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Just over 25 years ago, governments around the world began using
different policies and regulatory measures to slow the growth of
greenhouse gas (GHG) emissions linked to global warming and climate
change. Over that period, the focus of climate change policy
expanded to include more sectors of the economy and additional
forms of energy production and consumption. In 2015, 195 countries
signed the Paris Agreement, the most wide-ranging and ambitious
deal on climate action yet. As the first deadline of that accord
draws near, climate policy programs are expanding to include
sectors of the economy previously not targeted for GHG emission
reductions.
There are two key trends at work here. First, more governments
have made unprecedented commitments by signing the Paris Agreement.
Before 2015, approximately 70 countries had climate policies of one
sort or another in place. Now, there are more than 160 national
policy programs, called intended nationally determined
contributions (INDCs), in support of the Paris Agreement (see
Figure 1).
Second, this latest phase of climate policy development is
driven by higher levels of ambition. The GHG emissions reduction
targets in the Paris Agreement are challenging, to say the least.
To realize the goal of only a 2-degree Celsius increase in the
global average temperature this century, emissions of carbon
dioxide, methane, and other GHG would need to peak by 2020. Then
they must decline in absolute terms from close to 50 billion metric
tons of carbon dioxide equivalent (CO2e) today to around 30 billion
tons of CO2e by 2030. This is a drop of about 40%, depending on the
exact pathway assumed. To deliver those outcomes, IHS Markit
estimates the global economy would need to improve its emissions
intensity by more than 4% each year. Historically, the most
effective climate change policy has delivered an average annual
emissions intensity improvement of less than 2%.
Setting aside the U.S. for a moment, all major nations that
signed onto the Paris Agreement are developing policies to deliver
GHG reduction targets. Will all nations meet these targets?
Probably not. But, as nations take steps to fulfil their pledges,
major shifts in energy markets are expected. Refining and chemicals
operators should brace themselves for new types of regulations
across their value chains, with plant-level emissions set to become
a higher priority.
To date, climate policy has had a more direct impact on the
downstream energy industries through on-road fuel efficiency
standards, which are directly related to carbon emissions
regulation. Some governments, such as those of the European Union,
India, and the United States, formulated additional CO2e- or
GHG-specific targets for tailpipe emissions of light-duty vehicles.
These fuel efficiency standards are the primary policy mechanism
that governments use to reduce carbon in their transportation
sectors.
Consider the world's two biggest economies, the U.S. and China.
In the U.S., the Corporate Average Fuel Economy (CAFE) program was
enacted in 1975. The original miles-per-gallon (mpg) target on auto
manufacturers became a dual standard that now includes an
Environmental Protection Agency (EPA) regulation for CO2e
emissions. The 2016 target for light-duty vehicle sales - 250 grams
of CO2 per mile (gCO2/mi), equivalent to 34.1 mpg - was changed by
the Obama administration to 163 gCO2/mi, an equivalent of 54.5 mpg,
in 2025. However, the actual 2017 emissions were estimated to be
275 gCO2/mi - 10% above the 2016 target. The current U.S.
administration has proposed relaxing the targets, although the
outcome is uncertain at this writing. IHS Markit's base case view
is for only a slight reduction in the standard, given automotive
manufacturers' model development plans and the lawsuit and
discussions regarding California's continued participation in a
national standard.
While the U.S. is relaxing emissions standards, China is
tightening them further. By adding a new energy vehicle (NEV)
standard, China is essentially mandating that an increasing portion
of new auto sales will be electric vehicles (EVs). In fact, about
half of global 2017 EV sales were in China. The NEV is a dual
standard applied alongside an already stringent corporate average
fuel consumption (CAFC) standard. China's CAFC improves fuel
economy from about 34 mpg in 2015 to 47 mpg in 2020 and over 58 mpg
(proposed) in 2025.
How do regulations affect other sectors beyond
light-duty cars?
Japan was the first to adopt a heavy-duty vehicle fuel
efficiency standard, followed by the U.S., China, and the European
Union. More nations are expected to follow their lead, given the
increasing road transport demand and benefits of technology
advances in truck powertrains and transport supply chains.
Policymakers are also looking to the sea-borne shipping and
aviation sectors to contribute to emissions reduction efforts, but
these changes may affect the refining and chemicals businesses. In
response, those industries have taken it upon themselves to
organize collective responses befitting their international
character. Most of these responses emphasize the need to give
operators the chance to contribute to lower emissions outcomes in a
flexible manner that keeps costs down.
So, what is the future of refining in a world of flat or
declining demand?
Virtually all projections that measure progress toward the
objectives of the Paris Agreement include an eventual contraction
of oil demand. Even an energy transition that does not completely
align with a 2-degree emissions pathway will mark a departure for
many downstream businesses, whose strategies have been predicated
upon growth. Lower demand growth will certainly mean a weaker
business environment for refineries. But, the reality might not be
as dire as it first appears. It is true that fewer refining
projects will be needed to process crude oil into product. And,
yes, once peak demand is reached, total crude runs will decrease
and asset rationalization will take place.
However, rationalization in the refining industry has been
occurring for a long time. The industry has shuttered nearly 1
million barrels per day (B/D) per year of refining capacity in
mature markets over the past decade. During this time, the industry
has also added about 2 million B/D of new capacity, mostly in
growing markets. IHS Markit expects this same expansion in growing
markets and decline in contracting markets will continue for many
years, even as the global total demand begins to shrink.
What will change at the plant level?
Plant-level process emissions have been less important to the
achievement of environmental goals, at least to date. Asset owners
have been required to make moderate adjustments and trade-offs in
plant designs to stay compliant on new projects. However, in the
few countries where policies have been put in place to reduce
refinery plant-level emissions, like the European Union Emissions
Trading System, markets are not yet being impacted significantly in
either margin or price.
Nor are petrochemical producers being strongly influenced by
plant-level or supply chain emission requirements. In fact,
conversations about environmental outcomes in the petrochemical
industries have focused on the sustainability of plastics and the
opportunities to recycle petrochemical products (see prior
article). As petrochemical operations expand to meet growing
end-use demand, and as the oil product slate shifts further towards
petrochemical feedstocks, social and regulatory scrutiny of
industry GHG emissions from both products and plants is likely to
increase.
Most governments focused somewhat on the transport sector in the
initial policy outlines created to deliver on their Paris pledges.
But petrochemical and refining has not been called out by many
administrations. IHS Markit expects this situation to change as
governments increasingly grasp the need for GHG cuts across all
large emitting sectors. Striking the right balance between such
national environmental goals and the competitiveness of global
refining and chemicals businesses will be important.
Climate policy is expected to target additional emissions
reductions from refining and chemicals operations. The focus to
date has been on products and fuels, and that is likely to
intensify. At the same time, plant-level emissions will come under
greater pressure as governments seek to hit ever-more-ambitious
targets. As companies make critical investment and business
decisions - which often have multi-decade payouts and are based on
international trade - it is important that they have an integrated
view of the climate policy, energy, and petrochemical
landscape.
Posted 05 December 2018 by Kurt Barrow, Vice President, Oil Markets, Midstream, and Downstream, IHS Markit