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Before the coronavirus pandemic, Big Oil was under significant pressure to speed up their transitions to cleaner forms of energy — from politicians, financiers and climate activists alike.
This pressure may have receded from view amid Covid-19 lock downs and massive slumps in oil prices, but there is no reason it will diminish.
After all, the fears of “stranded assets” are only going to keep growing if the oil price — which has fallen by almost two thirds on the benchmark WTI index this year — remains at historic lows, reducing margins and making many oil fields uneconomic to exploit.
While mainly European oil players, such as Total, Shell, BP, Repsol and Equinor have begun to take the climate threat seriously, the US sector — exemplified by Exxon Mobil and Chevron — has continued its relentless focus on oil & gas production, having access to significantly higher reserves and coming under far less political pressure to change tack.
The investments of the European oil majors have encompassed almost every aspect of the power value chain (aside from the regulated grid sector), with a central focus on large capital-intensive projects in offshore/onshore wind and solar. They are also actively looking into clean hydrogen (both green and blue) to safeguard their ability to sell fuels for heating and transport over the long term and help fend off competition from heat pumps and electric vehicles (EVs).
However, they are still only spending 5-10% of their total annual capital expenditure on non-hydrocarbon investments (even if this is still significantly higher than the global industry average).
As a general point, it seems that the European oil companies are still undecided on the right business models in the power market, leading to speculation that major international utilities such as Iberdrola, Enel, Engie or RWE could be candidates for acquisition by the oil majors. Such a move would transform an oil company’s green credentials and long-term future overnight.
And despite the recent collapses in the value of the hydrocarbon multinationals — for instance, Shell’s market capitalization has fallen from $240bn to under $100bn this year ¬— they are still far richer than the likes of RWE, which is currently valued at about $14bn. So acquisitions are still very much on the cards.
Rates of return
While Big Oil favors huge renewable projects with large potential yields, the internal rates of return (IRR) on renewable projects tend to be significantly lower than oil & gas investments — an average of 5-10% compared to around 15-20%. And shareholders clearly appreciate the large profit margins and the attractive dividends such IRRs produce.
When the new BP chief executive Bernard Looney announced that the company would strive to reach net-zero emissions by 2050, he promised to maintain shareholder payouts throughout its decades-long transition.
But this will be difficult to achieve in practice.
To some extent, shareholders will have to accept lower returns as the current IRR levels might be the end of a golden era — similar to the dominance of conventional power generation until around 2010. However, these returns will be more stable if associated with feed-in tariffs or Contracts for Difference, and may provide significant upsides as variable renewable replace base load coal and nuclear plants — increasing wholesale market volatility, which will open up opportunities for the oil majors’ experienced trading departments.
The increased participation of Big Oil in the renewable sector should be positive for both industries.
The scale of investments required to implement the energy transition will be enormous and the oil majors are still financially strong, even when taking into account their recent falls in market capitalization.
Increased investment into the sector could speed up the build-out of wind and solar and related sectors (such as energy storage, green hydrogen and EV smart charging), while the financial strength of the oil companies will allow more power-purchase agreements to be signed, making more projects bankable in the subsidy-free era.
This does not mean that the oil sector will necessarily be able to undercut developers, including utilities, and push them out of the market. Big Oil is unlikely to be interested in the kinds of projects undertaken by most specialist wind and solar developers — which will simply be too small to be interesting to giant companies used to multi-billion-dollar investments.
Plus, local knowledge and connections are hugely beneficial for project development — connections with local stakeholders, permitting authorities, suppliers and contractors can make the difference between projects moving forward at speed or languishing for years.
Having said that, some oil companies have been buying up shares in developers with local knowledge, which can help the oil companies gain experience in wind and solar project development, while also helping these developers access lower-cost loans that reduce the levelized cost of energy and could put them at an advantage in auction situations.
This may well be the oil majors’ chosen route into green energy — purchasing small to medium-sized developers, while providing financial means, trading and risk-management expertise.
Big Oil therefore can become an important player in the energy transition — especially if they buy major renewable-led utilities.
But the challenge will be to take their shareholders with them. Any chief executive that reduces their company’s share price and shareholder dividends might struggle to hang on to their jobs.
The key will be to convince the ever-shrinking band of hydrocarbon investors that the good days are coming to an end, and the planet must take priority over profits.
Then their energy transition can gather speed and play a vital part in the fight against climate change.
