The energy transition and the fossil fuel industry

We live in fascinating times. Ed Crooks and Kiran Stacey write a good article in the Financial Times about how fossil fuel companies are adapting to the new world.

 

Big Oil: From black to green

In 2014 Joe Mocniak joined a growing number of his neighbours in the New York suburb of Massapequa and had solar panels fitted to the roof of his house. He is one of more than 1m American homeowners and businesses that have installed the panels, encouraged by tax breaks and falling costs.

Mr Mocniak has gone solar to provide back-up power in a blackout, and to cut his electricity bills in half. Helping the environment was an incidental benefit.

“The greenness of it offsets some of my gas-guzzling vehicles,” he says.

He did not know it, but the same company could be behind both the panels on his roof and the fuel in his tank. The panels are made by SunPower, a US solar company that is controlled by one of the world’s largest oil groups, Total of France. It took a majority stake in SunPower in 2011 for about $1.4bn, making the biggest bet on renewable energy by any of the large oil and gas companies.

The move was one answer to the growing threat that many analysts, investors and executives now see facing the oil and gas industry: the prospect of a long-term transition away from fossil fuels and towards renewable energy.

Total has been more enthusiastic about embracing that shift than many of its peers. Along with the other large international oil companies, including ExxonMobil, Royal Dutch Shell, Chevron and BP, it is facing a critical choice. Do they diversify into wind and solar power to compete in a world of tightening curbs on greenhouse gas emissions and increasingly competitive renewable energy and storage? Or do they stick to oil and gas, knowing the world will continue to need fossil fuels for decades to come? Their decisions will shape the future of the industry, of energy supplies and of the climate.

Lord Browne, the former chief executive of BP who took it into renewable energy and launched the “beyond petroleum” marketing campaign, says the oil industry should learn from the fate of the US coal companies driven into bankruptcy.

“Great companies do go into difficult times when they have a product that people don’t want,” he says. “If society is saying it is time to change the mix, I do think the big oils should be involved in the change.”

The Paris climate talks late last year showed a global consensus on the need to curb greenhouse gas emissions from fossil fuel use. Meanwhile, renewable energy has become more competitive as its cost has plummeted. In emerging economies such as Mexico, India, South Africa and the United Arab Emirates, which are driving the bulk of the growth in energy demand, wind and solar power developers are increasingly winning contracts without subsidies.

Value destruction

The short-term crisis for oil companies has been the slump in crude prices over the past couple of years, triggered by the US shale boom. In the longer term, the more fundamental challenge is a potential move away from oil that would hold down prices indefinitely.

Paul Spedding of the Climate Tracker Initiative, a think-tank that works on the financial risks of climate change, says investors can face large losses when companies invest in “stranded assets” that cannot be developed at a profit.

“That is the real risk climate change poses for the industry: over-investment, followed by oversupply, followed by value destruction via price,” he says.

At least in their rhetoric, there is a divide between US and European companies in their stance on climate change. BP, Shell, Total and Statoil of Norway signed a statement before the Paris talks saying they were “committed to playing our part” in keeping the rise in global temperatures below the internationally agreed limit of 2C.

The largest American oil groups, however, were not on that list. “We thought that Exxon and Chevron might sign up to things like this, but then do very little about it,” says one executive at a major European oil company. “But they haven’t even done that.”

The US companies do not deny that global warming is a threat. “We know the risks of climate change are real, and governments will and should take reasonable steps to address those risks,” says Bill Colton, vice-president of corporate strategic planning at Exxon. But he adds, “each government is limited in what it can do, and they might not go as far as some people would like”.

That means Exxon expects demand for fossil fuels can continue to grow. It projects that total world energy demand will grow by about 25 per cent in the next 25 years, compared to 59 per cent growth in the past 25, in part because climate policies will drive increased energy efficiency.

Even though overall energy demand growth is slowing, oil use can rise by 19 per cent by 2040 and gas use by 51 per cent. Not much sign of a disappearing market there.

Although renewables such as wind and solar are growing very fast, Exxon still thinks that by 2040, excluding hydro power, they will provide just 4 per cent of the world’s energy.

And while renewables might be a good business, Mr Colton says, they are not for Exxon, at least not now. Exxon is researching new energy technologies, including biofuels from genetically modified algae, but that is a long-range project. For the foreseeable future, it plans to stay focused on oil and gas.

“People sometimes say we should be in renewable energy. It’s like asking why GM isn’t in the aircraft business,” Mr Colton says. “Investors on Wall Street like the idea of companies sticking to what they are good at.”

While their public positioning has a greener tint, the European companies also argue they have a long future ahead of them in oil and gas.

Ben van Beurden, Shell’s chief executive, told a meeting of socially responsible investors in London recently: “Our assessment is that there will continue to be commercial opportunities for Shell in oil and gas for decades to come.”

Those fossil fuel revenues, he added, would provide a foundation “to position the company successfully for the energy transition to a lower-carbon system”.

Shell last month launched a New Energies division to invest in renewables, and has hit the headlines for its possible bid for a share of an upcoming offshore wind tender in the Netherlands. But even if it wins the right to build an entire wind farm there, its output will be modest compared to the oil and gas operations it acquired in its estimated £35bn takeover of BG Group.

Bob Dudley, BP’s chief executive, spoke in Washington last week about the company’s support for the Paris agreement and for a carbon price set by governments. Since Lord Browne left, though, much of the “beyond petroleum” strategy has been abandoned. BP pulled out of solar power and shut down its advanced biofuels research programme in 2014. It tried to sell its US wind operations, but gave up when it could not secure a good enough price.

One executive at a large international oil company says: “We do think it’s important to show we are changing the way we do business, especially in the wake of the Paris agreement. But has that agreement changed our capital allocation in the short term? Not really.”

Many companies say the key to success will be producing oil and gas at lower costs and with lower emissions than their competitors. If they can do that, they say, they can survive and thrive even if fossil fuel markets shrink. They also see big opportunities in a shift in power generation from coal to gas, which creates lower carbon dioxide emissions.

Oil companies have a long and inglorious history of diversification. For seven years to 1993, BP owned Purina Mills, the largest US animal feed supplier. Mobil owned Montgomery Ward, the US retail chain from the mid-1970s to 1988. Exxon had a big nuclear power business from 1969-86, and was a leader in solar power research in the 1970s and 1980s.

Looking at that history, Mr Spedding agrees with Exxon: oil groups should stick to what they know best. “Their efforts in renewable energy have generally failed, in part because they don’t really believe in it, and they haven’t brought in the right expertise,” he says.

Instead, he thinks the industry should follow tobacco companies and focus on returning capital to investors through share buybacks and special dividends.

Profitability breakthrough

However, Jules Kortenhorst, a former Shell executive who leads the Rocky Mountain Institute, an environmental group, argues that the industry is different now. “Every time in the past, renewable energy was a subsidy-dependent business where in the end the path to making money was not clear,” he says. “Now wind and solar can be profitable.”

A few European companies are starting to embrace that argument. Statoil is developing its business in offshore wind, doubling its investment in the past year.

Bjorn Otto Sverdrup, Statoil’s senior vice-president for sustainability, told a Financial Times conference this month that it was “shifting from being a mainly oil and gas company towards being much further into renewables”.

Total is the most ambitious of the large oil companies. As well as controlling SunPower, it agreed in May to pay $1.1bn for Saft, a battery company, and this month signed a $224m deal to buy Lampiris, a Belgian supplier of gas and renewable energy.

The company says it would still principally be an oil and gas company in 2035 but Patrick Pouyanné, its chief executive, says he wants 20 per cent of its assets in low-carbon energy by then.

Tom Werner, SunPower’s chief executive, describes Mr Pouyanné as “a hands-on guy” in his interest in the solar business, and says the relationship with Total has been valuable in winning contracts. “This isn’t rhetoric or advertising: it’s very real business,” he says. “It’s not greenwashing: it’s the opposite of that. It’s about making your numbers.”

Total’s model of allowing SunPower autonomy helps avoid the culture clashes that have hampered oil companies’ efforts in renewable energy, but the investment is still a gamble.

Philip Lambert, an energy banker who leads Lambert Energy Advisory, warns that the pressure for the industry to cut back investment in oil and gas means it is “sleepwalking towards disaster”. If companies hold back future supplies because they are “scared off” by concerns about climate change, he says, the result could be soaring prices a few years from now with renewable energy unable to meet the demand for reliable, affordable power.

But there are also risks on the other side. Oil companies that do not invest in renewable energy are betting that technology does not take a leap forward that wipes out their core business.

They are betting, too, that the pressure for governments to take action on climate will continue to be tempered by the need to secure reliable and affordable energy supplies. If they are wrong and worries about global warming come to be seen as urgent, oil companies and their investors will not be the only losers. But they could be among those affected soonest, and most sharply.

“Periods of transformation create winners and losers,” says Statoil’s Mr Sverdrup. “We believe we are in a strong position to be a winner in that process.”

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Using hydrocarbon profits to invest in cleaner power

The idea of a fossil fuel company turning itself into a renewable power giant might sound fanciful but it is already happening at Dong Energy, Denmark’s largest energy group.

The company owes its very name to oil, having grown out of a 1970s state-owned group called Danish Oil and Natural Gas. It still has oil and gas platforms in the North Sea, along with a mix of power generation and energy sales businesses. But over the past eight years it has made a striking shift to renewables and is now the world’s largest offshore wind farm group, with a 26 per cent share of global capacity.

Dong’s oil and gas business still provided nearly 18 per cent of revenues in 2015 but the company is not looking to replace its long-term reserves or invest in new projects. Instead, the oil and gas division is being run to generate cash for Dong’s expanding green ventures. Three-quarters of its capital is tied up with wind power, compared with less than a tenth going to oil and gas.

“The one megatrend really driving the sector is the transformation from black to green,” says Dong’s chief executive, Henrik Poulsen.

Whether Dong could be a model for its much larger and less diverse rivals is unclear. There is also the issue of state control: Denmark’s government still owns 50.1 per cent after the company’s listing this month. This has meant Dong had to please Danish politicians on both sides of the renewables debate, says Jens Houe Thomsen, an analyst at Denmark’s Jyske Bank.

As a result, Dong spread into a sometimes baffling array of energy businesses. “If you had let them into a casino they would have probably put a bet on every number in order to win,” says Mr Thomsen. But this also helped it withstand falling oil prices and expand in wind power as government support for that industry grew. “They moved from a very diversified philosophy into a very focused one at the right point in time,” he says.

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