Energy Transition: Addressing Oil and Gas’ Bad Rap

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Editor’s note: This is the first in a three-part series Oil and Gas Investor is featuring with Kenan-Flagler Energy Center at the University of North Carolina (UNC) at Chapel Hill. Parts two and three will appear in the September and October issues.

The energy transition is changing the way the oil and gas sector needs to look at cultivating its future workforce and, in particular, leaders.

However, even with the transition, any major energy company will need the “traditional workforce” that has made it into what it is today, according to Stephen Arbogast, professor of the practice of finance and director of the Kenan-Flagler Energy Center at the University of North Carolina (UNC) at Chapel Hill.

Still, the energy transition is real, Arbogast said, and it’s going to happen. Therefore, a portion of the future energy workforce will need to be able to help oil and gas companies navigate that transition.

In this first part of a three-part series, Arbogast talks about the value of messaging to the next generation of students who will one day become the leaders of the oil and gas industry.

Investor: The energy transition is underway. How is it changing the way the energy sector, particularly oil and gas, needs to look at cultivating its future workforce and its future leaders?

Arbogast: The key I think in the question that you asked is the word cultivate. Exactly how is the current management of the energy sector, and in particular oil and gas, going to appeal to the next generation of energy practitioners and develop the leaders in the industry?

Imagine that you’re the senior manager of a major oil and gas company in this town, and you take the energy transition seriously. What kind of workforce would you like to have? The first thing that you need is, you still need that traditional workforce, you still need all that literacy and all those engineering skills that have basically made the industry what it is today. So I would say that the first thing is that the leaders of the industry need to continue to robustly assert that. This is an industry that’s going to be here, [and] it’s going to be critical to the future of our economies, not just in the United States, but globally. It is not an industry that’s going to disappear anytime soon.

Now, the second piece of that is the transition is real, and it’s going to happen. So I need a portion of that workforce that is going to help me navigate that transition. The first ingredient that the management needs to convey to today’s energy students is we take the transition seriously, and oil and gas companies are going to be a major part of the solution. Now, this is true. The world is going to need the oil and gas companies to be a major part of the solution.

I think the industry has a bit of a credibility issue there because it actually doesn’t spend that much money on transition-type investments. So I think the students are looking for those signs that basically say, OK, this isn’t just talking, this is actually spending money. So that would be the first thing that they would need to, if you will, cultivate.

After that, there’s a couple of other aspects that I think are important. They need to convey to the students that solutions are going to be hybrid. The narrative today, it’s all wind, solar and storage. I know it’s going to be hopelessly inadequate for accomplishing decarbonization. So the industry has got to come along and basically say, it’s going to be other things that are going to be involved, in particular things like carbon capture and the introduction of new types of fuels, potentially including things like hydrogen. So inviting the students to participate and in fact, building new businesses inside the traditional oil and gas industry is going to be an important part of this cultivation.

Watch Stephen Arbogast’ recent interview with Hart Energy Editorial Director Len Vermillion

Investor: What are the specific skill sets that energy MBAs will need now that it is different than when we were talking about conventional oil and gas?

Arbogast: It’s a really interesting question, and the answers might surprise you a little bit. A big part is going to be the commercialization of new technology. You don’t see a lot of that in traditional MBA programs, but I think you’re going to need to see it in MBA programs going forward. What do we mean by commercialization? It’s like, how do you make a business that makes money around new technology? In the oil and gas industry, technology adoption has been very incremental, but now we’re talking about going outside our comfort zone and building new businesses in places where we haven’t operated. How are you actually going to make a business that makes money out of carbon capture, for example? I think that’s a really interesting question.

Another example, Kinder Morgan [Inc.] had an investor day where they talked about, [for example], what would be the role of their pipelines in the future? Well, they’re are talking about are they going to be carrying CO2? Are they going to be carrying hydrogen? These are interesting sort of questions, and you’re going to have to make a business that makes money out of them. So that’s a big question that MBA programs are going to have to take up.

Now, there’s one other one I want to mention and is nowhere on the radar screen. In what ways is oil and gas a consolidating industry in different markets, and how do you play your hand strategically in a consolidating industry? Do you be an early leaver? Do you want to be the last man standing? You see California; you see both things. You see people that have left early and people that are going to wait it out. The whole strategy around being in a consolidating industry in some markets is another skillset that MBAs are going to bring to the table.

Last one, working with public policy. Very, very different way. Lots of things in the energy transition are going to need sustainable public policy. Traditionally the oil and gas industry has hated to make investments that relied on subsidies or mandates. But now if you’re going to build businesses in these new places, you’re going to need sustainable public policy. How do you accomplish that? That’s going to be a new skillset. You’re not going to get that out of engineering schools. You’re going to need to find it someplace else.

Investor: Could you further expand how Kenan-Flagler the Energy Center at UNC is encompassing the outlook on energy?

Arbogast: We thought that since we’re a business school, we ought to focus on how to make money in the energy business. And it’s surprising how many energy programs are not actually that interested in that. They’re interested in policy advocacy or the nuts and bolts of the technical side. Let me put it to you this way, we conceive of the energy business as a particular type of commodity business. Now business schools actually don’t spend a lot of time on commodity businesses. They are very fascinated by tech businesses, for example. But a commodity business has particular characteristics. Its competition is on the basis of unit costs of production. So we teach the students, whether you are going to go into renewables, whether you were going to go into utilities, whether you’re going to go into oil and gas, you better be prepared to compete on the basis of cost leadership and unit cost leadership.

Second, commodity businesses have fragile price structures, and a fragile price structure is a function of the fact that relatively small imbalances in supply and demand can produce outsized price effects. So you have this big price cycle in the oil and gas industry. How do you navigate through an industry that has these tremendous ups and downs? How do you navigate financially and strategically through that business? We spend a lot of time on that kind of question. So you can see that the business of energy has distinctive characteristics that don’t get a lot of attention elsewhere.

Third thing, energy is the most strategic industry in the world. As a result, it traps a tremendous amount of public policy attention. So the third leg of the stool is OK, you’re in a commodity business, unit cost of production, volatile price structure and tremendous amount of government intervention. That’s how we teach the business of energy.

Investor: Teaching is a little bit different when it comes to energy markets. What’s different about students coming in today? What is their take on oil and gas?

Arbogast: That’s a really interesting subject, and it doesn’t do us a lot of favors to kind of avoid an unhappy truth, which is there’s a stigma on the oil and gas industry now. A lot of the students that come in, they walk through the door and they basically say, ‘I’m interested in renewable energy.’ I get that from students that have actually worked in oil and gas, [and] I get it from students that come out of the military. It’s not just the people that have been in Northeast liberal arts programs that have those kinds of attitudes.

The first thing that we have to deal with in this is, what has led you to that conclusion, and what are you not looking at in terms of other factors? What’s surprising to me is that today’s generation of students are not paying a lot of attention to very big issues that are very contemporary, which have kind of receded off the radar screen. Inflation, development, prosperity in the developing world, energy security, energy geopolitics. There’s been a tremendous loss of interest in all of those things because they’ve grown up in a period of time where basically those problems haven’t seemed to be that pressing. They’re still there, and they can come back, as Texas saw, in spades just a couple of months.

“A big part is going to be the commercialization of new technology. You don’t see a lot of that in traditional MBA programs, but I think you’re going to need to see it in MBA programs going forward.”

Investor: Does that make it harder to find students? What are the prospects of students who want to get into energy these days?

Arbogast: The good news is that although they come through the door deeply devoted to renewables, they’re educable. We show them these other issues, and we show them the reasons why oil and gas has been so fundamental. And we talk to them about ways in which the oil and gas industry is going to be extremely important to solving the energy transition.

Let give you one example of that. Interestingly enough, a lot of the press in the United States focuses only on decarbonization in the United States. But decarbonization is a global problem. So we make a point to the students: Guess what, it doesn’t accomplish a lot to decarbonize the United States if Asia and the developing world are increasing their carbon footprint, which they are and are dramatically. So we put the question to them. How are you going to decarbonize China and India when they’re adding coal plants all the time?

Surprisingly enough, they quickly discover that LNG is one of the big reasons and one of the big ways you can decarbonize out there. Then they find the surprising conclusion that the way to keep LNG viable for substitution in Asia it has to be affordable, which means that fracking, which has kept natural gas relatively cheap and LNG affordable, becomes important to decarbonization. So it’s points like this that I think help make a much more nuanced outlook for our students when they leave at the end of two years.

Investor: I think they would look at oil and gas less as an obstacle than they previously did when they came in. Is that true?

Arbogast: Well, absolutely. We also challenge this idea that wind and solar can decarbonize. If they’re going to have real limits, you’re actually going to need another pathway. How much sense does it make to tear down everything you have and substitute it with things that are less efficient? So obviously, there’s the second pathway, which is to decarbonize the energy infrastructure you already have. You’re going to need the oil and gas industry to do that.

“We teach the students, whether you are going to go into renewables, whether you were going to go into utilities, whether you’re going to go into oil and gas, you better be prepared to compete on the basis of cost leadership and unit cost leadership.”

Investor: We talked a lot about what has changed with an MBA program, but at the end of the day, it’s still about making money, as you said. So what is the same? What has not changed?

Arbogast: The first thing, if you want to sort of say what’s not changed in MBA program, technical literacy still matters. And so, we talk to our students a lot about the fact that if you’re going to be effective in an industry that is deeply embedded and based on engineering, you have to be technically literate in the aspects of the industry that are going to continue. To illustrate this, one example we use is, you’re not going to have to know how to operate [equipment], but you’re going to have to know what goes in, what goes out and how to value it in order to have that conversation with the engineers. And that’s true whether you’re talking about exploration and production or midstream or refining or petrochemical. So the technical piece is still going to be there.

The second thing is energy finance and economics. You have to be grounded in those things, but this is where things are going to change a little bit. If you’re doing a traditional capital project in the energy industry, basically, it’s what you call marginal economics. You look at what are the changes from the base case. But in the future, a lot of projects in the oil and gas industry are also going to be defending the base business. They’re going to have to pioneer, if you will, economics, or take those kinds of things into effect.

Investor: What are the characteristics of this program that make it unique but also one of the top energy MBA programs out there?

Arbogast: There’s a couple of characteristics that you really won’t find in other energy MBA programs. The biggest is, it’s a full value chain program. If you look at programs at places like Duke or a Ross, or even a place like University of Texas [UT], they tend to focus on one part of the value chain. It might be oil and gas at UT, it might be renewables at Duke. We do the whole value chain—oil and gas exploration and production through the midstream, refining petrochemicals, business of power and renewables. So it’s all there. We tell the students, look, you have to understand the full value chain because whether you care about renewables, oil and gas, you’re going to compete with the other sectors, and you’re going to cooperate with the other sectors. So you need to know the whole piece.

The other thing that’s really distinctive about our program is taught entirely by practitioner faculty. Everybody, the teachers in the program has been in the industry, or is still in the industry, for 20 years. For example, Dan Domeracki was at Schlumberger [Inc.] for 40 years, [and] teaches the business of oil and gas exploration and production. Energy tax is taught by the current tax counsel at Kinder Morgan [Inc.]. And the business of renewables is taught by president of Duke Energy Renewables. So, you get exposure to people that have actually been there and done it, and they write case studies about what they learned in their industry.

Investor: What kind of response do you get from people in the industry to come in and teach? This is not a case of [someone] coming to give a lecture and then leave, right?

Arbogast: No. It takes us about a year to prepare an industry person who wants to come and teach in our program. They have to develop a detailed syllabus. We take them through a curriculum committee. They have to write three to five case studies as part of doing this. Industry people who haven’t been in the classroom, point of fact, they have to actually learn what’s required to deliver a course there and have material worth a top MBA program.

Investor: When we talk about the full value chain in the program, why is that important to have a program like that?

Arbogast: So let’s say you’re interested in renewables. What’s setting the return in renewable energy these days? It’s the price of natural gas. Now, let’s say you’re at the other end of the spectrum and you’re interested in oil and gas exploration and production. Well, in point of fact, one of the big questions there is, how long are your reserves going to be, if you will, allow to be commercialized? What’s your reserve life? That’s going to depend on the aggressiveness and adoption of alternative energy at the other end of the spectrum.

So, if you’re going to present to your management and say, ‘Hey, let’s do this project, we got 40 years of reserves.’ Well, do you? So, you really need to understand everything that’s coming on across the value chain to make judgements in this specific sector.