As the energy transition continues to gain momentum, established oil and gas companies are facing increasing challenges as the world demands an answer to climate change. A slew of legislation, including a new EPA regulatory proposal released in August, is pushing consumers and corporations away from hydrocarbons and forcing venerable energy companies to (re)consider their roles in a world not powered by fossil fuels. While industry leaders largely agree that such a future is inevitable and necessary, there’s little consensus on how to prepare for it.

Furthermore, the Intergovernmental Panel on Climate Change (IPCC) recently released a report clearly linking human activity to our earth's changing climate. As the world grapples with the challenges of replacing cheap, reliable and plentiful fossil fuels, the climate transition looms. The future of energy is uncertain, and the role oil and gas companies will play in that future is even more uncertain. However, there is a great deal of opportunity for oil and gas in both the energy and climate transitions.

A critical turning point

The challenges oil and gas firms are confronting today didn’t appear overnight. Scientists have been exploring the effects that human emissions of greenhouse gas have had on our climate for more than a century. Still, it wasn’t until the late 1980s that climate change became a hot-button political issue, when Dr. James Hansen of NASA’s Institute for Space Studies delivered a landmark testimony before the U.S. Senate outlining the threats of our continued reliance on high-carbon energy.

We often think of climate change as an element of temperature: The world is getting warmer. Yet the impacts are far more vast. The most commonly quoted examples are melting polar ice caps and rising oceans. These changes alone could displace millions from coastal cities while causing billions of dollars in flood damage. However, displacing millions costs more than the property damaged. It will strain urban areas as coastal populations migrate to new cities, overwhelming health systems and social services. Changing temperatures also affect more localized climates, increasing flooding and droughts, which will have significant impacts on agriculture. Rising temperatures also increase the intensity of storms, which easily overwhelm infrastructures such as power and water. Climate change will also impact our energy-use patterns as systems have to work hard to keep indoor temperatures cooler or warmer.

In 1992, 165 nations signed an international treaty to scale back carbon emissions in an effort to minimize disruption to the earth’s climate systems. Now, public opinion seems to be finally catching up, as concerned citizens, individual and institutional investors, global corporations and world governments are increasingly united in calling for urgent change.

This heightened sense of urgency doesn’t mean industry leaders are facing immediate obsolescence. Oil and gas is still a multitrillion-dollar market. As much as many would like to see the dependency on hydrocarbons disappear, the reality is that we’re still many years from that happening. Multiple industries—aviation, shipping, plastics and others—lack a viable near-term alternative that will scale to the size needed to completely displace oil and gas dependencies.

However, as organizations everywhere look for ways to optimize for a zero-carbon future, the pressure on oil and gas companies is mounting. It’s been more than 15 years since the sector outperformed the S&P 500. If industry leaders fail to take dramatic steps toward business model innovation, then shareholders, governments and the public at large might be content to leave these firms behind.

Searching for answers

In general, there are three approaches that established oil and gas companies have adopted in response to these challenges. First, some firms have chosen to simply stay the course, remaining fully committed to the product and business model they’ve relied on throughout their existence. Among them, some simply don’t have the resources (or don’t see the need) to change, while others see a strategic advantage in focusing on their core competencies to deliver value to stakeholders. Bigger companies in this category have made some R&D investments around alternatives for oil and gas, but broadly speaking, these firms don’t have climate technology on their long-term road maps.

They’ll continue to grapple with regulations that demand greater operational efficiency and a small(er) carbon footprint—and will be punished in the capital markets—as savvy investors move away from hydrocarbons. In light of an increase in the cost of capital, the economics of hydrocarbon extraction change, which might leave some assets stranded as they’ll simply be too expensive to develop and produce. As assets are written down on balance sheets, these companies will ultimately see lower valuations and find it increasingly difficult to leverage capital to finance new and existing operations.

A second approach to confronting the present challenges—favored by many large, globally integrated firms like BP, Royal Dutch Shell and Chevron, as well as national oil companies like Equinor and TotalEnergies—is the energy-integrated approach. Companies opting for this approach are complementing their hydrocarbon portfolios with investments in renewable energy projects (e.g., wind farms and solar arrays). These investments create carbon offsets that set a path toward achieving carbon neutrality. Some firms in this category have set goals for reaching carbon neutrality by 2050 and aim to leverage renewable energy platforms and carbon sequestration solutions (CCUS: carbon capture, utilization, and storage) to achieve them. However, most are starting to realize that offsets alone don’t solve the larger problem.

If the use of hydrocarbons doesn’t decrease, the negative impact on the environment remains. A firm using alternative green energy sources to achieve a zero-carbon footprint without scaling back the release of carbon into the atmosphere is still contributing to climate change. These companies also have to contend with the challenging economics of renewables. Many of the solar and wind projects they’re undertaking are extremely expensive and often subsidized.

Additionally, given the lack of reliability of wind and solar (given that the wind does not always blow and the sun does not always shine), there is still a need for a reliable, on-demand peak power-generating source. Oftentimes, this is fulfilled by fossil fuel-burning power plants. The scale of batteries needed as an alternative is not yet economical, and some countries are simply not exposed to enough sun or wind to fully rely on renewables. These challenges bring into question whether renewables are the right larger-scale solution. Without scale, these investments will remain a far cry from the profitability of hydrocarbons.

Moreover, the business model for power generation via renewables is quite different from the model that makes commodity extraction and production profitable. This will create economic pressures on companies as they learn to compete in power generation markets that are well-established and often highly regulated.

Finally, there are companies like Denmark’s Ørsted that have opted for a comprehensive business model transition. These companies have abandoned all hydrocarbon work and staked their futures on a full commitment to renewable energy. They’ll face significant challenges, too. As more companies seek clean energy solutions to offset carbon-intensive business operations, the market is experiencing a rapid flood of new entrants. In his book "Zero to One," Peter Thiel explains the situation that these former oil and gas firms are now encountering: Players in perfectly competitive markets suffer from a lack of differentiation, which means the price of a good is essentially controlled by the market itself.

The frequent outcome is a race to the bottom, with sellers being forced to implement cost-takeout strategies that introduce new issues. As the market for renewables becomes more saturated and regulated over time, these firms will have to think more broadly about how they’ll earn the profits that drive sustained growth.

A matter of focus

Clean power generation is undoubtedly necessary for our global future, but it’s too early to say which of the approaches above will ultimately yield the most success for established oil and gas firms. To be clear, the industry’s leading companies are no strangers to innovation. Many of them have developed processes and strategies for driving optimal outcomes in a wide range of political and economic climates. They’ve survived (and even thrived) amid periods of market chaos, and proven their resiliency time and again. That experience will serve them well in the years ahead, but it doesn’t minimize the problems at hand. And for most of these firms, the biggest problem today is one of misplaced focus.

By and large, the eventual outcome that most established oil and gas companies are seeking is a hybrid portfolio of hydrocarbons and clean energy. They see the complete elimination of hydrocarbons as a reality that future generations will have to contend with, so they’re not repurposing the “established” processes that have served them thus far to drive new innovation. They’re simply focused on meeting the near-term requirement of achieving carbon neutrality. Because they expect hydrocarbon production to remain a profitable enterprise, they see little reason to invest in clean energy solutions beyond what’s needed to net a zero-carbon footprint. After all, that’s what the general public wants.

This prevailing approach leaves little room for massive disruption in energy technology: the kind of disruption that could undermine the very foundation upon which legacy oil and gas companies operate. However, it also precludes the type of self-examination that could result in groundbreaking discoveries that allow these companies to lead the world into the zero-carbon future instead of reluctantly following. Today’s challenges also present massive opportunities, and by augmenting their proven processes with new core competencies, industry leaders could break into new markets beyond hydrocarbon and energy generation.

But their focus is on energy.

Redefining resiliency

Oil and gas companies that choose to remain focused on energy can and will find success. However, it won’t be the same level of success that they’ve enjoyed in decades past, and it won’t be sustainable for decades to come. In short, they won’t be truly resilient enterprises.

In the modern business environment, resiliency isn’t about weathering the storm; it's about continual evolution. Resilient companies don’t merely overcome the challenges they face today; they anticipate and plan for the challenges of tomorrow, upending existing markets or creating entirely new ones. Resiliency is an intense focus on achieving an optimal future state, which is simply not what oil and gas companies are prioritizing. Instead, they’re merely reacting to market pressures to solve the climate change problem and pursuing incremental change. And who could blame them? The energy future is uncertain. What is certain are the current expectations of the market toward climate change response and that the world still relies on more than 50% of its energy from hydrocarbons.

If oil and gas companies hope to exist in a world without hydrocarbons, they must now take dramatic steps toward creating that world. That means looking beyond incremental change to find entirely new, completely sustainable business models. Yes, many have no choice but to keep a large portion of their resources deployed toward the existing models that enable them to operate. Those that have recognized the need to offset their carbon footprint must also continue to allocate resources to clean energy and carbon sequestration solutions. But they can’t let these obligations hamper their resiliency. Without implementing initiatives aimed at proactive transformation, the proverbial profit ceiling for these companies is low, and the floor is underground.

It’s perhaps telling that some firms seem to think they’ve already transformed. They’ve ditched the oil and gas label and now call themselves energy companies. It’s quite possible that this external rebrand is shaping the way they view their future existence. If so, it’s blinding them to the opportunities just ahead.

The future will require large-scale capital projects to support the enhanced electrification of our grid to meet the increasing demands of energy, city relocation as oceans rise and displace millions, new city construction as metropolitan areas redefine population centers built around autonomous machines and green infrastructure, and supporting the growth of emerging markets such as Africa that have massive untapped potential to drive exponential growth and development.

So how can industry leaders develop proactive strategies that ensure near-term profitability while leading the charge in the energy transition, while also spearheading the projects needed to protect the masses from a changing climate? The following four principles might help guide them:

1. The energy transition simply demands a response to the carbon footprint situation. Any of the three approaches mentioned above must embrace, to some degree, the call to reduce or eliminate the carbon footprint. Capital markets will increasingly seek greener investment opportunities to meet growing demand. As such, it’s critical that oil and gas companies continue investing in carbon footprint reduction and the technologies and processes required to achieve it. They should also remember that green energy markets will (perhaps quickly) become saturated, limiting revenue upsides. Even though future demand will be much higher than it is today, a significant increase in competition, combined with more stringent regulations, will make it hard to drive growth by selling energy alone.

2. Objective self-evaluation can point to the best way forward. Again, to become truly resilient, established oil and gas firms must look beyond energy. That starts with evaluating core competencies through a neutral lens. Once companies have a firm grasp of what they do well, they should begin exploring other markets within the energy and climate transitions that might benefit from these competencies. Those markets will present new opportunities that aren't necessarily a stretch from existing business models, but these opportunities will require additional knowledge and capabilities. Leaders must set a road map for augmenting existing competencies and shedding systems and processes that could be a barrier to success in target markets. This is a multidecade strategy, as differentiating core competencies could take years to build. Thus, the time to start implementing it is now.

3. The world will rally around a good idea. It’s not easy to envision a rapid worldwide movement away from hydrocarbons, given the integral role they play across industries. However, governments and corporations are steadily allocating more resources to combat climate change and with greater urgency than ever before. Moreover, the younger generations entering the workforce have demonstrated a passion for environmental protection, and they’ll increasingly have the means to act on it. There is also a growing chorus of voices, including notable thought leaders like Tim O’Reilly, calling for massive investment in clean energy technology and suggesting that a meaningful reduction in our dependency on hydrocarbons could be achieved much sooner than the 30-year time horizon many predict. Such an aggressive outcome might be unlikely, but given the continual uptick in resource deployment, it’s certainly not a pipe dream. Oil and gas companies must make time for scenario planning and must build in-depth response models to various levels of disruption velocity. These exercises will both inform and be driven by the strategies firms adopt for exploring and entering new markets, and can be conducted nearly simultaneously. Oil and gas companies must also look beyond their own walls as they plan for the future. This is a massive problem space best solved in partnership with governments, academia, finance, existing value chains and the private sector.

4. Talent powers performance. Oil and gas companies have historically offered highly competitive compensation and benefits packages as a means of offsetting the volatility of the industry. Oftentimes, they could do this thanks to big commodity price swings that generated massive profits. Future spikes in hydrocarbon commodity prices are likely, given the industry’s ability to control supply, but long-term higher prices are not. Firms that have assets that are historically cheap to produce will have opportunities to thrive, but that won’t be the case for all operators. Differentiation through compensation and benefits alone will inevitably become more difficult to achieve. Companies must think carefully about the corporate culture they are building internally and the employer brand they’re presenting to the world. Having a purpose that the next generation of talent resonates with is critical. Innovation is driven by diversity, and oil and gas companies must strive toward greater diversity—not in culture alone, but in thought leadership for how the future will play out amidst multiple energy transitions and climate change.

In today’s society, personal brands matter. Younger candidates are deeply aware of how an employer’s purpose and image affect their own brand, and it’s possible that many young people don’t give the industry high marks in either category. A deliberate focus on positive change with respect to ESG initiatives is quite simply a requirement for companies hoping to attract the talent they’ll need to compete in the future.

Focus has been lacking in the industry of late. It's time for that to change.

Alan Henson is a principal at Pariveda Solutions, a consulting firm driven to create innovative, growth-oriented, and people-first solutions. He has two decades of diverse experience in technology, including leading operations for an international software company, handling software development projects and delivering implementation solutions for emerging technologies. Henson's many years of expertise allow him to map out comprehensive, tech-based solutions to pressing problems.