are developing from surprising sources. The newly-announced Saudi Arabian 2030 plan to diversify its economy from oil to a wider industrial base has its skeptics, who believe such a grand ambition can only fail.

However, like the ambition of the Tesla EV narrative, it sets a compelling vision and starts to mobilise opinion, analysis and competitive action. It starts to shape its own reality.

The announcement of the Saudi Vision 2030 and simple actions such as the introduction of product taxation indicates a narrative move from a rentier state dependent on oil to a modern manufacturing one, viable beyond it. It also reinforces the idea of Saudi Arabia continuing to produce oil to maximize its current value and maintain its share with key customers, rather than be defined as the lead in a cartel that manipulates global price. This an especially sensitive point as two large consumers, the US and China, aim toward self-sufficiency and energy security, and as a major competitor, Iran, re-develops its production.

In sum:

The competing narrative to high levels of fossil fuel investment has developed from outside the industry largely from a base of climate science and governmental policy. In recent years however the narrative has developed in three distinct areas;

  • From the actions and strategies of alternative technology companies developing utility scale energy for power markets, and visionary statements about EV adoption
  • The emergence of disinvestment financial strategies of wealth funds, and the creation of alternative ex-growth financial models from new think tanks
  • The shift in economic positioning of key industry players such as Saudi Arabia toward a more market-oriented strategy

It has developed tangible examples of increasing utility-scale energy investment, and a distinctive contra-language that the industry would not use, such as “unburnable or stranded carbon” or “post-oil future” that forces the conventional narrative to provide responses.

A Clash of Realities

“Unfortunately many companies will likely continue to plan for more rapid growth, either led by political goals or through a desire to avoid a fading future and outgrow their peers.”

This is the conclusion from the Critical Resources report on the coal industry – it could have an analog to the oil industry as they note.

Its clear that increasingly the two narratives above will clash.

Simply put, the oil industry narrative is pro-growth and hydrocarbon-focused

The alternative narrative is ex-growth and rapid transition to non-hydrocarbons.

How is this likely to play out?

A base-case scenario is the following:

The fundamental question is – if the world does require an extra net 15 million bbls of oil per day by 2030 as IEA predicts, how is this achieved? By continued investment and growth or by demand reduction and alternative fuels?

  • Assuming demand growth a given, and renewables progress as modest, the oil industry will continue to pursue relatively aggressive pro-growth investment strategies
  • However, a key constraint will remain on large-scale megaprojects which will be assumed too high risk, long-term and cash intensive with modest oil prices – plus the counter-narrative will question their value versus more restrained investments in line with carbon-level goals and rapidly-growing competing technologies
  • Attention will therefore switch to acquisition of assets, extension of existing resources or investment in manufacturing plays (oil shale and so on)– more modest in capex and more rapid in payback
  • The industry will also continue to profile plays in alternative energy investments, but these are likely to be marginal in capex terms compared to core business (<2-5%)
  • Reserves replacement ratios and production levels will then become a source of key debate – if they are to decline naturally due to constraints on high levels of capex, the counter-narrative will question why not manage the decline more efficiently rather than resist the ex-growth model and over-invest (the US coal effect)
  • This means that non-OPEC growth is likely to fall over the next few years, which leads many analysts to suggest a price spike in the medium term
  • However, if oil prices do rise higher to say $80-120/bbl, a surge in new investment will also be challenged on the same basis – CarbonTracker have already placed a marker by stating that the ex-growth model is still higher in NPV terms up to oil prices of $120/bbl
  • A sustained price spike is also likely to usher in more tight oil growth investments, and accelerate switches to alternative energy for security of supply and less price volatility
  • Overall, a constrained capex world likely unfolds, and oil companies will have to take the ex-growth models seriously, and look to more efficient asset management, smaller scale project delivery, and services-based models for NOCs for example.
  • All of this is anathema to the base industry narrative, and will be viewed as a paradigm shift in oil industry reality.


A clash of two narratives is competing for the oil industry reality.

The long-term pro-growth model may have reached a limit due to the large drop in productivity that the megaproject investment model brings.

Simultaneously, a competitive utility-scale renewables energy sector has emerged, along with low-carbon think-tanks proposing sophisticated alternative investment models for the oil sector, and major shifts in the economic policies of the leading industry producer Saudi Arabia, and consumer, China.

These changes combined will force a change to the existing narrative, and the reality that is then shaped.

For the incumbents, the language of engagement and idea development will be more worthwhile than opposition and defense of the status quo. Robust stress scenarios, alternative investment models for ex-growth, and business model solutions need to be prepared not only for a low oil price environment, but for a far higher one too.

Professor Stevens’ outlook was a gloomy and pessimistic one for the old oil business model, if it adheres to its present course.

The industry now has to produce a more optimistic and engaged energy narrative: one based less on scarcity and more on competition, and with futuristic ideas about efficiency rather than volumes.

The old business model is not dead. But it is threatened, and it needs to adapt quickly to manage the new style and complexity of the challenges ahead.