Net-zero and climate pledges from oil companies are not the new normal; they are just a phase.

A good way to tell whether or not something is a trend in the business community is whether the idea being talked about would still be useful if sentiment shifted. If it turned out that everyone was suddenly not interested in fighting climate change, would net zero commitments still make business sense? If gender equity disappeared from everyone’s radar, would it still make financial sense to aim for parity in representation? In some cases, yes – gender parity helps bring new perspectives into a room that can add value to conversations, discuss strategy to target new markets and can genuinely improve long-term earnings. In some cases, probably not – net-zero commitments are expensive and for some companies, require writing down valuable assets. This is the challenge currently faced by oil companies. If they had it their way, climate change would be solved in a way that didn’t require the full transformation of their entire business model and supply chain. But decades of funding skepticism have resulted in the public perception that they’ve stood in the way of progress, and the calls for change have grown ever louder in our new era of increased climate ambition.

Non-state owned oil companies have responded to this in one of two ways: first, they simply say “the world needs oil so I’m going to produce it” and simply pursue a business-as-usual approach. Two, they take a more measured approach and make commitments that align with the level of international or domestic ambition. These commitments come in a cornucopia of flavours: some encompass only production, some have claimed they will take consumption of their products into account, and some have merely sought to have the lowest emissions intensity (GHGs per unit of production) they can rather than target their overall level of emissions. Some of these investments make practical business sense – reducing the emissions intensity of production means you use less energy and lower your costs of production. Some are likely to be rather expensive – there is not a model for what accounting for emissions from final consumption (which can be 85% of associated emissions) might cost, but it almost certainly doesn’t make business sense.

That’s because oil companies aren’t pledging to be held accountable because it makes business sense – they are trying to maintain their social license to operate (i.e. public support and approval by stakeholders and society) in a world that wants to use less of their core product. While it’s debatable what the emission impacts of going net-zero might be in practice, the strategy has certainly proven popular with politicians – world leaders are clamouring to argue that a net-zero oil company should be allowed to operate into the future because their claim aligns with domestic emissions commitments (and avoids the messy process of being held accountable for lost jobs or natural disasters). This has motivated projects seeking regulatory approval to clamour in their climate ambition and created an odd wave of fossil fuel leadership amongst climate pledgers. But the question of whether or not this is a trend or the new normal still remains. However, in this case, the design of the oil market is likely to cause this movement of claims to prove temporary.

To understand why the market will impede this process from working out, it helps to compare the world’s most traded liquid commodity (oil) with the world’s second most traded liquid commodity – coffee. When each of us purchase coffee, we do so from a variety of options. We can select roast type, style of production, volume and roast location. The market allows us to differentiate by product type – luxury production processes or brands can charge a premium for their products that is aligned with consumer demand. This also allows for sustainability and social initiatives that charge their own premium – such as fair trade certification – to be compensated for “doing the right thing”. In other words: their social license efforts make business sense because people are willing to pay more for their products and they can realize these returns. It’s called the “sustainability premium” effect, and studies have shown consumers are willing to pay 10%-25% more for products that align with their environmental views. Coffee as a commodity can pull this off because products sold to consumers are differentiated based on these categories.

Oil, on the other hand, is not. Oil is an input product for a range of products like gasoline and plastics. Oil is also priced globally on commodity markets as a non-differentiated product – that means that regardless of source or origin, a barrel of oil trades for the same price all over the world (there are regional price differentials based the costs of shipping or producing a product but these impact production costs and profits, not revenues per barrel). The market does not differentiate between production process or inputs – this means that there is no compensation mechanism for products that cost more to produce for environmental or social reasons. If it costs more to do, they simply take home less. Another factor is that oil isn’t sold to consumers directly – it’s a supply chain input for a range of products. Petrochemical producers, plastics manufacturers and refineries are subject to the whims of the market as well – their returns are also based off oil. This means that, in most cases, it wouldn’t be possible to differentiate based on carbon-content. Producers who make net zero claims and expand their ambition can’t be rewarded for it by the market. Eventually, this means that interest will wane in the idea and the public argument for “net-zero oil” will dissipate as more companies simply claim they have a fiduciary responsibility and can’t afford the costs of going net-zero if it isn’t compensated.

The fix for this is, simply put, to allow for premium charges for product differentiation. Oil companies who pledge to be net-zero in their production process and are vertically integrated could begin to market (and charge a higher price) for lower-carbon gasoline at their fill-up stations. Petrochemical and plastics producers could pledge to create low-carbon plastics and prioritize products based on the emissions intensity of supply chains, allowing low-carbon oil to receive its price premium if consumers are willing to pay more for the lower-carbon goods it produces. Other methods of transparency, including publishing environmental assessments of production processes, putting carbon labels on consumers products and mandating minimum carbon standards for supply chains, could also be effective. This would allow for consumers and intermediaries to differentiate between product types and genuinely receive a premium for “environmentally or socially good” oil. In theory, a carbon price is meant to achieve this by forcing more emissions-intensive producers to pay more (thereby making “greener” oil less expensive) but schemes contain enough exemptions for oil producers that they don’t genuinely impose a transformative price signal. They can’t pay full price or they’ll go out of business – unless their oil can be bought at a “sustainability premium”, in which case they could be compensated for making these investments.

The flip side of this coin is that even with these major changes, “green oil’s” days are numbered. Any of these actions would make it abundantly clear to consumers and investors just how risk-exposed oil companies really were relative to their peers, and would dramatically lower the barriers to entry for disruptive product alternatives. That is a net good for society and the environment – more transparency means the market can start to value lower-carbon solutions more and the innovation/efficiency engine that is capitalism can begin to create the exponential change needed to transform the economy. It would also give oil companies a boost in the short-term while other products were developed. But if these changes don’t take place – don’t expect the era of the net-zero oil company to endure. The oil companies that survive will be the ones that transform away from the oil sector entirely and pivot into new industries and business models. Net zero oil doesn’t make business sense – and in an era of shifting markets and sentiments, it’s important to understand the difference between virtue signalling and smart strategy.